<PAGE>

================================================================================
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC 20549

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

                                   FORM 10-K

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

                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

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

                  For the fiscal year ended December 29, 2001

                                      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)

<TABLE>
<CAPTION>
                        MASSACHUSETTS                                     04-3035323
<S>                                                            <C>
(State or other jurisdiction of incorporation or organization) (IRS Employer Identification No.)
           5 FORBES ROAD, LEXINGTON, MASSACHUSETTS                           02421
           (Address of principal executive offices)                       (Zip Code)
</TABLE>

       Registrant's telephone number including area code: (781) 861-2069

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

<TABLE>
<CAPTION>
         Title of Each Class      Name of Each Exchange on Which Registered
         -------------------      -----------------------------------------
     <S>                          <C>
     Common Stock, $.01 Par Value          American Stock Exchange
</TABLE>

================================================================================

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

   Indicate by check mark if disclosure of delinquent filers in response to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  [_]

   As of March 15, 2002, there were 9,951,018 outstanding shares of common
stock. The aggregate market value of shares of common stock held by
non-affiliates of the registrant on that date, based on the last sale price for
such stock on that date as reported by the American Stock Exchange, was $2.88.

                      DOCUMENTS INCORPORATED BY REFERENCE

   Portions of the Proxy Statement for the Special Meeting in Lieu of Annual
Meeting of Stockholders of the Company on June 14, 2002 are incorporated by
reference into Part III of this Report.
================================================================================

<PAGE>

                           PHOTOELECTRON CORPORATION

                        2001 ANNUAL REPORT ON FORM 10-K

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<CAPTION>
 Item                                                                                        Page
Number                                                                                      Number
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<C>    <S>                                                                                  <C>
                                              PART I

 1.    Business............................................................................    3

 2.    Properties..........................................................................   22

 3.    Legal Proceedings...................................................................   22

 4.    Submission of Matters to a Vote of Security Holders.................................   22


                                             PART II

 5.    Market for Registrant's Common Equity and Related Stockholder Matters...............   23

 6.    Selected Financial Data.............................................................   24

 7.    Management's Discussion and Analysis of Financial Condition and Results of Operation   25

 8.    Financial Statements and Supplementary Data.........................................   30

 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   30


                                             PART III

10.    Directors and Executive Officers of the Registrant..................................   31

11.    Executive Compensation..............................................................   31

12.    Security Ownership of Certain Beneficial Owners and Management......................   31

13.    Certain Relationships and Related Transactions......................................   31


                                             PART IV

14.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................   31
</TABLE>

                                      2

<PAGE>

           CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

   Certain statements contained in this report, 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, without
limitation, those referred to in this report, 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.

                                    PART I

Item 1.  Business.

Company Overview

   Photoelectron Corporation ("PeC" or the "Company") is a technology company
dedicated to developing, manufacturing and marketing miniature x-ray systems
for multiple market applications.

   Established in 1989, the Company initially focused on research and
development for the miniaturization of an x-ray system for cancer treatment.
PeC has since expanded its development efforts and is now creating and adapting
miniature x-ray systems for a variety of applications in healthcare and
non-healthcare related markets. The Company has established an intellectual
property portfolio of twenty-two (22) U.S. patents and has fourteen (14)
additional U.S. patents pending, all of which relate to the Company's core
technology and use of that technology.

   The Company's business strategy is to identify opportunities in which its
patented core technology can be used to gain access to new markets by means of
strategic alliances with industry leaders. This strategy allows PeC to foster
the development of multiple applications of its technology, while remaining
focused on its core expertise of developing, manufacturing and marketing
micro-adaptive x-ray systems. By joining with one or more industry leaders to
develop an x-ray system to satisfy the needs of a specific market, the Company
gains market and application expertise without having to internalize many of
the costs and organizational overhead necessary to support the specific
application. Leveraging the market expertise of these strategic relationships
allows the Company to rapidly bring the technology to new markets. The Company
plans to identify additional market opportunities that can both be linked to
the core technology and present the opportunity to access the market through a
strategic partner with application expertise and the sales and marketing
organization necessary to drive market acceptance.

   The Company is currently pursuing initiatives in the industrial and medical
markets with micro-adaptive x-ray systems designed for x-ray fluorescence
analysis, intravascular radiation therapy, brachytherapy, radiosurgery,
intra-operative radiation therapy, and instrumentation.

  X-Ray Fluorescence Analysis--LASER-X(TM)

   LASER-X is the Company's recently introduced x-ray system designed for x-ray
fluorescence analysis, a recognized method of measuring the atomic composition
of a material. The process involves irradiating a sample with x-rays and
analyzing the resulting radiation emitted by the sample. This procedure can be
used in a variety of applications, including environmental monitoring, testing
for lead in paints, analyzing alloys and geological samples, testing paints and
pigments in works of art, and identifying the atomic composition of artifacts.
Building on the Company's core technologies, LASER-X utilizes a miniature x-ray
source with high radiation output but low power requirements, thus making the
unit compatible with battery operation. As a result, LASER-X offers many of the
advantages of x-rays with the portability of a radioactive source. Among other

                                      3

<PAGE>

benefits, LASER-X significantly reduces the concern over radiation safety
relative to handling and disposal issues associated with radioactive materials.
The prototype of the LASER-X was announced in October 2000 and market
implementation has proceeded, with the shipment of the first product in the
first quarter of 2001. OEM relationships currently exist with multiple
independent suppliers of x-ray fluorescence systems. This rapid implementation
of the LASER-X program demonstrates the Company's business development process
of identifying market opportunities for the core technology and accessing the
market through strategic relationships with third parties.

  Intravascular Radiation Therapy - X-SEED(TM)

   X-SEED is currently being developed by PeC as a disposable miniature x-ray
source for intravascular radiation therapy. The need for such a small x-ray
source stems from documented clinical research, which demonstrates that
radiation is effective in preventing restenosis (i.e., frequent postoperative
reclogging) of blood vessels following angioplasty and stent placement. X-SEED
uses a combination of lasers and high voltages to produce x-rays and is
designed to replace the small radioactive seeds currently used for
intravascular radiation therapy. As an alternative to the use of these
radioactive seeds which pose numerous clinical challenges for handling
radioactive materials and tracking them in the body, PeC's patented approach
for delivery of a miniature x-ray source is planned to be small enough to be
inserted into a blood vessel in a catheter and emit no radiation except when
activated.

   In February 2001, PeC announced a strategic relationship with Cordis
Corporation ("Cordis"), a Johnson & Johnson company, to co-develop and
co-manufacture an x-ray based system for the delivery of intravascular
radiation therapy. Cordis, a world leader in intravascular technology focused
on therapeutic solutions, will exclusively market and sell the x-ray based
system incorporating X-SEED in the field of intravascular radiation therapy on
behalf of the two companies. A co-development program was initiated in early
2001 and the product is currently under development.

  Brachytherapy--X-SEED(TM)

   With some modifications to the X-SEED intravascular product, the Company
believes that the X-SEED technology has a potential use for brachytherapy.
Brachytherapy is a cancer therapy process that involves the placement of
radiation sources inside tumor tissue in order to destroy tumor cells. The
small dimensions of X-SEED may make it a potentially effective replacement for
the radiation sources currently used in performing brachytherapy for cancer
treatment in such body areas as the prostate, esophagus and breast. The Company
is currently developing this application of the X-SEED and evaluating potential
strategic relationships with third parties.

  Intra-Operative Radiation Therapy Cancer Treatments--PRS400 technology

   The Photon Radiosurgery System (the "PRS") was the first treatment system to
incorporate the Company's micro-adaptive x-ray system technology, the
PRS400(TM) system (the "PRS400" or the "PRS400 system"). The PRS400 was
initially developed for the treatment of brain tumors using radiosurgery. The
PRS400 enables the tip of the miniature x-ray source to be accurately inserted
into the center of brain tumors to destroy the tumors from the inside. To
access the neurosurgical market, the Company entered into a strategic
arrangement with Carl Zeiss Oberkochen ("Carl Zeiss"), an international
technology leader located in Oberkochen, Germany whose medical systems division
specializes in high technology equipment such as surgical microscopes for
various medical disciplines. In 1998, the Food and Drug Administration (the
"FDA") gave market clearance under Section 510(k) of the Federal Food, Drug and
Cosmetic Act, as amended (the "FDC Act"), for intracranial treatment of tumors
with the PRS400.

   Building on the PRS400 system, the Company recognized further market
opportunity for the technology to deliver intra-operative radiation therapy
("IORT"). IORT involves the delivery of radiation therapy to a tumor

                                      4

<PAGE>

cavity, immediately following surgical resection of the tumor in order to
reduce the likelihood of tumor recurrence. This technique had been used on
thousands of patients throughout the world with very encouraging results, but
until recently, logistical considerations in connection with available
radiation-source technology have prevented its widespread adoption. In response
to this market need, the Company developed the INTRABEAM(TM) system
("INTRABEAM"), which combines the PRS400 technology with a sophisticated,
counterbalanced surgical support stand co-developed with Zeiss and a set of
specially designed applicators, to enable the use of the PRS400 miniature x-ray
source at any body site and form a significant new tool for IORT. The
portability of the INTRABEAM enables its use in virtually any operating room.
Radiation treatments can now be delivered to the inside of a tumor cavity while
the patient is still in the operating room, potentially reducing the likelihood
of the re-growth of a tumor.

   The Company has received FDA Section 510(k) market clearance to use the
PRS400 for the treatment of tumors anywhere in the body. The INTRABEAM has been
used to deliver treatments for breast, colo-rectal and vaginal cancer, as well
as brain tumors and skin lesions. Its role in routine radiation therapy
treatments is becoming established at centers throughout the United States,
Europe and Australasia. On-going clinical trials, such as the "TARGIT" breast
cancer trial in the United Kingdom as well as the Australasian based "TROG"
(Trans-Tasmin Radiation Oncology Group) trial for breast cancer, may
significantly improve the way in which radiation therapy treatments are
delivered. The goal of these trials is to confirm that for some patients the
standard six-week course of radiation therapy may not be necessary and could be
replaced by a single radiation treatment delivered intra-operatively using the
INTRABEAM.

  Instrumentation

   As a result of its extensive work developing miniature x-ray systems, the
Company has developed high-precision radiation measurement tools that provide
information about the radiation dose surrounding small radiation sources. PeC's
measurement products have gained acceptance by scientific groups, including the
U.S. National Institute of Standards ("NIST"), as the standard tool for
measuring the relative dose distribution around High Dose Rate ("HDR")
brachytherapy sources (sources used for cancer treatments). Beta-test versions
of these products have been installed at several hospitals and manufacturing
facilities, where they are used to measure a variety of small radioactive
sources. The product is expected to be available for sale in 2002.

Product, Market and Technology Overview

X-Ray Fluorescence Analysis--LASER-X(TM)

  Market

   The x-ray fluorescence ("XRF") market is comprised of many diverse
applications served by a number of independent x-ray fluorescence system
suppliers, most of whose technologies are based on radioactive isotope sources
that pose challenges in terms of portability, storage and disposal. XRF system
suppliers generally focus on specific market applications such as environmental
monitoring, testing lead in paints, analyzing alloys and geological samples,
testing paints and pigments in works of art, and identifying the atomic
composition of artifacts.

   LASER-X is an OEM replacement for radioactive isotope sources currently used
in the market and is applicable for the broad range of applications currently
performing analysis using XRF. This versatile system can be configured to fit
into many of the small desktop and hand-held XRF units currently on the market.
As described below, LASER-X combines the advantages of x-rays with the
portability of a radioactive source.

   LASER-X has the potential to be included in the thousands of portable XRF
units produced each year and placed for use within the broad range of
applications discussed above. LASER-X also provides the opportunity to be
retrofitted into the existing installed base of hand-held XRF systems in the
field. LASER-X may also be of value in the future for other applications such
as product security and manufacturing quality assurance.

                                      5

<PAGE>

  Technology

   LASER-X combines the many advantages of x-rays with the portability of a
radioactive source. LASER-X utilizes a miniature x-ray source with high
radiation output but low power requirements, thus making the unit compatible
with battery operation. The x-ray tube utilizes PeC's patented and
patent-pending technology of configuring a laser to provide the heating effect
necessary for x-ray production, an approach based on the same principles used
in the Company's X-SEED product line. The use of a laser helps to ensure
minimal power consumption and optimum system performance. Among other benefits,
LASER-X significantly reduces the concern over radiation safety relative to
handling and disposal issues associated with radioactive materials. These are
particularly significant when it is necessary to take fluorescence systems out
of a laboratory setting, such as in environmental monitoring. Radioactive
materials also require replacement as they "decay," resulting in a need for
periodic source replacements to compensate for the reduction in the emitted
radiation intensity. Typically, source replacements are needed once every one
to two years and can cost thousands of dollars. The use of the LASER-X can
eliminate the need for regular replacement of radioactive materials and the
related common storage, handling and disposal problems.

   Prior to the introduction of the LASER-X, x-ray tubes similar to medium
sized diagnostic tubes used for medical and dental radiography provided the
only alternative to using radioactive materials. The radiation spectrum emitted
from such x-ray systems is broad enough to cover the range necessary for
analysis of most materials, thereby eliminating the need for multiple sources.
Although these x-ray systems have many practical and technical advantages over
radioactive materials, they tend to be large and suitable only for permanent
installation in a laboratory environment. PeC's new LASER-X miniature x-ray
source is small enough to fit easily into portable hand-held x-ray fluorescence
systems and small desktop units. LASER-X retains the advantages of x-rays over
radioactive materials while providing the portability of a radioactive source.

   The Company believes LASER-X has several advantages over traditional
radioactive x-ray fluorescence units, including the following:

   . LASER-X can be turned off and will not emit radiation. In contrast,
     radioactive materials constantly emit radiation, which presents challenges
     in handling, storage and disposal.

   . LASER-X provides a consistently high-intensity beam of x-rays. The
     radioactive materials used for x-ray fluorescence often provide a lower
     intensity beam, which will decay with time as the source itself decays.

   . LASER-X eliminates the need for radioactive isotope source replacement.

   . The range of radiation energy emitted by a single LASER-X system compares
     favorably with the limited range of energy emitted by a radioactive
     source. With conventional radiation technologies, it is often necessary
     for users to purchase multiple radioactive sources to achieve a comparable
     range of measurement requirements.

  Distribution

   To best serve the diverse x-ray fluorescence market, the Company has
positioned itself as an independent OEM supplier of LASER-X systems to
companies manufacturing fluorescence measurement units. The Company currently
has established OEM relationships with multiple suppliers of XRF systems and is
actively pursuing additional relationships.

  Status

   The prototype of the LASER-X was announced in October 2000. The first
commercial units were shipped in the first quarter of 2001. The product is
currently in full production and the Company is actively exploring additional
OEM relationships to expand the market opportunity for this technology.

                                      6

<PAGE>

Intravascular Radiation Therapy--X-SEED(TM)

  Market

   Intravascular radiation is a treatment that has emerged as an effective
therapeutic approach that promises to improve the lives of patients who suffer
from re-narrowing (restenosis) of their coronary arteries after angioplasty and
stent placement. Intravascular radiation therapy is currently performed by
temporarily inserting radiation-emitting sources into an artery through a
minimally invasive catheter. The radiation affects the cells of blood vessels
in a way that helps prevent reclosure of the artery after angioplasty. The
therapy has been shown to reduce the incidence of restenosis after balloon
angioplasty, allowing patients to live healthier lives and avoid the serious
complications that often require rehospitalization and follow-up surgery. The
New England Journal of Medicine reported in their January 25, 2001 edition
that, "findings from two preliminary randomized, double-blind clinical trials
from single centers have demonstrated a reduction of more than 50% in the
incidence of clinical and angio-graphic restenosis with radiation therapy as
compared with placebo."

   PeC is using its patented approach of miniaturization to develop an x-ray
source that is both small enough to be inserted into a blood vessel and free
from the clinical precautions and tracking and handling challenges necessitated
by radioactive seeds.

   The market for this technology is significant:

   . An estimated 1.4 million stent placements are estimated to be performed
     worldwide in 2002, and that number is expected to grow to 2 million by
     2005.

   . Restenosis occurs in approximately 20-30% of all stent placements.

   . An estimated 400,000 - 600,000 patients per year will require
     intravascular radiation therapy by 2005.

   Several companies have invested heavily in producing systems that introduce
radioactive materials into the blood vessels at the time of angioplasty to
deliver an appropriate dose of radiation. However, the application of such
systems may well be restricted as a result of the problems associated with
handling radioactive materials in a clinical environment and placing them
inside patients. An x-ray catheter, such as the one PeC is developing, would
have no such problems since the catheter would only produce radiation when the
device was activated. It is therefore expected that the clinical technique
would be opened up to many more users than had previously been anticipated.

   Alternative technologies for the treatment of restenosis, such as
drug-eluting stents, are under development. Even if the drug-eluting stents are
as successful as early trials would seem to indicate, both the Company and
Cordis (which has developed its own drug-coated stent) believe that the use of
intravascular radiation to treat restenosis will continue to offer significant
market opportunities. For example, approximately 5.1 million stent procedures
were performed worldwide from 1995-2001 and restenosis is expected to occur in
approximately 20% of those patients. Currently, drug-eluding stents are not
being evaluated to treat in-stent restenosis in arteries that have already been
stented, and therefore these patients would be candidates for intravascular
radiation. Similar opportunities exist with respect to diffused or long lesions
or vessels under 2.5 millimeters in diameter.

  Technology

   In July 2000, PeC announced that it had produced X-SEED, a prototype of a
new system for delivering x-rays from inside blood vessels following an
operation for clogged arteries. Based on a concept of the Company's patented
and patent-pending technology, the x-ray source uses a combination of lasers,
fiber-optics, and high voltages to produce x-rays. The X-SEED miniature x-ray
system is completely self-contained and its key components are less than 1
millimeter in diameter. X-SEED is designed to be placed at the end of a fine,
flexible catheter, which will then be inserted inside blood vessels to deliver
a dose of radiation to the interior

                                      7

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surface. The dose is expected to be sufficient to prevent restenosis after
angioplasty or a stent procedure. The system incorporates many of the elements
from the PRS, enabling cost efficiency and rapid development.

   The Company believes X-SEED has several advantages over radioactive
materials including:

   . Elimination of universal environmental concerns over the handling,
     management and disposal of radioactive materials.

   . X-SEED is a controllable radiation source. No radiation remains after the
     source is turned off.

   . Controllable radiation output enables flexible treatment approaches.

   . There is increased market access to hospitals without facilities for
     handling radioactive materials.

   . Overall treatment costs are likely to be less than treatments involving
     radioactive materials, and therefore resource requirements are
     significantly reduced.

   The controllability of an x-ray source is a key technical advantage of x-ray
technology over radionuclide sources. The radiation output of an x-ray source
can be varied as the treatment is delivered making it possible to specifically
tailor the treatment to each patient. In addition, potentially higher radiation
output of x-ray sources (x-ray sources do not 'decay' like radioactive
materials) should lead to consistently shorter treatment times.

  Distribution

   In February 2001, the Company signed an agreement with Cordis, a Johnson &
Johnson Company, to co-develop and co-manufacture a disposable miniature x-ray
source, based on the Company's X-SEED and associated technology, for the
delivery of intravascular radiation therapy to prevent restenosis
(re-narrowing) of coronary arteries following angioplasty and stent procedures.
Cordis will supply the catheter technology in which the Company will
incorporate the X-SEED miniature x-ray system. Cordis is responsible for the
clinical trials and obtaining regulatory approval. Both companies will
manufacture components for the system, which will be co-labeled. Cordis has the
exclusive right to market, distribute and use the new system in the field of
intravascular radiation therapy. The Company has a non-exclusive right to use
and sell a pullback delivery device which is to be developed by Cordis under
the agreement. Certain components of the technology of the new system are owned
solely by Cordis and others are owned solely by the Company, and the technology
relating to the new system itself is owned jointly by Cordis and the Company.

   Co-incident with the agreement, Johnson & Johnson Development Corporation
("JJDC") purchased 904,762 shares of the Company's Common Stock for an
aggregate purchase price of $3.8 million. The proceeds from this equity
investment are assisting in the funding of additional development required for
the commercialization of X-SEED.

  Status

   The joint development program with Cordis is currently in process. Pending
regulatory approval, the Company expects to release a product to market within
the next 18 to 24 months.

Brachytherapy--X-SEED(TM)

  Market

   The X-SEED technology has the potential for brachytherapy with minimal
modifications from the intravascular product. Brachytherapy is a time tested
and safe method that allows physicians to treat cancer by placing a radiation
source inside a tumor to destroy tumor cells. The small dimensions of X-SEED
may make it a potentially effective replacement for the radioactive materials
currently used as radiation sources for brachytherapy.

                                      8

<PAGE>

   There is a significant market for brachytherapy products:

   . In 1999, an estimated 1,030 radiation oncology sites in the U.S. reported
     treating an estimated 64,000 patients with brachytherapy.

   . Each brachytherapy treatment utilizes multiple radiation sources.

   . There was a 62% increase in the U.S. from 1997 to 1999 in the volume of
     brachytherapy patients.

   . The American Cancer Society estimates that in 2002 there will be 189,000
     new cases of prostate cancer in the U.S., as well as 205,000 new cases of
     breast cancer; each a major cancer site suitable for brachytherapy.

  Technology

   Similar to the intravascular x-ray source, the x-ray source developed for
brachytherapy is likely to use a combination of lasers, fiber-optics, and high
voltages to produce x-rays, a concept based on the Company's patented and
patent-pending technology. The X-SEED miniature x-ray system is completely
self-contained and its key components are less than 1 millimeter in diameter.
The miniature x-ray source for brachytherapy is likely to be designed to be
placed at the end of a flexible catheter and inserted interstitially to deliver
a dose of radiation to the tumor tissue. The X-SEED brachytherapy system should
also incorporate many of the components of the intravascular version of X-SEED
and the PRS, enabling cost efficiency and rapid development.

   The Company believes X-SEED for brachytherapy will have several advantages
over the radioactive materials currently used such as:

   . X-SEED will be a controllable radiation source and no radiation emission
     will occur after the source is turned off.

   . X-SEED will produce low energy, high intensity radiation that will avoid
     the need for costly, shielded treatment rooms and reduce treatment times.

   . As an x-ray source, X-SEED will eliminate universal environmental concerns
     over radioactive material handling management and disposal.

   . X-SEED will produce a stable, predictable dose rate that will eliminate
     the need for decay corrections and the problem of intra-batch seed
     activity variation.

   . X-SEED will enable a variable dose rate from a single unit. This will
     enable a range of treatments to be delivered (High Dose Rate, Low Dose
     Rate and Pulsed Dose Rate) that currently require different treatment
     delivery units and different room configurations.

   . X-SEED does not need to be activated until its location in the patient has
     been confirmed, significantly reducing the problems of imprecise source
     placement and seed migration.

   . Overall treatment costs are likely to be less than treatments involving
     radioactive materials; resource requirements are, therefore, significantly
     reduced.

   A key technical advantage of x-ray technology as compared to radioactive
sources is the controllability of an x-ray source. The radiation output of an
x-ray source can be varied as the treatment is delivered, making it possible to
specifically tailor the treatment to each patient. In addition, potentially
higher radiation output of x-ray sources (x-ray sources do not 'decay' like
radioactive materials) should lead to consistently shorter treatment times.

   The brachytherapy application of the X-SEED miniature x-ray system will
require further exploration and development.

                                      9

<PAGE>

  Distribution and Status

   The Company is currently exploring development, sales, and marketing
alliances to support the opportunities in the brachytherapy market place.

PRS400(TM) Technology--Neuro-Oncology

  Market

   The PRS is the first treatment incorporating the PRS400 technology. The
first application of the Company's miniature x-ray source was used in the
treatment of brain tumors using radiosurgery. For this application, the
miniature source is attached to a "stereotactic frame," a form of guidance
system commonly used by neurosurgeons, which guides the radiation probe into
brain tumors for radiosurgery and IORT treatments. Once inserted into the brain
tumor, the miniature x-ray source destroys the tumor from the inside out, thus
protecting the healthy surrounding tissue. Due to the very localized radiation
dose patterns created by the system, the PRS400 system is particularly well
suited for the treatment of pediatric brain disease cancer. The PRS is
currently being used to treat both primary as well as metastatic brain tumors.

  Technology

   The key component of the PRS400 system is a miniature x-ray source designed
to be placed inside a tumor or the residual surgical cavity after tumor
removal. The x-ray source generates x-rays at the tip of a long, needle-like
probe that can be placed directly into the target area. The PRS400 system
produces low energy photons that are rapidly absorbed in the tissue immediately
surrounding the probe, minimizing irradiation of surrounding healthy body
tissue. The Company holds twenty-two (22) U.S. patents relating to the PRS400
system and all its associated technologies.

   A complete PRS400 system consists of (i) equipment for clinical use in
treating patients, principally consisting of the miniature x-ray source, its
electronic control box and a standard computer-based treatment system; (ii)
clinical quality assurance equipment for use in the operating room to verify
the accuracy of the treatment; and (iii) custom equipment for use in the
laboratory to calibrate the output of the probe. The PRS400 system is also sold
with various accessories, such as applicators to irradiate body cavities or
surfaces, and fixturing devices to support the x-ray probe during patient
treatment. The PRS400 system miniature x-ray source delivers radiation directly
to the tumor site from the tip of a minimally invasive, needle-like probe. Low
energy x-rays are emitted in a spherical distribution around the tip of a small
x-ray source. The system precisely controls x-ray production and enables
radiation treatments to be delivered directly to the inside of a tumor or tumor
cavity, minimizing unwanted irradiation to surrounding healthy tissue.

  Distribution

   In August 1999, the Company entered into a strategic relationship with Carl
Zeiss, an international technology leader whose medical systems division
specializes in high technology equipment such as surgical microscopes for
neurosurgery and other medical disciplines and state-of-the-art image-guided
surgery equipment. The Company appointed Carl Zeiss as its exclusive
distributor for the PRS throughout the world (except for Japan where Toshiba
Medical Systems Co., Ltd. is the Company's distributor of the PRS) for
intracranial applications and spinal radiation therapy and as the Company's
non-exclusive distributor for the PRS in the same territory for all other
clinical applications. In addition, Carl Zeiss agreed to assist the Company in
the development of new intra-operative radiation therapy products and to
provide service and support for the Company's PRS400 based products.

  Status

   The Company is actively working with Carl Zeiss to market the PRS400 system
for neurosurgery. As of December 29, 2001, the PRS400 system is installed at
sixteen (16) centers worldwide, including in the US:

                                      10

<PAGE>

Massachusetts General Hospital, Rhode Island Hospital--Hasbro Children's
Hospital, Cleveland Clinic Foundation, Children's Memorial Hospital--Chicago
and Our Lady of Mercy Medical Center--New York Medical College.

PRS400 Technology--Intra-Operative Radiation Therapy (IORT)

  Market

   The portability of the Company's PRS400 system miniature x-ray source and
INTRABEAM enables these technologies to be used in any operating room. This
reduces the logistical drawbacks involved in moving the patient to a radiation
therapy ward during surgery. Instead, radiation treatments are delivered to the
inside of a tumor cavity while the patient is still in the operating room,
potentially enhancing clinical outcomes. Consequently, INTRABEAM is now
considered to be an enabling technology for IORT. INTRABEAM has been used to
deliver treatments for breast, colo-rectal and vaginal cancer, as well as brain
tumors and skin lesions. Its role in routine radiation therapy treatments is
becoming established at centers in the United States, Europe and Australasia.

   The potential market for INTRABEAM is significant as the American Cancer
Society estimates that in the United States in 2002:

   . 205,000 new cases of invasive breast cancer will be diagnosed;

   . 107,000 new cases of colon cancer will be diagnosed; and

   . 41,000 new cases of rectal cancer will be diagnosed.

   In addition, major on-going clinical trials, such as the "TARGIT" breast
cancer trial in the United Kingdom and the "TROG" Australasian based trial for
breast cancer, may revolutionize the way in which radiation therapy treatments
are delivered by encouraging the use of IORT methodologies and the INTRABEAM in
particular.

  Technology

   INTRABEAM combines the PRS400 system miniature x-ray source with a
counterbalanced surgical support stand and a set of specially designed
applicators for the delivery of IORT treatment of any body site. The
applicators ensure a uniform radiation dose when the miniature x-ray source is
used inside a tumor cavity after the surgical resection of a tumor. In
September 1999, the Company received clearance under Section 510(k) of the FDC
Act for use of these applicators and for use of the PRS400 at any body site.

  Distribution

   The Company is actively marketing INTRABEAM in conjunction with Carl Zeiss
to leading clinicians in the field.

  Status

   Having obtained Section 510(k) market clearance from the FDA to market its
miniature x-ray source for use anywhere in the body, the Company has focused
its attention on the development of the tools and technology to expand the
range of accepted clinical applications. In general, these are technical
developments rather than clinical trials. However, there are certain clinical
on-going trials using the technology that could markedly expand the range of
accepted uses of the system.

   Major clinical trials, such as the "TARGIT" breast cancer trial at the
Middlesex Hospital, London in the United Kingdom as well as the "TROG"
Australasian based trial for breast cancer initially taking place at Sir

                                      11

<PAGE>

Charles Gairdner Hospital in Perth, Australia and The Peter MacCallum Cancer
Institute in Melbourne, Australia, may significantly improve the way in which
radiation therapy treatments are delivered. The University Clinic Mannheim
(University of Heidelberg) in Heidelberg, Germany as well as Our Lady of Mercy
Medical Center--the University Hospital of New York Medical College have also
agreed to actively participate in the international breast cancer trial and
have begun treating patients according to the study protocol. The goal of these
trials is to confirm that for some patients the standard six-week course of
radiation therapy may not be necessary and could be replaced by a single
radiation treatment delivered intra-operatively using the INTRABEAM. The time
taken to complete the trials will depend on the rate of patient accrual but it
may take several years to assess the trials. Several additional U.S. and
international hospitals have also expressed an interest in participating in
similar trials.

   In addition to the above clinical trials, treatment protocols are in place
at the Cleveland Clinic to treat colo-rectal cancer, and at Our Lady of Mercy
Medical Center--the University Hospital of New York Medical College to
routinely provide a boost radiation dose to the tumor bed following resection
of breast tumors. There are also active protocols to treat pediatric brain
tumors at Children's Memorial Hospital--Chicago as well as Rhode Island
Hospital--Hasbro Children's Hospital in Providence, Rhode Island. Other
applications for INTRABEAM include gynecological cancer and skin disease.

Patents and Proprietary Rights

   A U.S. patent directed to the base PRS400 system technology was issued to
the Company in October 1992. Two U.S. patents were issued to the Company in
1995 directed to shaped radiation patterns and electron beam steering. From
1994 through 1996, three U.S. patents directed to the use of the PRS to treat
brain tumors were issued to the Company. A U.S. patent directed to a flexible
probe PRS for endoscopic purposes was also issued to the Company in 1995.
Another U.S. patent was issued to the Company in 1996 for an apparatus for use
in x-ray dosimetry for the PRS. One U.S. patent issued in 1996, one U.S. patent
issued in 1997, and one pending U.S. patent application are directed to use of
the PRS to deliver x-rays to internal surfaces and adjoining regions of body
cavities, such as the bladder, esophagus, anal region, nasal orifice and
gynecological area. The Company was issued two other U.S. patents in 1997
relating to accessory equipment, including the Company's CCD microdensitometer.
As of February, 2002, the Company has ten (10) additional patents and thirteen
(13) additional pending U.S. patent applications, and has foreign patent
applications in selected foreign countries which correspond to certain of the
Company's U.S. patent applications.

Manufacturing

   The Company intends to continue its practice of sub-contracting the
fabrication of most of its electrical and mechanical components while
maintaining in-house responsibility for unit assembly and for manufacture of
certain proprietary components. The Company believes that this strategy can
serve to reduce administrative costs, facilitate supplier partnerships, and
reduce inventory requirements. In general, the Company's procurement strategy
is to keep the number of its suppliers to a minimum while identifying as many
multiple sources as possible. Due to the Company's current limited supply
needs, the Company acquires certain supplies from the same vendors. While the
Company intends to negotiate supply contracts with certain of its key suppliers
where appropriate, the Company currently procures its supplies through open
purchase orders. There can be no assurance that the Company's vendors will
continue to provide such supplies on terms acceptable to the Company, if at
all. In addition, the Company has sole-source suppliers for some of the PRS400
system parts. If the sole-source suppliers are unwilling or unable to provide
such parts to the Company, it could have a material adverse affect on the
ability of the Company to manufacture its products.

   The Company has implemented or intends to implement the necessary
operational systems to support the successful commercial production of the PRS,
INTRABEAM, LASER-X, X-SEED and any other products. Specifically, the Company
intends to continue to pursue or maintain full functional compliance with ISO
9001, EN46001, and the FDA's current Good Manufacturing Practices ("cGMP")
standards that govern, among other things, quality assurance, personnel
training, process control, customer service, design control, supply management
and facility and equipment maintenance.

                                      12

<PAGE>

Medical Advisory Board

   The Company's Medical Advisory Board consults with the Company's Board of
Directors and senior management from time to time as requested by the Company's
Board of Directors and as the schedules of the members of the Medical Advisory
Board permit. The members of the Medical Advisory Board may be employed on a
full-time basis by employers other than the Company. In addition, the members
have commitments to, or consulting, advisory or other contractual relationships
with, other third parties. These third party commitments and relationships
limit the availability of the Medical Advisory Board members to the Company,
and may potentially result in conflicts of interest.

   The following individuals currently serve as members of the Medical Advisory
Board:

<TABLE>
<S>                                 <C>
               Name                                       Position
               ----                                       --------
Nicholas T. Zervas, M.D. (Chairman) Distinguished Higgins Professor of Neurosurgery,
                                    Harvard Medical School, Boston, Massachusetts;
                                    Visiting Neurosurgeon, Massachusetts General
                                    Hospital, Boston, Massachusetts

Michael Baum, ChM. FRCS............ Professor of Surgery, The Institute of Surgical
                                    Studies, University College, London Medical School,
                                    London, England

Basil S. Hilaris, M.D., FACR....... Professor and Chairman of the Department of
                                    Radiation Oncology, Our Lady of Mercy Medical
                                    Center, New York Medical College, Bronx, New
                                    York

Christoph B. Ostertag, M.D......... Professor and Director of Department of Stereotactic
                                    Neurosurgery, Neurosurgical University Clinic,
                                    Albert-Ludwigs University, Freiburg, Germany

Kintomo Takakura, M.D., Ph.D....... Director of Neurosurgical Institute, President and
                                    Professor of Neurosurgery, Tokyo Women's Medical
                                    College, Tokyo, Japan

Jay S. Loeffler, M.D............... Professor of Radiation Oncology, Harvard Medical
                                    School; Chairman, Department of Radiation
                                    Oncology, Massachusetts General Hospital, Boston
                                    Massachusetts
</TABLE>

   The Company grants to each member of the Medical Advisory Board, with the
exception of Dr. Zervas, options to purchase 1,000 shares of the Company's
common stock for each full year that such member serves on the Medical Advisory
Board. The exercise price per share for options granted to Medical Advisory
Board members is the lesser of the fair market value of such share on August 1
and the subsequent July 31, or if the member joins after August 1, the lesser
of the fair market value of such share on the date the member joins and the
subsequent July 31. The Company is paying Dr. Zervas, the current Chairman of
the Medical Advisory Board, a stipend of $10,000 for each year that he serves
on the Medical Advisory Board. Each member also receives a fee of $1,000 per
regular or special Medical Advisory Board meeting attended in person (together
with reimbursement of reasonable travel expenses), and a fee of $500 per each
such Medical Advisory Board meeting participated in by means of conference
telephone arrangements.

Competition

   The medical and industrial device industry is highly competitive. The
Company believes that there are numerous universities, research institutions
and medical device, chemical and biotechnology companies that are engaged in
the development of cancer treatment and disease therapies. Many of these
entities have substantially

                                      13

<PAGE>

greater technical, financial and regulatory resources than the Company and may
be better equipped to develop, manufacture, and market their products.

   In order to achieve successful commercialization of the PRS and INTRABEAM,
the Company will need such products to compete with established radiation
therapy devices such as Linear Accelerators and the Gamma Knife(TM). In
addition the Company will need to compete with lesser known radiation therapies
such as proton beam treatment and brachytherapy. The Company is also aware of
various other cancer tumor treatment methods currently under development. Any
of these other treatment methods, if successfully developed, could have a
different approach or means of accomplishing the intended purposes of the
Company's product. As a result, one of these methods may render the Company's
technology non-competitive. While the Company believes that the PRS and
INTRABEAM offer certain therapeutic, operational, and economic advantages over
the cancer treatment methods likely to compete with them, there can be no
assurance that the Company will be able to compete successfully within this
highly competitive market.

   In order to achieve successful commercialization of the X-SEED, the Company
will need the X-SEED to compete with current radiation therapy devices that
utilize beta and gamma radioactive sources for intravascular radiation therapy.
In addition the Company will possibly need to compete with other manufacturers
of miniature x-ray sources. The Company is also aware of various other
intravascular treatment methods currently under development such as drug coated
stents. Any of these other treatment methods, if successfully developed, could
have a different approach or means of accomplishing the intended purposes of
the Company's product. As a result, one of these methods may render the
Company's technology non-competitive. While the Company believes that the
X-SEED offers certain therapeutic, operational, and economic advantages over
the treatment methods likely to compete with it, there can be no assurance that
the Company will be able to compete successfully within this highly competitive
market.

   In order to achieve successful commercialization of the LASER-X, the Company
will need the LASER-X to compete with radioactive isotope sources currently
used for industrial x-ray fluorescence applications. In addition the Company
will possibly need to compete with other manufacturers of miniature x-ray
sources for industrial applications. As a result, the Company's technology
could become non-competitive. While the Company believes that the LASER-X
offers certain operational and economic advantages over the currently used
radioactive isotope sources likely to compete with it, there can be no
assurance that the Company will be able to compete successfully within this
highly competitive market.

   The Company believes that its ability to compete in the marketplace will
depend on its technological advantages and the strength of its patent position,
its ability to complete clinical trials and to obtain regulatory approvals for
its products in a timely fashion, its success in developing and maintaining
collaborative relationships, its transition to commercial manufacturing and
marketing and its ability to achieve and maintain a superior cost structure
relative to other competitive treatments.

Government Regulation

  U.S.

   The PRS, INTRABEAM and X-SEED are subject to regulation in the United States
by the FDA. Manufacturers of medical devices must comply with applicable
provisions of the FDC Act, the Safe Medical Devices Act of 1990 (the "SMDA"),
the Modernization Act of 1997, and certain associated regulations governing the
safety, effectiveness, design, testing, manufacturing, labeling, marketing and
distribution of medical devices and the reporting of certain information after
initiating distribution. Both the FDC Act and the SMDA require certain
clearances from the FDA before medical devices, such as the PRS, INTRABEAM and
X-SEED, can be marketed. The Company intends to continue to pursue a strategy
intended to result in marketing clearance of products and components as quickly
as possible in order to maximize flexibility in marketing.

                                      14

<PAGE>

   As discussed above, in order to sell medical device products in the United
States, the FDC Act requires a manufacturer to obtain FDA approval. One method
for obtaining such approval is for a medical device manufacturer, if it intends
to introduce a device into commercial distribution which is similar to others
already being sold in the United States, to submit a pre-market notification
under Section 510(k) of the FDC Act. The Section 510(k) notification form must
be submitted to the FDA 90 days before marketing unless the device is exempt
from the 510(k) requirements. The notification must show that the device is
"substantially equivalent" to one or more devices which are already legally
marketed in the United States. According to the FDA, a Section 510(k)
application is required for modifications to an existing legally marketed
device if either of two conditions exist: (1) if the modifications could
significantly affect the safety or effectiveness of the device or (2) if the
device is to be marketed for a new or different indication.

   In July 1998, the FDA granted Section 510(k) marketing clearance for the
PRS400 system for use in the irradiation of intracranial tumors. In September
1999, the FDA granted Section 510(k) marketing clearance for the PRS400 system
for radiation treatments, without restriction to particular body sites, and the
Company also received clearance to utilize a range of applicators for use with
the PRS400 system in intraoperative radiotherapy. The Company believes that the
Section 510(k) market clearance for the PRS400 system can also be applied to
the INTRABEAM.

   The regulatory path for the Company's X-SEED, for use in intravascular
radiation therapy, will be determined in conjunction with the Company's
strategic partner, Cordis Corporation. Under the terms of the development
agreement, Cordis is responsible for regulatory submissions and the funding of
any clinical trials required for the approval of the device for intravascular
radiation therapy. The X-SEED is currently under development and the timing of
the regulatory filings have not been determined.

   In addition to the clearance and approval procedures described above, the
FDA also imposes various requirements on manufacturers and sellers of medical
devices under its jurisdiction, such as labeling, manufacturing practices,
record keeping and reporting requirements. Prior to selling a product, a
company's manufacturing operations need to comply with the FDA's cGMP
standards. The Company believes that the combination of its ISO9001
registration and satisfaction of the prerequisites for use of the CE Mark is
sufficient for the Company's PRS products to comply with the FDA's cGMP
standards.

   Even with key regulatory clearances and approvals obtained, such clearances
or approvals may be withdrawn or limited for non-compliance with regulatory
standards or the occurrence of unforeseen problems following the initial
clearance or approval (either of which could result in restrictions, including
withdrawal of the product from the market or sanctions or fines being imposed
on the Company).

   In addition, the Company may need to obtain export licenses from the U.S.
government in order to export products manufactured by the Company. Such
licenses may be required for equipment used in foreign clinical trials. The
Company has already been granted export licenses and corresponding foreign
import licenses for clinical trials in England, Japan, Australia, Germany and
Italy.

  Foreign Countries

   The Medical Device Directive (June 1993) sets forth the regulatory
requirements adopted by the European Union, pursuant to which "National
Competent Authorities" approve European commercialization of new medical
products through a procedure whereby both the products and the manufacturing
facilities must conform to well defined specifications.

   The transition period for the Medical Device Directive ended in June 1998
after the expiration of a five year transition period. All medical devices to
be marketed in any European Union country must first obtain a CE Mark. The CE
Mark is an international symbol of adherence to quality assurance standards.
Obtaining a CE Mark

                                      15

<PAGE>

with respect to a particular medical device requires the submission of
information that is similar in certain respects to that which is submitted to
the FDA in connection with a Section 510(k) notification. In order for the
Company to sell its products in Europe, it must comply with European Union
directives relating to manufacturing and quality assurance documentation under
the ISO 9000 series standards and to the performance, safety, and manufacture
and quality assurance of the particular device. The National Competent
Authorities have mandated Notified Bodies (non-governmental organizations) to
act as their agents and qualify equipment in accordance with European Community
("EC") standards. The Company engaged British Standards Institution ("BSI"), a
registered Notified Body, to certify its compliance with BS EN ISO9001:1994
(ISO9001) standards for a quality management system. BSI issued to the Company
a Certificate of Registration signifying compliance with the requirements of BS
EN ISO9001:1994 on September 22, 1997. Subsequently, the Company engaged BSI to
assess its compliance to Annex II Section 3 of the Medical Device Directive
(93/42/EEC), the applicable regulations pertaining to the design manufacture
and other aspects of medical devices intended to be distributed in the EC. On
May 13, 1998, BSI issued an EC-Certificate to the Company signifying its
compliance with requirements stipulated in Annex II Section 3 of the Medical
Device Directive. The Company is thereby able to affix the CE Mark to its PRS
products, including the INTRABEAM system, and to freely distribute them within
the EC and cooperating countries.

   Sales of medical devices within other jurisdictions outside the U.S. and
Europe are subject to regulatory requirements that vary widely from country to
country. The time required to obtain approval for sale in a foreign country may
be longer or shorter than that required for FDA approval, and the requirements
for obtaining such approvals may also be different.

Third Party Reimbursement

   The Company's ability to generate revenues from the manufacturing and
marketing of the PRS, INTRABEAM and X-SEED in the United States will depend in
large part upon whether they qualify for reimbursement from third party payors.
Such third party payors include, among other sources, private insurance
companies, self-insured employers, health maintenance organizations, and
federal and state sources of payment under the Medicare and Medicaid programs.
As a general matter, each third party payor has developed independent criteria
for determining whether a particular device or treatment modality should be
reimbursable and the Company cannot predict whether or to what extent the PRS,
INTRABEAM and X-SEED will gain acceptance for reimbursement with any third
party payors. The Company believes, however, that the reduced capital and
operation costs of these systems, when compared to competing modalities
together with the expected lower hospitalization costs, will encourage third
party payors to provide reimbursement for system-based procedures.

   In addition, many third party payors in the U.S., including the federal
Medicare program and many state Medicaid programs, have shifted or are planning
to shift to partially or fully capitated systems. Under such systems, providers
receive either a fixed payment amount per diagnosis or general treatment
approach regardless of the specific treatment modality, or a fixed payment
amount to provide for all the care needs of a patient over time regardless of
illness. To the extent that the PRS, INTRABEAM and X-SEED are comparatively
more cost effective than existing treatment modalities, providers subject to
partial or fully capitated systems will have an incentive to utilize them. The
Company will provide ongoing assistance for all customers through a user's
group information base and the general exchange of coding, cost and general
reimbursement information.

   The level of revenues and profitability of sales of medical devices may be
affected by the continuing efforts of governmental and third party payors to
contain or reduce the costs of health care through various means and the
initiatives of third party payors with respect to the availability of
reimbursement. For example, in the U.S. there have been, and the Company
expects that there will continue to be, a number of federal and state proposals
to subject pricing or profitability of medical devices to governmental control.
Although the Company cannot predict what legislative reforms may be proposed or
adopted or what actions federal, state or private payors for

                                      16

<PAGE>

health care products may take in response to any health care reform proposals
or legislation, the existence and pendency of such proposals could affect the
Company.

   With respect to health care reimbursement in the EC, the Company believes
there are presently no EC-wide reimbursement procedures. The majority of the EC
member nations each have a dominant national health service with distinct and
unique reimbursement policies and procedures. In addition, private insurers
within the EC offer a great variety of benefits. With the Medical Devices
Directive becoming mandatory in the EC, the principal prerequisite for
reimbursing a procedure involving new medical equipment is obtaining a CE Mark.

   Other foreign countries also have their own health care reimbursement
systems, and there can be no assurance that third party reimbursement will be
made available to the Company under any foreign reimbursement system.

Employees

   As of December 29, 2001, the Company had 37 employees. None of the Company's
employees are covered by a collective bargaining agreement, and the Company
believes that its relationship with its employees is good.

                                      17

<PAGE>

                  RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

   The value of an investment in PeC will be subject to the significant risks
inherent in its business. Investors should consider carefully the risks and
uncertainties described below and the other information in this prospectus
before deciding whether to invest. If any of the possible adverse events
described below actually occur, our business, financial condition or operating
results could be adversely affected in a material way. This could cause the
trading price of our common stock to decline, perhaps significantly.

We are an early stage company with a limited operating history and your basis
for evaluating us is limited.

   We were incorporated in January of 1989 and thus have a limited operating
history. We are still in the process of commercializing treatment systems based
on the PRS400 system, our core technology for the treatment of cancer. We may
not succeed in completing commercialization of our product range. We have sold
sixteen (16) systems based on the PRS400 system, and may not be able to sell
any more systems based on the PRS400 system technology. The LASER-X x-ray
source for industrial applications has just been introduced and there is no
assurance that market acceptability and commercial viability will be achieved.
The development program for the X-SEED disposable x-ray source is in process
and there can be no assurance of a successful development and/or
commercialization of this product.

We have a history of significant operating losses and anticipate further
substantial losses.

   We have experienced significant operating losses in each year since our
incorporation, primarily due to the cost of substantial research and
development of the PRS400 system. As of December 29, 2001, we had an
accumulated deficit of approximately $55 million and expect to continue to
incur losses until we generate revenues to offset the funds spent on
commercializing our products. Our ability to achieve profitable operations will
depend, in large part, on whether we can successfully commercialize the PRS,
INTRABEAM, X-SEED, LASER-X or any other products, and whether we can
effectively make the transition to a manufacturing and marketing company. It is
possible that the PRS, INTRABEAM, X-SEED, LASER-X and other products will never
gain commercial acceptance, and we may never generate significant revenues or
achieve profitability. For these reasons, we believe we will continue to incur
substantial operating losses for the foreseeable future, and that these losses
may be significantly higher than our current losses.

We have significant capital needs and we may not be able to raise additional
capital.

   We have expended, and will continue to expend, substantial funds on the
following:

   . Research and development of the PRS400 system, INTRABEAM, LASER-X, X-SEED
     and other products;

   . Establishing commercial scale manufacturing in our own facilities or in
     the facilities of others; and

   . Marketing the PRS, INTRABEAM, LASER-X, X-SEED and other products.

   Our future capital requirements will depend on a variety of factors,
including the following:

   . Time and costs involved in obtaining further regulatory approvals;

   . Market acceptance of the PRS, INTRABEAM, LASER-X, X-SEED and any of our
     other products;

   . Expense and results of our continued scientific research and development
     programs;

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

   . Development of competing technologies.

Our products are subject to extensive ongoing government regulation which could
make it more difficult for us to operate our business.

   We may need to obtain additional approvals from the FDA if we decide to
change or modify the PRS and INTRABEAM. In that case, the FDA may not grant any
new approvals. In addition, if we fail to comply with

                                      18

<PAGE>

FDA regulatory standards, the FDA could force us to withdraw our products from
the market or impose sanctions or fines.

   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. We may not be able to attain or maintain compliance with the cGMP or
with EC standards. In addition, we may not be able to identify and retain
manufacturers on commercially acceptable terms, if at all, and any
manufacturers we do retain might not be able to meet all relevant regulatory
requirements. Any problems with our ability to meet regulatory standards could
prevent us from marketing the PRS, INTRABEAM or other products.

We may be unable to protect our intellectual property.

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

   We hold twenty-two (22) U.S. patents and have fourteen (14) U.S. patent
applications pending relating to the PRS400 system and associated technologies.
In addition, we have filed foreign patent applications in selected foreign
countries, which correspond to certain of our U.S. patents and patent
applications. Those applications may not result in issued patents. If patents
are issued, any questions relating to the validity and scope of the patents may
not be resolved in our favor. In addition, our current or future patents, trade
secrets, or know-how may not protect us against competitors with similar
technologies or processes. Also, others may infringe any patents issued to us
and other companies may develop independently proprietary technologies or
processes which are the same as or substantially equivalent to our proprietary
technologies and processes.

   We 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 our technical and
management personnel. Further, any adverse determination in such litigation or
proceeding could subject us to significant liability and could prevent us from
manufacturing or marketing our products.

Our industries are subject to rapid, unpredictable, and significant
technological change and are competitive.

   The medical device and industrial device industries are subject to rapid,
unpredictable, and significant technological change. Our business is subject to
competition in the U.S. and abroad from a variety of sources, including
universities, research institutions, and medical device, chemical,
biotechnology and other companies. Many of these potential competitors have
substantially greater technical, financial, and regulatory resources than we do
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 our products, we may not be able to compete
successfully against them.

We depend on non-company distribution channels to sell our products.

   As we make the transition from a company with products in development but
limited product sales to a manufacturing and marketing company, we are relying
substantially upon Carl Zeiss to sell and distribute the PRS and INTRABEAM;
Cordis to sell and distribute the X-SEED for use in intravascular radiation
therapy; and other distributors to sell and distribute our other products. Carl
Zeiss, Cordis, or the other distributors may be unsuccessful in selling our
products or unable to distribute our products in a satisfactory manner which
could have a material adverse effect on our business, financial condition and
results of operations.

                                      19

<PAGE>

Our customers may not be reimbursed by third party payors which could reduce
our revenues.

   The ability of our customers to be reimbursed for the cost of our medical
products and related treatments from third party payors will have a significant
impact on our ability to commercialize our 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 no uniform policy on
reimbursement among third party payors, and the PRS and INTRABEAM or any of our
other products may not qualify for reimbursement. In addition, foreign
countries have their own health care reimbursement systems, and we 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 our revenues. Furthermore, legislative proposals to reform government
health care insurance programs, including the Medicare and Medicaid programs,
could have a significant impact on the purchase of health care services and
products and could result in lower prices and reduced demand for our products.
We are unable to predict whether such proposals will be enacted or whether
other health care legislation or regulation affecting our business may be
proposed in the future.

We are still waiting for some regulatory clearances outside of the United
States in order to market the PRS and INTRABEAM

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

   In addition, the length of time we will need to wait to obtain approval for
the sale of the PRS and INTRABEAM in a foreign country may be longer, and the
requirements may be more burdensome or expensive, than that required for FDA
approval. We will also need to obtain export licenses from the U.S. government
in order to export our products to certain countries. In addition, foreign
countries may not grant us any import licenses.

   Furthermore, we may not receive any necessary regulatory approvals for the
LASER-X, X-SEED or additional products in the future, the length of time for
such approvals may be extensive, and the cost of attempting to obtain any such
approvals may be prohibitive. In addition, our inability to obtain or maintain
requisite governmental approvals could delay or preclude us from further
developing and marketing the PRS, INTRABEAM and other products. Consequently,
such delays could impair our ability to generate revenues.

We depend on key personnel, the loss of whom could cause our business to suffer.

   We depend on the continued services and performance of our scientific
personnel and senior management. If we lose any key personnel, it could
significantly and adversely impact our research and development efforts or our
strategic objectives. In addition, competition among technical and medical
device companies for skilled scientific and management personnel is
increasingly intense. In order to achieve and maintain the commercialization of
our products, we will need to attract and retain additional key personnel, and
we cannot be sure that we will be able to do so. We have no employment
agreements with any of our employees, nor have we purchased "key person" life
insurance.

We may experience shortages of components for our products.

   We manufacture our 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, we have built up and maintain an
inventory of certain components for our products. We also try to identify,
where feasible, multiple suppliers of materials and components.

                                      20

<PAGE>

   While we sometimes have negotiated supply contracts with certain key
suppliers, we currently purchase all our supplies through open purchase orders.
Our vendors may not continue to provide supplies on acceptable terms, if at
all. In addition, if our forecasted product orders prove to be different than
actual product orders, we may have excess or inadequate inventory.

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

We may be exposed to product liability claims.

   We will be exposed to the risk of medical product liability claims if any of
our products causes or is alleged to have caused harm or injury. We might not
have sufficient resources to satisfy any liability resulting from such claims.
The level or scope of our liability insurance with respect to the clinical
testing or use of the PRS, INTRABEAM and other products 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 us significant financial harm.

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

   As of December 29, 2001, Peter M. Nomikos, Chairman of the Board and our
President and Chief Executive Officer, beneficially owned approximately 50.6%
of the issued and outstanding shares of common stock, and our principal
stockholders (including Mr. Nomikos) beneficially owned in the aggregate
approximately 57% of the issued and outstanding shares of common stock. Due to
his beneficial ownership of common stock coupled with the fact that he is
Chairman of the Board, President and Chief Executive Officer, Mr. Nomikos,
either alone or with the other principal stockholders, has the ability to
significantly influence all matters requiring approval by our stockholders,
including the election of all directors, acquisitions, sales of all or
substantially all of our stock or assets, and other extraordinary transactions.

Provisions of Massachusetts law and our Articles of Organization and By-Laws
may make a takeover more difficult.

   Certain provisions of our Articles of Organization and By-Laws are intended
to enhance the likelihood of continuity and stability in the composition of our
Board of Directors and in the policies formulated by the Board and to delay or
prevent a change in control if the Board determines that such a change in
control is not in our best interest. These provisions could have the effect of
discouraging certain attempts to acquire us or to remove incumbent management
even if some or even a majority of our stockholders deem such an attempt to be
in our 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, we are subject to the
provisions of Chapter 110F of the Massachusetts General Laws, the Business
Combination Statute. This statute prohibits us 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 in control.

   In addition, the Board of Directors is authorized, subject to certain
limitations, to cause us to issue one or more series of preferred stock and, to
the extent permitted by Massachusetts law, to grant different 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 in control. We have no current
plans to issue any shares of preferred stock, but the Board of Directors may
elect do so in the future.

                                      21

<PAGE>

Our stock price is volatile.

   The trading price of our common stock fluctuates significantly. Our stock
price may fluctuate as a result of various factors such as variations in our
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, the stock
market has experienced price and volume fluctuations that have particularly
affected medical device companies and have often been unrelated to such
companies' operating performance. Such broad market fluctuations may adversely
affect the market price of our common stock.

We do not pay dividends.

   We have never paid any dividends on our capital stock and do not anticipate
paying any cash dividends to holders of our capital stock in the foreseeable
future.

Item 2.  Properties.

   The Company currently occupies approximately 30,000 square feet of space in
a building located in Lexington, Massachusetts under a lease expiring in July
2002. This facility is suitable for research and development, corporate
administration and assembly of our products. The Company believes that its
facility will be adequate to meet its foreseeable requirements through the
expiration of the lease. The Company is currently evaluating options relative
to renewal or relocation.

Item 3.  Legal Proceedings.

   The Company is not currently involved in any material pending legal
proceeding.

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

   No matters were submitted to a vote of the Company's security holders during
the last quarter of the fiscal year ended December 29, 2001.

                                      22

<PAGE>

                                    PART II

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

   As of December 29, 2001, there were 69 holders of record of the Company's
common stock. The Company believes that there are approximately 2,300
beneficial holders of its common stock. The Company has not declared or paid
any dividends on its common stock since its inception. The current policy of
the Company's Board of Directors is to retain any earnings to finance the
operation of the Company's business. Accordingly, it is anticipated that no
cash dividends will be paid to the holders of the common stock in the
foreseeable future.

   Since December 1999, the Company's common stock has been listed on the
American Stock Exchange ("AMEX") under the symbol "PHX." Prior to its listing
on AMEX, the Company's common stock was listed on the Nasdaq National Market
under the symbol "PECX" from the time it started to trade publicly on January
29, 1997. The price ranges presented below represent the high and low sale
prices for each quarter, as reported by "The Nasdaq-AMEX Stock Market Summary
of Activity Report."

<TABLE>
<CAPTION>
                                            High   Low
                                            ----- ------
                        <S>                 <C>   <C>
                        First Quarter 2000.  9.25   2.25
                        Second Quarter 2000 5.875  2.625
                        Third Quarter 2000.  7.00 4.1875
                        Fourth Quarter 2000  5.25   3.00
                        First Quarter 2001.  6.05   3.25
                        Second Quarter 2001  4.95   3.15
                        Third Quarter 2001.  4.70   3.00
                        Fourth Quarter 2001  4.00   3.00
</TABLE>

                                      23

<PAGE>

Item 6.  Selected Consolidated Financial Data.

   The selected consolidated balance sheet data presented below as of December
30, 2000 and December 29, 2001 and the selected consolidated statement of
operations data presented below for the periods ending January 1, 2000,
December 30, 2000 and December 29, 2001 are derived from the Company's
Consolidated Financial Statements and Notes thereto included elsewhere in this
Form 10-K, which have been audited by Arthur Andersen LLP, independent public
accountants. The selected consolidated statement of operations data and
consolidated balance sheet data presented below as of and for the periods
ending January 3, 1998 and January 2, 1999, and the consolidated balance sheet
data presented below as of January 1, 2000, are derived from the Company's
Consolidated Financial Statements and Notes thereto not included in this
Form 10-K, which have also been audited by Arthur Andersen LLP, independent
public accountants. The selected consolidated financial data set forth below
should be read in conjunction with the Consolidated Financial Statements and
Notes thereto, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other financial information included elsewhere in
this Form 10-K.

<TABLE>
<CAPTION>
                                                                    Fiscal Year Ended
                                                ---------------------------------------------------------
                                                January 3, January 2, January 1, December 30, December 29,
                                                   1998       1999       2000        2000         2001
                                                ---------- ---------- ---------- ------------ ------------
                                                          (in thousands, except per share data)
<S>                                             <C>        <C>        <C>        <C>          <C>
Consolidated Statement of Operations Data:
Revenues.......................................  $    725   $    678   $    535    $  1,428     $    996
Cost of goods sold.............................       361        278        267         518          597
                                                 --------   --------   --------    --------     --------
Gross margin...................................       364        400        268         910          399
Operating expenses:
   Research and development expenses...........     4,626      5,434      4,426       3,219        4,208
   General and administrative expenses.........     2,306      3,107      3,426       3,815        4,488
                                                 --------   --------   --------    --------     --------
   Total operating expenses....................     6,933      8,541      7,852       7,034        8,696
                                                 --------   --------   --------    --------     --------
Operating loss.................................    (6,569)    (8,141)    (7,584)     (6,124)      (8,297)
   Interest income (expense), net..............       713        467         35      (1,653)        (811)
                                                 --------   --------   --------    --------     --------
Net loss.......................................  $ (5,856)  $ (7,674)  $ (7,549)   $ (7,777)    $ (9,108)
                                                 ========   ========   ========    ========     ========
Net loss per basic and diluted share...........  $  (0.87)  $  (1.02)  $  (0.97)   $  (0.97)    $  (0.94)
                                                 ========   ========   ========    ========     ========
Weighted average basic and diluted shares......     6,694      7,489      7,749       8,001        9,707

                                                January 3, January 2, January 1, December 30, December 29,
                                                   1998       1999       2000        2000         2001
                                                ---------- ---------- ---------- ------------ ------------
Consolidated Balance Sheet Data:
Cash and cash equivalents......................  $  2,287   $  3,686   $    134    $    663     $  4,008
Investments held to maturity...................    11,889      1,993          0       3,973        1,594
Total assets...................................    16,425      9,135      2,864       8,448        9,203
Total long-term debt, including current portion     1,686        719      1,566      10,727       15,024
Deficit accumulated during development stage...   (23,239)   (30,913)   (38,462)    (46,239)     (55,347)
Total shareholders' equity (deficit)...........  $ 14,012   $  7,453   $    247    $ (3,291)    $ (6,951)
</TABLE>

                                      24

<PAGE>

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

Overview

   The Company is a technology company dedicated to developing, manufacturing
and marketing miniature x-ray systems for multiple market applications.

   Established in 1989, the Company initially focused on research and
development for the miniaturization of an x-ray system for cancer treatment.
The Company has since expanded its development efforts and is now creating and
adapting miniature x-ray systems for a variety of applications in healthcare
and non-healthcare related markets. The various miniature x-ray products based
on the Company's extensive research and development program are known
collectively as "micro-adaptive x-ray systems." The Company has established an
intellectual property portfolio of twenty-two (22) U.S. patents and has
fourteen (14) additional U.S. patents pending, all of which relate to the
Company's core technology and use.

   The Company's business strategy is to identify opportunities in which its
patented core technology can be used to gain access to new markets by means of
strategic alliances with industry leaders. This strategy allows the Company to
foster the development of multiple applications of its technology, while
remaining focused on its core expertise of developing, manufacturing and
marketing micro-adaptive x-ray systems. By joining with one or more industry
leaders to develop an x-ray system to satisfy the needs of a specific market,
the Company gains market and application expertise without having to
internalize many of the costs and organizational overhead necessary to support
the specific application. Leveraging the market expertise of these strategic
relationships allows the Company to rapidly bring the technology to new
markets. The Company plans to identify additional market opportunities that can
both be linked to the core technology and present the opportunity to access the
market through a strategic partner with application expertise and the sales and
marketing organization necessary to drive market acceptance.

   The Company is currently pursuing initiatives in the industrial and medical
markets with micro-adaptive x-ray systems designed for x-ray fluorescence
analysis, intravascular radiation therapy, brachytherapy, radiosurgery,
intra-operative radiation therapy, and instrumentation.

   In February 2001, the Company announced a strategic relationship with
Cordis, a Johnson & Johnson company, to co-develop and co-manufacture an x-ray
based system for the delivery of intravascular radiation therapy. Cordis, a
world leader in intravascular technology focused on therapeutic solutions, will
exclusively market and sell the x-ray based system incorporating the Company's
X-SEED technology in the field of intravascular radiation therapy on behalf of
the two companies. Co-incident with the Cordis agreement, Johnson & Johnson
Development Corporation purchased 904,762 shares of the Company's common stock
for an aggregate purchase price of $3.8 million.

   On December 17, 2001, the Company raised $5,000,000 in a private placement
of a 6% Senior Convertible Debenture (the "6% Debenture") to PYC Corporation,
whose advisor, Peter M. Nomikos, is the Company's Chairman of the Board of
Directors, President and Chief Executive Officer. The Company is using the net
proceeds of the private placement for general and administrative expenses and
for general corporate purposes, including, without limitation, to fund
intra-operative radiation therapy for breast cancer clinical trials, for the
sales and marketing of PRS400 system cancer treatment products, for the
development of an X-SEED intravascular radiation therapy device, for
brachytherapy product development, for the general support of clinical trials,
and for further development of industrial applications and distribution
alliances.

   The Company has experienced significant operating losses in each year since
its inception, due primarily to substantial research and development
expenditures. As of December 29, 2001, the Company had an accumulated deficit
of approximately $55 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 Company's products will ever gain commercial acceptance,
or that the Company will ever generate significant revenues or achieve

                                      25

<PAGE>

profitability. The Company's ability to achieve profitable operations will be
dependent in a large part on whether it can successfully commercialize its
products and make the transition to a manufacturing and marketing company. The
Company anticipates that its sales and marketing efforts through its existing
sales and distribution channels will continue to increase sales of its products
in the upcoming year.

  Subsequent Event

   On February 1, 2002, the Company's Board of Directors elected Peter M.
Nomikos, its Chairman of the Board, to the additional posts of President and
Chief Executive Officer. In addition, the Board of Directors elected Timothy W.
Baker, the Company's Executive Vice President and Chief Financial Officer, to
the additional post of Chief Operating Officer. Euan S. Thomson resigned as
President, Chief Executive Officer and a Director on that same date.

Critical Accounting Policies

   The Company's discussion and analysis of its financial condition and results
of operations are based upon the Company's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure
of contingent assets and liabilities. On an on-going basis, PeC evaluates its
estimates, including those related to product returns, bad debts, inventories
and warranty obligations. PeC bases its estimates on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under
different assumptions or conditions.

   The Company believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation of its
consolidated financial statements:

  Revenue Recognition

   The Company recognizes revenue in accordance with SEC Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"), as
amended by SAB 101A and 101B. SAB 101 requires that four basic criteria must be
met before revenue can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred or services have been rendered; (3) the fee
is fixed and determinable; and (4) collectibility is reasonably assured.
Determination of criteria (4) is based on management's judgments regarding the
collectibility of those revenues. Should changes in conditions cause management
to determine these criteria are not met for certain future transactions,
revenue recognized for any reporting period could be adversely affected.
Revenue results are difficult to predict, and any shortfall in revenue or delay
in recognizing revenue could cause PeC's operating results to vary
significantly from quarter to quarter and could result in future operating
losses.

  Warranty Reserve

   The Company's products are generally covered by a one-year warranty period
from the date of installation. The Company's standard warranty requires it to
repair or replace defective products returned to the Company during the
warranty period at no cost to the customer. The Company accrues a warranty
reserve for estimated costs to provide warranty services for this one-year
period. The Company's estimate of costs to service its warranty obligations is
based on historical experience and expectation of future conditions. To the
extent the Company experiences increased warranty claim activity or increased
costs associated with servicing those claims, its warranty accrual will
increase, resulting in decreased gross profit.

  Inventory Valuation

   The Company values inventory at the lower of the actual cost to purchase
and/or manufacture the inventory or the current estimated market value of the
inventory. PeC regularly reviews inventory quantities on hand and

                                      26

<PAGE>

records a provision for excess and obsolete inventory based primarily on its
estimated forecast of product demand and production requirements for the next
twelve months. A significant increase in the demand for PeC's products could
result in a short-term increase in the cost of inventory purchases while a
significant decrease in demand could result in an increase in the amount of
excess inventory quantities on hand. In addition, the Company's industry is
characterized by rapid technological change, frequent new product development
and rapid product obsolescence that could result in an increase in the amount
of obsolete inventory quantities on hand. Additionally, PeC's estimates of
future product demand may prove to be inaccurate, in which case it may have
understated or overstated the provision required for excess and obsolete
inventory. Therefore, although PeC makes every effort to ensure the accuracy of
its forecasts of future product demand, any significant unanticipated changes
in demand or technological developments could have a significant impact on the
value of PeC's inventory and its reported operating results.

Results of Operations

  Fiscal Year Ended December 29, 2001 and December 30, 2000

   Revenues:  Revenues decreased by $432,462 from $1,428,401 in 2000 to
$995,939 in 2001. The 2000 revenues reflect sales of the PRS400 core system in
conjunction with the Company's INTRABEAM for intra-operative radiation therapy.
The 2001 revenues reflect continued sales of the Company's INTRABEAM for
intra-operative radiation therapy in addition to the first commercial sales of
LASER-X, the company's x-ray source for industrial applications. Gross margins
decreased by $511,552 from $910,449 in 2000 to $398,897 in 2001. The decrease
in gross margin reflects the decreased revenue from sales combined with lower
average selling prices of the INTRABEAM system to select customers to support
the ongoing international breast cancer trial.

   Research and development expenses:  Research and development expenses
increased by $988,650 from approximately $3.2 million in 2000 to approximately
$4.2 million in 2001. The principal costs in research and development are
attributed to the continued development of the PRS400 system and INTRABEAM for
commercialization, and the development of the new miniature x-ray sources for
intravascular radiation therapy (X-SEED) and x-ray fluorescence systems
(LASER-X). The Company filed eight new patent applications in 2001.

   Selling, general and administrative expenses:  Selling, general and
administrative expenses increased by $673,932 from approximately $3.8 million
in 2000 to approximately $4.5 million in 2001. Expenses were incurred as a
result of a major marketing initiative, which commenced in 2000, and continued
into 2001. The initiative was aimed at raising awareness of Photoelectron
products and technologies in the medical, non-medical, patient and investment
communities. In 2000 and 2001, this initiative included the launch of a new
website, attendance at major domestic and international radiation oncology and
surgical oncology trade shows, and a series of dedicated symposia where
experienced physicians presented to the medical community clinical data and
case studies utilizing PeC's products.

   Interest income:  Interest income decreased by $2,656 from $206,644 in 2000
to $203,988 in 2001. The decrease resulted from a decrease in amounts invested
by the Company in conjunction with lower market interest rates.

   Interest expense:  Interest expense decreased by $845,491 from $1,860,514 in
2000 to $1,015,023 in 2001. The change resulted from a decrease in amounts
borrowed throughout the year due to the conversion of debentures issued in the
Company's $10.4 million 10% senior convertible debenture private placement,
which closed in June 2000, into shares of the Company's common stock along with
the absence of $638,696 of non cash interest expense associated with the
warrants issued in conjunction with the 8% convertible note payable issued to
PYC Corporation in November 1999.

                                      27

<PAGE>

  Fiscal Year Ended December 30, 2000 and January 1, 2000

   Revenues:  Revenues increased by $893,767 from $534,634 in 1999 to
$1,428,401 in 2000. The 1999 revenues reflect the Company's continuing sales of
the PRS. The 2000 revenues reflect increased sales of the PRS400 core system in
conjunction with the Company's INTRABEAM for intra-operative radiation therapy.
Gross margins increased by $642,468 from $267,981 in 1999 to $910,449 in 2000.
The increase in gross margin reflects the increased revenue from sales combined
with higher average selling prices of the equipment.

   Research and development expenses:  Research and development expenses
decreased by $1,206,458 from approximately $4.4 million in 1999 to
approximately $3.2 million in 2000. The principal costs in research and
development are attributed to the continued development of the PRS400 system
and INTRABEAM for commercialization, and the development of the new miniature
x-ray sources for intravascular radiation therapy and x-ray fluorescence
systems. The reduction also reflects the full year impact of the restructuring
of the Company, which occurred in the second quarter of 1999. The Company still
continues to support clinical trial efforts in skin and breast cancer research
and development programs, and the development of applicators for the
interstitial portion of the breast program. The Company filed ten new patent
applications in 2000.

   Selling, general and administrative expenses:  Selling, general and
administrative expenses increased by $388,223 from approximately $3.4 million
in 1999 to approximately $3.8 million in 2000. A portion of this increase is
attributable to expenses incurred in connection with the $10.4 million 10%
senior convertible debenture private placement completed by the Company in June
2000. Expenses were also incurred as a result of a major marketing initiative,
which commenced in 2000, and continued into 2001. The initiative is aimed at
raising awareness of Photoelectron products and technologies in the medical,
non-medical, patient and investment communities. In 2000, this initiative
included the launch of a new website, attendance at major domestic and
international radiation oncology and surgical oncology trade shows, and a
series of dedicated symposia where experienced physicians presented to the
medical community clinical data and case studies utilizing PeC's products.

   Interest income:  Interest income increased by $76,017 from $130,627 in 1999
to $206,644 in 2000. The increase resulted from an increase in amounts invested
attributable to the Company's $10.4 million 10% senior convertible debenture
private placement which closed in June 2000.

   Interest expense:  Interest expense increased by $1,765,330 from $95,184 in
1999 to $1,860,514 in 2000. The change resulted from an increase in amounts
borrowed throughout the year, which is primarily attributable to the Company's
$10.4 million 10% senior convertible debenture private placement, which closed
in June 2000.

Liquidity and Capital Resources

   The Company has expended substantial funds to research and develop the PRS,
INTRABEAM, LASER-X, X-SEED and other potential products, conduct clinical
trials, pursue regulatory approvals, establish commercial scale manufacturing
in its own facilities or in the facilities of others, and market the PRS,
INTRABEAM, LASER-X, X-SEED and other products. The Company anticipates it will
continue to expend substantial funds in the future on such activities as such
funds become available.

   Since its inception, the Company has financed its operations through the
issuance of convertible debt and equity in a series of private placements
totaling approximately $36.6 million and its initial public offering with net
proceeds of $16,818,854.

   Consolidated working capital was $6,605,311 at December 29, 2001, compared
with $5,587,706 at December 30, 2000. Included in working capital are cash and
cash equivalents of $4,007,547 at December 29, 2001, compared with $662,857 at
December 30, 2000 and $1,594,166 investments held to maturity at December 29,
2001 compared with $3,972,770 at December 30, 2000. Held to maturity
investments consist of investment grade commercial paper with maturities
generally less than 120 days. During 2001, $7,405,695 of cash was used for
operating activities as compared to $5,368,160 in fiscal 2000.

                                      28

<PAGE>

   The Company used $161,634 of cash in 2001 for fixed assets and leasehold
improvements associated with its facility.

   The Company received $81,109 of cash in 2001 from the exercise of stock
options to purchase common stock.

   In June 2000, the Company issued in a private placement $10,458,909 of 10%
senior convertible debentures. The Company is using the net proceeds of the
private placement for general and administrative expenses, refinancing of
$2,312,755 of short-term debt bridge financing provided by PYC Corporation and
$786,153 due under an 8% Subordinated Convertible Demand Note to Peter M.
Nomikos, and for general corporate purposes, including, without limitation, to
support the accelerated testing and marketing of the Company's new products.

   The holders of the 10% senior convertible debentures are entitled to receive
interest payments at the rate of 10% per annum on the outstanding principal
amount of the debentures. At the option of the Company, interest may be paid
when due by adding the amount payable to the outstanding principal of the
debentures. The principal amount of the debentures, together with all accrued
and unpaid interest, is due and payable on May 1, 2005. The holders of the
debentures have the option, at any time prior to May 1, 2005, to convert the
debentures, in whole or in part, into shares of the Company's common stock at a
price of $4.00 per share.

   On February 5, 2001, Johnson & Johnson Development Corporation purchased
904,762 shares of the Company's common stock for an aggregate purchase price of
$3.8 million.

   On December 17, 2001, the Company raised $5,000,000 in a private placement
of the 6% Debenture to PYC Corporation, whose advisor, Peter M. Nomikos, is the
Company's Chairman of the Board of Directors, President and Chief Executive
Officer. The Company is using the net proceeds of the private placement for
general and administrative expenses and for general corporate purposes,
including, without limitation, to fund intra-operative radiation therapy for
breast cancer clinical trials, for the sales and marketing of PRS400 system
cancer treatment products, for the development of an X-SEED intravascular
radiation therapy device, for brachytherapy product development, for the
general support of clinical trials, and for further development of industrial
applications and distribution alliances.

   PYC Corporation is entitled to receive interest payments at the rate of 6%
per annum on the outstanding principal amount of the 6% Debenture. At the
option of the Company, interest may be paid when due by adding the amount
payable to the outstanding principal amount of the 6% Debenture. The principal
amount of the 6% Debenture, together with all accrued but unpaid interest, is
due and payable on May 1, 2005. The holder of the 6% Debenture has the option,
at any time prior to May 1, 2005, to convert the 6% Debenture, in whole or in
part, into shares of the Company's common stock at a price of $3.25 per share.
If any shares of common stock or securities convertible into shares of common
stock are issued at an effective price lower than $3.25 per share (as adjusted
and subject to certain exclusions), then the conversion price of the 6%
Debenture will be automatically adjusted to that lower price.

   The Company may redeem any portion of the 6% Debenture at any time, provided
that the average closing bid price per share of the Company's common stock as
reported on the American Stock Exchange for the twenty (20) consecutive trading
days prior to the date of the redemption notice is at least 175% of the
conversion price. The redemption price will be 105% of the outstanding
principal amount of the 6% Debenture being redeemed, along with accrued but
unpaid interest. In addition, so long as 50% of the outstanding principal
amount of the 6% Debenture originally issued is outstanding and subject to
certain exceptions, the registrant may not incur more than $10,000,000 in
indebtedness after December 17, 2001.

   Prior to entering into the transaction with PYC Corporation, the Company
attempted over a period of several months to raise funds from other sources.
After considering other financing alternatives, including a proposal

                                      29

<PAGE>

from another stockholder of the Company, the Board of Directors determined that
the terms and conditions of the financing proposal from PYC Corporation were
more favorable to the Company than the terms and conditions available from the
other stockholder or from non-related parties.

   The securities sold in the offering have not been registered under the
Securities Act of 1933 or the securities laws of any state. The offering was
made in reliance upon the exemptions from the registration provisions afforded
by Section 4(2) of the Securities Act of 1933 and Rule 506 of Regulation D
thereunder. The Company has agreed to use its best efforts to file with the
Securities and Exchange Commission, no later than May 16, 2002, a registration
statement on Form S-3 with respect to the resale of shares of the Company's
common stock issuable upon conversion of the 6% Debenture.

   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 obtained product liability insurance covering the
commercial use of its products.

   The Company's future capital requirements will depend on a variety of
factors, including the time and costs involved in obtaining FDA and other
regulatory approvals, the results of the Company's ongoing clinical trials, the
market acceptance of the PRS, INTRABEAM, LASER-X, X-SEED and any other Company
products, the expense and results of the Company's continued scientific
research and development programs, the time and costs expended in filing,
prosecuting and enforcing patent claims, and the development of competing
technologies.

   The Company believes that its existing cash and investments together with
anticipated revenues will be sufficient for at least the next twelve months.
The Company's primary source of liquidity in 2002 is the $5,000,000 of proceeds
from the 6% senior convertible debt issued in December 2001. The Company will
have to raise additional capital for fiscal 2003 unless revenues are greater
than anticipated. There is no assurance that it will be able to find additional
financing on acceptable terms, if at all.

   The Company has a commitment under an operating lease agreement for office
space to make payments of approximately $352,360 in 2002. At the Company's
option, as interest comes due under the senior convertible debt instruments it
may be added to principal, so that no cash payments will be required until May
2005, when all outstanding principal and accrued interest will be due.

Forward-Looking Statements:

   Certain statements contained in this Report, 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, without
limitation, those referred to herein, 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.

Item 8.  Financial Statements and Supplementary Data.

   The Company's financial statements begin on page F-3. Reference is made to
the Index to Financial Statements on page F-1 herein.

Item 9.  Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.

   None.

                                      30

<PAGE>

                                   PART III

Item 10.  Directors and Executive Officers of the Registrant.

   The information required by this item is included in the Proxy Statement for
the Special Meeting in Lieu of Annual Meeting of Stockholders on June 14, 2002
to be filed with the Securities and Exchange Commission (the "SEC") on or about
April 26, 2002 (the "Proxy Statement") and is incorporated herein by reference.

Item 11.  Executive Compensation.

   The information required by this Item is included in the Company's Proxy
Statement under "Executive Compensation" and is incorporated herein by
reference.

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

   The information required by this Item is included in the Company's Proxy
Statement under "Beneficial Ownership of Common Stock" and is incorporated
herein by reference.

Item 13.  Certain Relationships and Related Transactions.

   The information required by this Item is included in the Company's Proxy
Statement under "Certain Relationships and Related Transactions" and is
incorporated herein by reference.

                                    PART IV

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

   (a) See the Exhibit Index included immediately preceding the exhibits to
this Form 10-K.

   (b) No financial statement schedules are required to be filed under the
instructions relating to the applicable accounting regulations of the SEC.

   (c) Reports on Form 8-K

   The Company filed a Current Report on Form 8-K on December 27, 2001, which
disclosed the sale of a 6% senior convertible debenture to PYC Corporation, the
Company's largest stockholder.

                                      31

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<S>                                                                                                 <C>
Report of Independent Public Accountants........................................................... F-2
Consolidated Balance Sheets as of December 30, 2000 and December 29, 2001.......................... F-3
Consolidated Statements of Operations for the years ended January 1, 2000, December 30, 2000 and
  December 29, 2001................................................................................ F-4
Consolidated Statements of Cash Flows for the years ended January 1, 2000, December 30, 2000 and
  December 29, 2001................................................................................ F-5
Consolidated Statements of Shareholders' (Deficit) Equity at January 1, 2000, December 30, 2000 and
  December 29, 2001................................................................................ F-6
Notes to Consolidated Financial Statements......................................................... F-7
</TABLE>


                                      F-1

<PAGE>

                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders and Board of Directors of
Photoelectron Corporation and Subsidiary:

   We have audited the accompanying consolidated balance sheets of
Photoelectron Corporation and its subsidiary (a Massachusetts corporation) as
of December 30, 2000 and December 29, 2001, and the related consolidated
statements of operations, shareholders' (deficit) equity and cash flows for
each of the three years in the period ended December 29, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

   In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Photoelectron Corporation and its subsidiary as of December 30, 2000 and
December 29, 2001, and the results of their operations and their cash flows for
each of the three years in the period ended December 29, 2001, in conformity
with accounting principles generally accepted in the United States.

                                            ARTHUR ANDERSEN LLP

Boston, Massachusetts
February 27, 2002

                                      F-2

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                            December 30,  December 29,
                                                                                2000          2001
                                                                            ------------  ------------
<S>                                                                         <C>           <C>
                                  ASSETS
Current Assets:
   Cash and cash equivalents............................................... $    662,857  $  4,007,547
   Accounts receivable.....................................................      278,743       277,674
   Inventories.............................................................    1,389,710     1,656,889
   Prepaid expenses........................................................      295,588       198,289
   Held to maturity investments (Note 2)...................................    3,972,770     1,594,166
                                                                            ------------  ------------
       Total current assets................................................    6,599,668     7,734,565
                                                                            ============  ============
Property and Equipment:
   Computer equipment......................................................      984,237     1,026,534
   Lab and production equipment............................................    1,068,793     1,188,131
   Clinical site equipment.................................................      875,122       875,122
   Sales demo equipment....................................................      148,450       148,450
   Furniture and fixtures..................................................      183,104       183,104
   Leasehold improvements..................................................      866,230       866,230
                                                                            ------------  ------------
   Property and equipment..................................................    4,125,936     4,287,571
   Less--Accumulated depreciation and amortization.........................    3,384,127     3,849,728
                                                                            ------------  ------------
   Net property and equipment..............................................      741,809       437,843
                                                                            ------------  ------------
Other Assets:
   Deferred offering costs, net............................................    1,106,422     1,030,444
                                                                            ------------  ------------
       Total assets........................................................ $  8,447,899  $  9,202,852
                                                                            ============  ============
                  LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
   Accounts payable........................................................ $    218,614  $    298,182
   Accrued expenses (Note 3)...............................................      569,447       659,360
   Accrued payroll and benefits............................................      223,901       171,712
       Total current liabilities...........................................    1,011,962     1,129,254
                                                                            ============  ============
Long Term Liabilities
   Senior convertible debentures...........................................   10,727,361    15,024,333
                                                                            ------------  ------------
Commitments and Contingencies (Note 7)
Shareholders' Deficit (Notes 8 , 9, 10 and 11):
   Preferred stock, $0.01 par value--Authorized--2,500,000 at December 30,
     2000 and December 29, 2001, respectively; shares issued and
     outstanding--none and none at December 30, 2000 and December 29,
     2001, respectively....................................................           --            --
   Common stock, $0.01 par value--Authorized--20,000,000 shares at
     December 30, 2000 and December 29, 2001, respectively; issued and
     outstanding--8,551,685 and 9,947,418 at December 30, 2000 and
     December 29, 2001, respectively.......................................       85,517        99,474
   Capital in excess of par value common stock.............................   42,943,997    48,374,531
   Deferred compensation...................................................      (82,047)      (77,298)
   Accumulated deficit.....................................................  (46,238,891)  (55,347,442)
                                                                            ------------  ------------
       Total shareholders' deficit.........................................   (3,291,424)   (6,950,735)
                                                                            ------------  ------------
       Total liabilities and shareholders' deficit......................... $  8,447,899  $  9,202,852
                                                                            ============  ============
</TABLE>

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

                                      F-3

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                  Year Ended
                                                    -------------------------------------
                                                    January 1,   December 30, December 29,
                                                       2000          2000         2001
                                                    -----------  ------------ ------------
<S>                                                 <C>          <C>          <C>
Revenues........................................... $   534,634  $ 1,428,401  $   995,939
Cost of Goods Sold.................................     266,653      517,952      597,042
                                                    -----------  -----------  -----------
Gross Margin.......................................     267,981      910,449      398,897
Operating Expenses:
   Research and development expenses...............   4,425,739    3,219,281    4,207,931
   Selling, general and administrative expenses....   3,426,327    3,814,550    4,488,482
                                                    -----------  -----------  -----------
       Total operating expenses....................   7,852,066    7,033,831    8,696,413
                                                    -----------  -----------  -----------
       Operating loss..............................  (7,584,085)  (6,123,382)  (8,297,516)
                                                    -----------  -----------  -----------
Interest income....................................     130,627      206,644      203,988
Interest expense...................................     (95,184)  (1,860,514)  (1,015,023)
                                                    -----------  -----------  -----------
Interest income (expense), net.....................      35,443   (1,653,870)    (811,035)
                                                    -----------  -----------  -----------
Net loss........................................... $(7,548,642) $(7,777,252) $(9,108,551)
                                                    ===========  ===========  ===========
Basic and diluted net loss per share (Note 13)..... $     (0.97) $     (0.97) $     (0.94)
                                                    ===========  ===========  ===========
Weighted average basic and diluted shares (Note 13)   7,749,040    8,001,204    9,706,836
</TABLE>



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

                                      F-4

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

                     CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                              Year Ended
                                                                                -------------------------------------
                                                                                January 1,   December 30, December 30,
                                                                                   2000          2000         2001
<S>                                                                             <C>          <C>          <C>
                                                                                -----------  -----------  -----------
Cash flows from operating activities:
  Net loss..................................................................... $(7,548,642) $(7,777,252) $(9,108,551)
  Adjustments to reconcile net loss to net cash used in operating activities--
    Depreciation and amortization..............................................     563,953      511,491      465,601
    Noncash amortization of offering expenses..................................          --      140,638      209,647
    Noncash compensation expense...............................................      12,764       25,348       54,999
    Noncash interest converted to notes........................................      46,981       82,828           --
    Noncash commission expense.................................................          --        7,481           --
    Noncash consulting expense.................................................          --      186,842        9,106
    Noncash interest expense on bridge financing...............................      33,790      638,696           --
    Noncash interest on 10% convertible debt...................................          --    1,114,387    1,005,160
    Noncash interest on 6% convertible debt....................................          --           --        9,863
  Changes in current accounts--
    Inventories................................................................      17,149       47,847     (267,179)
    Accounts receivable........................................................     172,500     (191,243)       1,069
    Prepaid expenses...........................................................     189,488     (148,789)      97,299
    Other current assets.......................................................      83,531       32,272           --
    Accounts payable...........................................................     (89,381)     (38,368)      79,568
    Accrued expenses...........................................................      89,126       87,163       37,724
    Deferred revenue...........................................................      87,500      (87,500)          --
                                                                                -----------  -----------  -----------
       Net cash used in operating activities...................................  (6,341,239)  (5,368,160)  (7,405,695)
                                                                                -----------  -----------  -----------
Cash flows from investing activities:
  Proceeds from (Purchase of) held to maturity investments.....................   1,993,056   (3,972,770)   2,378,604
  Purchases of equipment and leasehold improvements............................    (300,836)    (227,940)    (161,634)
       Net cash provided by (used in) investing activities.....................   1,692,220   (4,200,710)   2,216,970
                                                                                -----------  -----------  -----------
Cash flows from financing activities:
  Proceeds from issuance of common stock.......................................     296,668      270,001    3,881,109
  Proceeds from issuance of convertible notes payable..........................     800,000    1,450,000           --
  Proceeds from issuance of 10% senior convertible debentures..................          --    7,360,000           --
  Proceeds from exercise of warrants...........................................          --    1,725,000           --
  Proceeds from issuance of 6% senior convertible debentures...................          --           --    5,000,000
  Deferred offering expenses...................................................          --     (707,378)    (347,694)
       Net cash provided by financing activities...............................   1,096,668   10,097,623    8,533,415
                                                                                ===========  ===========  ===========
Increase (decrease) in cash and cash equivalents...............................  (3,552,353)     528,753    3,344,690
                                                                                -----------  -----------  -----------
Cash and cash equivalents, beginning of year...................................   3,686,457      134,104      662,857
                                                                                -----------  -----------  -----------
Cash and cash equivalents, end of year.........................................     134,104      662,857    4,007,547
                                                                                ===========  ===========  ===========
Noncash financing activities:
  Conversion of 10% Convertible Debentures to common stock..................... $        --  $   273,727  $ 1,701,879
                                                                                ===========  ===========  ===========
  Fair value of warrants issued in connection with 10% Convertible
   Debentures.................................................................. $        --  $   836,954  $        --
                                                                                ===========  ===========  ===========
  Fair value of warrants issued in connection with Bridge Financing............ $    33,790  $   638,696  $        --
                                                                                ===========  ===========  ===========
  Refinancing of Bridge debt with 10% Convertible Debentures................... $        --  $ 2,312,756  $        --
                                                                                ===========  ===========  ===========
  Refinancing of Note Payable with 10% Convertible Debentures.................. $        --  $   786,153  $        --
                                                                                ===========  ===========  ===========
  Beneficial conversion feature on 10% Convertible Debentures issued........... $        --  $   497,458  $        --
                                                                                ===========  ===========  ===========
</TABLE>
  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-5

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

           CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY

<TABLE>
<CAPTION>
                                                          Common     Preferred
                                   Preferred  Common       Stock       Stock
                                    Stock,    Stock,    Capital in   Capital in
                                     $0.01     $0.01   Excess of Par Excess of    Deferred   Subscription Accumulated
                                   Par Value Par Value     Value     Par Value  Compensation  Receivable    Deficit
                                   --------- --------- ------------- ---------- ------------ ------------ ------------
<S>                                <C>       <C>       <C>           <C>        <C>          <C>          <C>
Balance, January 2, 1999..........   $  --    $77,042   $38,324,377    $  --      $(29,913)    $(5,842)   $(30,912,997)
  Exercise of stock options.......      --        646       290,180       --            --          --              --
  Recording of deferred
   compensation...................      --         --        26,627       --        19,927          --              --
  Payment of subscription
   receivable.....................      --         --            --       --            --       5,842              --
  Net loss........................      --         --            --       --            --          --      (7,548,642)
                                     -----    -------   -----------    -----      --------     -------    ------------
Balance, January 1, 2000..........   $  --    $77,688   $38,641,184    $  --      $ (9,986)    $    --    $(38,461,639)
                                     =====    =======   ===========    =====      ========     =======    ============
  Exercise of stock options and
   warrants.......................              7,005     1,985,252       --            --                          --
  Fair value of equity
   instruments issued to non-
   employees......................      --         10     1,466,451       --         9,189          --              --
  Beneficial conversion
   feature........................      --         --       497,455       --            --          --              --
  Conversion of convertible
   debt...........................      --        814       272,405       --            --          --              --
  Intrinsic value of options
   granted to employees...........      --         --        81,250       --       (81,250)         --              --
  Net loss........................      --         --            --       --            --          --      (7,777,252)
                                     -----    -------   -----------    -----      --------     -------    ------------
Balance, December 30, 2000........   $  --    $85,517   $42,943,997    $  --      $(82,047)    $    --    $(46,238,891)
                                     =====    =======   ===========    =====      ========     =======    ============
  Exercise of stock options and
   warrants.......................                654        80,455       --            --                          --
  Fair value of equity
   instruments issued to non-
   Employees......................      --         --         9,106       --            --          --              --
  Deferred offering costs related
   to debt conversions............      --         --      (197,853)      --            --          --              --
  Conversion of convertible
   debt...........................      --      4,255     1,697,624       --            --          --              --
  Sale of Common Stock............      --      9,048     3,790,952       --            --          --              --
  Intrinsic value of options
   granted to employees...........      --         --        50,250       --       (50,250)         --              --
  Amortization of deferred
   compensation...................      --         --            --       --        54,999          --              --
  Net loss........................      --         --            --       --            --          --      (9,108,551)
                                     -----    -------   -----------    -----      --------     -------    ------------
Balance, December 29, 2001........   $  --    $99,474   $48,374,531    $  --      $(77,298)    $    --    $(55,347,442)
                                     =====    =======   ===========    =====      ========     =======    ============
</TABLE>
<TABLE>
<CAPTION>




                                      Total
                                   -----------
<S>                                <C>
Balance, January 2, 1999..........   7,452,667
  Exercise of stock options.......     290,826
  Recording of deferred
   compensation...................      46,554
  Payment of subscription
   receivable.....................       5,842
  Net loss........................  (7,548,642)
                                   -----------
Balance, January 1, 2000.......... $   247,247
                                   ===========
  Exercise of stock options and
   warrants.......................   1,992,257
  Fair value of equity
   instruments issued to non-
   employees......................   1,475,650
  Beneficial conversion
   feature........................     497,455
  Conversion of convertible
   debt...........................     273,219
  Intrinsic value of options
   granted to employees...........          --
  Net loss........................  (7,777,252)
                                   -----------
Balance, December 30, 2000........ $(3,291,424)
                                   ===========
  Exercise of stock options and
   warrants.......................      81,109
  Fair value of equity
   instruments issued to non-
   Employees......................       9,106
  Deferred offering costs related
   to debt conversions............    (197,853)
  Conversion of convertible
   debt...........................   1,701,879
  Sale of Common Stock............   3,800,000
  Intrinsic value of options
   granted to employees...........          --
  Amortization of deferred
   compensation...................      54,999
  Net loss........................  (9,108,551)
                                   -----------
Balance, December 29, 2001........ $(6,950,735)
                                   ===========
</TABLE>


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

                                      F-6

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(1)  Nature of Operations and Summary of Significant Accounting Policies

  Nature of Operations and Relationship to Principal Shareholders

   Photoelectron Corporation ("Photoelectron," "PeC" or the "Company") is a
technology company dedicated to developing, manufacturing and marketing
miniature x-ray systems for multiple market applications.

   Established in 1989, the Company initially focused on research and
development for the miniaturization of an x-ray system for cancer treatment.
PeC has since expanded its development efforts and is now creating and adapting
miniature x-ray systems for a variety of applications in healthcare and
non-healthcare related markets. The various miniature x-ray products based on
the Company's extensive research and development program are known collectively
as "micro-adaptive x-ray systems." The Company has established an intellectual
property portfolio of twenty-two (22) U.S. patents and has fourteen (14)
additional U.S. patents pending, all of which relate to the Company's core
technology and use.

   The Company's business strategy is to identify opportunities in which its
patented core technology can be used to gain access to new markets by means of
strategic alliances with industry leaders. This strategy allows PeC to foster
the development of multiple applications of its technology, while remaining
focused on its core expertise of developing, manufacturing and marketing
micro-adaptive x-ray systems. By joining with one or more industry leaders to
develop an x-ray system to satisfy the needs of a specific market, the Company
gains market and application expertise without having to internalize many of
the costs and organizational overhead necessary to support the specific
application. Leveraging the market expertise of these strategic relationships
allows the Company to rapidly bring the technology to new markets. The Company
plans to identify additional market opportunities that can both be linked to
the core technology and present the opportunity to access the market through a
strategic partner with application expertise and the sales and marketing
organization necessary to drive market acceptance.

   The Company is currently pursuing initiatives in the industrial and medical
markets with micro-adaptive x-ray systems designed for x-ray fluorescence
analysis, intravascular radiation therapy, brachytherapy, radiosurgery,
intra-operative radiation therapy, and instrumentation.

   In February 2001, the Company announced a strategic relationship with Cordis
Corporation ("Cordis"), a Johnson & Johnson company, to co-develop and
co-manufacture an x-ray based system for the delivery of intravascular
radiation therapy. Cordis, a world leader in intravascular technology focused
on therapeutic solutions, will exclusively market and sell the x-ray based
system incorporating the Company's X-SEED(TM) technology in the field of
intravascular radiation therapy on behalf of the two companies. Co-incident
with the Cordis agreement, Johnson & Johnson Development Corporation purchased
904,762 shares of the Company's common stock for an aggregate purchase price of
$3.8 million.

   On December 17, 2001, the Company raised $5,000,000 in a private placement
of a 6% Senior Convertible Debenture (the "6% Debenture") to PYC Corporation,
whose advisor, Peter M. Nomikos, is the Company's Chairman of the Board of
Directors, President and Chief Executive Officer (see Note 10). The Company is
using the net proceeds of the private placement for general and administrative
expenses and for general corporate purposes, including, without limitation, to
fund intra-operative radiation therapy for breast cancer clinical trials, for
the sales and marketing of PRS400 system cancer treatment products, for the
development of an X-SEED intravascular radiation therapy device, for
brachytherapy product development, for the general support of clinical trials,
and for further development of industrial applications and distribution
alliances.

   On February 1, 2002, the Company's Board of Directors elected Peter M.
Nomikos, its Chairman of the Board, to the additional posts of President and
Chief Executive Officer. In addition, the Board of Directors

                                      F-7

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

elected Timothy W. Baker, the registrant's Executive Vice President and Chief
Financial Officer, to the additional post of Chief Operating Officer.

  Fiscal Years

   The Company has adopted a fiscal year ending on the Saturday nearest
December 31. References to fiscal 2001, fiscal 2000, and fiscal 1999 are for
the fiscal years ended December 29, 2001, December 30, 2000, and January 1,
2000, respectively.

  Inventory

   Inventories are stated at the lower of cost (first-in, first-out basis) or
market and include materials, labor and overhead. The Company has parts,
supplies and manufactured parts (components) in inventory which are intended to
be used and capitalized as part of the Company's products that will be used for
distribution and in clinical trials.

   Inventories consist of the following:

<TABLE>
<CAPTION>
                                        2000       2001
                                     ---------- ----------
                      <S>            <C>        <C>
                      Components.... $1,160,882 $1,445,766
                      Finished goods    228,828    211,123
                                     ---------- ----------
                                     $1,389,710 $1,656,889
                                     ========== ==========
</TABLE>

  Use of Estimates

   The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses and income during the reporting
period. Actual results could differ from those estimates.

  Property and Equipment

   The cost of additions and improvements are capitalized while maintenance and
repairs are charged to expense as incurred. The Company provides for
depreciation and amortization on the straight-line method over the estimated
useful lives of the property as follows:

<TABLE>
<CAPTION>
Asset Classification                              Estimated Useful Life
--------------------                              ---------------------
<S>                           <C>
Machinery and equipment...... 5 Years
Clinical site equipment...... The shorter of three years or the life of the agreement
Furniture and fixtures....... 3-5 Years
Computer equipment & software 2-5 Years
Leasehold improvements....... The shorter of the term of the lease or the life of the asset
</TABLE>

   Management believes that the useful lives selected result in net book values
which approximate net realizable values based upon alternate future uses.
Periodically, management reviews specific assets to verify this assertion.

                                      F-8

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  Cash and Cash Equivalents

   As of December 29, 2001, cash and cash equivalents include the Company's
operating accounts and holdings of a money market mutual fund as well as
commercial paper which has an original maturity of three months or less. Highly
liquid investments with an original maturity of 3 months or less at the date of
the acquisition are considered to be cash equivalents. Similar investments with
original maturity beyond three months are classified as held to maturity
investments. Cash equivalents are carried at cost, which approximate market
value.

  Held to Maturity Investments

   Pursuant to Statement of Financial Accounting Standards (SFAS) No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", the Company
classifies its investments in commercial paper as held to maturity and measures
the value of such investments at amortized cost because the Company has the
positive intent and ability to hold such investments to maturity. Interest
income, including amortization of premiums and discounts, is recorded in
earnings. Management reviews all reductions in fair value below book value to
determine if an impairment is other than temporary in nature; if this occurs,
the carrying value of the investment is written down to the appropriate level
by a charge to earnings.

  Income Taxes

   The Company adopted SFAS No. 109, "Accounting for Income Taxes," as of the
beginning of 1989. Under SFAS No. 109, deferred tax assets and liabilities are
recognized for the expected future tax consequences of events that have been
included in the financial statements or in the tax returns. The amount of
deferred tax asset or liability is based on the difference between the
financial statement and tax basis of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to be
reflected in the tax return.

  Revenue Recognition

   The Company generally recognizes revenue and provides a reserve for
estimated warranty costs upon shipment of its product to the customer, provided
that there is persuasive evidence of an arrangement and collection of the sales
price is probable.

   In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition". This bulletin
summarizes certain views of the Staff on applying accounting principles
generally accepted in the United States to revenue recognition in financial
statements. The Company believes that its current revenue recognition policy
complies with SAB No. 101 and there was no impact on the financial statements
as a result of adopting this statement.

  Comprehensive Income

   The Company applies the provisions of SFAS No. 130, "Reporting Comprehensive
Income" which establishes standards for reporting and displaying comprehensive
income and its components in the consolidated financial statements.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. As the Company had no components of other comprehensive
income, the reported net loss is the same as comprehensive loss for all periods
presented.

  Research and Development Expenses

   Research and development expenses include the portion of indirect costs
allocable to research and development efforts based on actual labor hours
incurred.

                                      F-9

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   In connection with the Phase II FDA clinical trials, as well as the efforts
to obtain the CE Mark, PRS400 systems have been provided to certain hospitals
to conduct the clinical trials. The cost of these units and the related
accumulated depreciation is included in property and equipment in the
accompanying consolidated balance sheets. The cost of the units is charged to
research and development expenses over the term of the agreements with the
hospitals.

  Principles of Consolidation

   The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, Photoelectron (Europe) Ltd. All
material intercompany accounts and transactions have been eliminated.

  Foreign Currency

   All assets and liabilities of the Company's foreign subsidiary are
translated at year-end exchange rates, and revenues and expenses are translated
at average exchange rates for the year in accordance with SFAS No. 52, "Foreign
Currency Translation". Resulting translation adjustments are not material.
Foreign currency transaction gains and losses included in the accompanying
consolidated statements of operations are not material for the three years
presented.

  Net Loss Per Share

   During 1997, the Company adopted SFAS 128, "Earnings per Share" (Note 13).
Basic loss per share has been computed by dividing net loss by the weighted
average number of shares outstanding during the year. Diluted loss per share
has been computed by excluding the effect of exercising the stock options,
warrants and convertible securities which are all anti-dilutive given the
operating losses of the Company. The Company has outstanding 5,950,821,
4,775,657 and 2,383,620 potential common shares related to such options and
convertible instruments at December 29, 2001, December 30, 2000 and January 1,
2000, respectively.

  Fair Value of Financial Instruments

   The Company's financial instruments primarily consist of cash and cash
equivalents, held to maturity investments, accounts receivable, accounts
payable, 10% senior convertible debentures and 6% senior convertible
debentures. The fair value of the 10% and 6% senior convertible debentures
approximate book value at December 29, 2001, based upon the underlying common
stock. The held to maturity investments are carried at amortized cost on the
accompanying balance sheet. See Note 2 for fair value disclosure. The carrying
amounts of the Company's remaining financial instruments approximate fair value
due to their short-term nature.

  Stock Option Plans

   The Company applies Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock option plans (Note 12). Accordingly, no accounting
recognition is given to stock options granted with exercise prices equal to the
fair market value of the stock until they are exercised. Upon exercise, net
proceeds including tax benefits realized, if any, are credited to equity.

  Concentration of Credit Risk and Significant Customers

   Financial instruments that subject the Company to the potential for credit
risk consist primarily of cash and cash equivalents and trade accounts
receivable with customers in the health care industry. The Company

                                     F-10

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

minimizes the impact of credit risk on cash and cash equivalents by allocating
its cash among financial institutions and by investing in high quality cash
equivalents. The Company performs ongoing credit evaluations of its customers'
financial condition but does not require collateral.

   Historically, the Company has not experienced significant losses related to
its accounts receivable. For fiscal years 1999 and 2000, due to the stage of
the Company's development, the Company had a limited number of customers.
Substantially all of the revenue and accounts receivable in those fiscal years
relate to these customers. For fiscal 2001, one customer represented
approximately 32% of revenue and 71% of accounts receivable. Three other
customers represented a total of 45% of revenue in fiscal 2001.

  New Accounting Pronouncements

   In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets
and does not apply to goodwill or intangible assets that are not being
amortized and certain other long-lived assets. This Statement supersedes FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for
the disposal of a segment of a business (as previously defined in that
Opinion). This Statement also amends APB No. 51, "Consolidated Financial
Statements," to eliminate the exception to consolidation for a subsidiary for
which control is likely to be temporary. SFAS No. 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001
with early adoption encouraged. The Company does not expect the adoption of
SFAS No. 144 to have a material impact on the Company's financial condition or
results of operations.

(2)  Held to Maturity Investments

   Investments in commercial paper are classified as held to maturity as of
December 29, 2001. The amortized cost and fair values as of December 29, 2001
are as follows:

<TABLE>
<CAPTION>
                                         Commercial Paper
                                 --------------------------------
                                              Gross
                                            Unrealized
                                 Amortized     Gain
                                   Cost       (Loss)   Fair Value
                                 ---------- ---------- ----------
               <S>               <C>        <C>        <C>
               December 30, 2000 $3,972,770   $1,198   $3,973,967
               December 29, 2001 $1,594,343   $ (177)  $1,594,166
</TABLE>

   All the commercial paper has a contractual maturity due within one year.

(3)  Accrued Expenses

   Accrued liabilities in the accompanying balance sheets include the following
balances:

<TABLE>
<CAPTION>
                                       December 30, December 29,
                                           2000         2001
                                       ------------ ------------
                <S>                    <C>          <C>
                Warranty Accrual......   $297,000     $276,649
                Annual Report Accrual.         --       60,000
                Other Accrued Expenses    272,447      322,711
                                         --------     --------
                                         $569,447     $659,360
                                         ========     ========
</TABLE>

                                     F-11

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(4)  Income Taxes

   The components of the deferred tax asset at December 30, 2000 and December
29, 2001 are as follows:

<TABLE>
<CAPTION>
                                             December 30,  December 29,
                                                 2000          2001
                                             ------------  ------------
        <S>                                  <C>           <C>
        Deferred tax asset--
           Federal tax loss carryforwards... $ 14,874,000  $ 17,613,000
           Federal tax credit carryforwards.    1,103,000     1,157,000
           State tax loss carryforward......    3,439,000     3,520,000
           State tax credit carryforward....      996,000     1,035,000
           Other, net.......................      836,000       791,000
                                             ------------  ------------
                                               21,248,000    24,116,000
        Valuation allowance.................  (21,248,000)  (24,116,000)
                                             ------------  ------------
           Deferred tax asset...............           --            --
                                             ============  ============
</TABLE>

   As of December 29, 2001, the Company had federal net operating loss
carryforwards of approximately $51,802,000, state net operating loss
carryforwards of approximately $37,056,000, federal tax credit carryforwards of
approximately $1,157,000, and state tax credit carryforwards of approximately
$1,035,000. Due to the fact that the Company has sustained cumulative losses,
the potential future benefit of these attributes, which expire in the years
2002 through 2016, is fully reserved by means of a valuation allowance because
their realization is uncertain.

   Certain stock transactions may result in a change of control under Sections
382 and 383 of the Internal Revenue Code of 1986, as amended; and as a result,
the net operating loss and tax credit carryforwards available to be utilized in
any given year may be limited, and certain amounts of the net operating loss
carryforwards may expire unutilized due to such limitations.

(5)  Employee Benefit Plan

   In April 1995, the Company adopted a 401(k) Plan. The Company contributes
50% of the first 6% of annual contributions by each employee with at least
three months of service to the 401(k) Plan. During fiscal years 1999, 2000 and
2001, the Company contributed approximately $29,057, $59,436, and $67,244,
respectively.

(6)  Related Party Transactions

  Thermo Electron Corporation

   Thermo Electron is a shareholder of the Company. The Company utilizes Thermo
Electron's resources on an as-needed basis without a formal contract and is
charged at actual cost for such services. The Company paid $6,093, $6,557 and
$6,388 in fiscal 1999, 2000 and 2001, respectively, for these services. In
addition, the Company has been provided with certain services by a wholly-owned
subsidiary of Thermo Electron. These services include data processing services,
administrative services and machine shop services, which are charged to the
Company at actual cost. The Company paid $147,315, $42,947 and $14,724 in
fiscal 1999, 2000 and 2001, respectively, for these services. As of
December 30, 2000 and December 29, 2001, $0 and $1,751, respectively, was
payable to Thermo Electron and was included in accounts payable in the
accompanying consolidated balance sheets.

                                     F-12

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   Management believes that the fees charged by Thermo Electron are reasonable
and such fees are representative of the expenses the Company would have
incurred on a stand-alone basis.

  Cordis Corporation

   In February 2001, the Company signed an agreement with Cordis Corporation, a
Johnson & Johnson Company, to co-develop and co-manufacture a disposable
miniature x-ray source, based on the Company's X-SEED(TM) and associated
technology, for the delivery of intravascular radiation therapy to prevent
restenosis (re-narrowing) of coronary arteries following angioplasty and stent
procedures. Co-incident with the agreement, Johnson & Johnson Development
Corporation purchased 904,762 shares of the Company's common stock for an
aggregate purchase price of $3.8 million. The proceeds from the equity
investment assist in the funding of additional development required for the
commercialization of X-SEED.

  PYC Corporation

   On December 17, 2001, the Company raised $5,000,000 in a private placement
of the 6% Debenture to PYC Corporation, whose advisor, Peter M. Nomikos, is the
Company's Chairman of the Board of Directors, President and Chief Executive
Officer (see Note 10).

(7)  Commitments and Contingencies

  Litigation

   The Company is party to legal matters which arise in the normal course of
business. Management, after reviewing these matters with legal counsel, is of
the opinion that the resolution of these matters will not have a material
effect on the financial condition or results of operations.

  Leases

   In 1996, the Company entered into an operating lease for its office and
research facilities expiring in July 2002. The minimum lease payments under the
agreement are $599,689 in 2001 and $352,360 in 2002. The accompanying
consolidated statements of operations include expenses for operating leases of
$471,859, $587,820, and $600,673 for fiscal 1999, 2000 and 2001, respectively.

(8)  Convertible Subordinated Notes

   Since its inception, the Company has financed its operations in part through
the issuance of subordinated convertible debentures. In May 1992, the Company
entered into a $4,500,000 8% convertible subordinated demand note and warrant
purchase agreement with Mr. Peter M. Nomikos, who then served as President and
Chief Executive Officer of the Company and presently serves as Chairman of the
Board, President and Chief Executive Officer. This note was reissued in 1996 as
the Amended and Restated 8% Subordinated Convertible Note Due on Demand as of
August 1, 1996. The amended and restated demand note was convertible into
common stock at a conversion price of $3.00 on demand. The Company borrowed
$4,252,000 in the form of a demand loan with detachable warrant purchase rights
under this agreement, of which $705,000 was still outstanding at the beginning
of fiscal 2000. All earned but unpaid interest on the subordinated demand note
was convertible into common stock at a conversion price equal to the fair
market value of the Company's common stock on the first day of the fiscal
quarter in which the interest to be converted accrued. In June 2000,
Mr. Peter M. Nomikos exchanged the principal balance of the note together with
all accrued unpaid interest for $786,153 in 10% senior convertible debentures.


                                     F-13

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

   Warrant purchase rights issued in conjunction with the amended and restated
demand note entitle the holder to purchase warrants for $0.20. Each warrant is
exercisable upon issuance and allows the holder to purchase one share of common
stock at $3.00. At December 29, 2001, warrants to purchase 235,000 shares of
the Company's common stock were outstanding under the amended and restated
demand note. These remaining warrants expired on January 27, 2002 and were not
exercised. All warrants purchased by Mr. Nomikos have been accounted for as
capital in excess of par value--common stock.

(9)  Convertible Note Payable

   On November 15, 1999, the Company and PYC Corporation entered into a six
month $2.25 million line of credit at an 8% interest rate. This note was
convertible into common stock at the holder's request within 30 days subsequent
to its maturity or prepayment. In June 2000, PYC Corporation exchanged the
principal balance of the note together with all accrued unpaid interest for
$2,312,756 in 10% senior convertible debentures (see Note 10). In connection
with the line of credit, the Company issued to PYC Corporation warrants to
purchase an aggregate of 450,000 shares of the Company's common stock with an
exercise price equal to the average closing price of the Company's common stock
for the ten trading days preceding each draw made under the line of credit. The
fair value of the warrants issued, in the amounts of $33,790 and $638,696,
respectively, has been recognized as non cash interest expense in fiscal 1999
and fiscal 2000. The weighted average exercise price of the warrants issued to
PYC Corporation is $3.29 per share.

(10)  Senior Convertible Debt

   In June 2000, the Company issued in a private placement $10,458,909 of 10%
senior convertible debentures. The Company is using the net proceeds of the
private placement for refinancing of short-term debt bridge financing and other
convertible debt and general corporate purposes, including, without limitation,
to support the accelerated testing and marketing of the Company's new products.

   The placement agent for the offering received cash for commission and
expenses in the amount of $515,200 plus $52,818 for fees and the actual
disbursements of counsel to the placement agent. In addition, the Company
issued to the placement agent and an affiliate of the placement agent warrants
to purchase 195,000 shares of the Company's common stock. The Company recorded
the fair value of the warrants in the amount of $600,704 as deferred offering
costs. The warrants issued to the placement agent and to the affiliate of the
placement agent are exercisable at any time for five years from June 30, 2000,
the final closing date of the offering, at an exercise price of $4.00 per share.

   As part of the $10,458,909 raised in the offering, the Company issued to PYC
Corporation a 10% senior convertible debenture with a face amount of $2,312,756
in exchange for the total amount due under the November 1999 $2.25 million line
of credit bridge financing between the Company and PYC Corporation (see Note
9). In addition, the Company issued to Peter M. Nomikos a 10% senior
convertible debenture, with a face amount of $786,153, in exchange for the
total amount due to Mr. Nomikos under the Amended and Restated 8% Subordinated
Convertible Note Due on Demand as of August 1, 1996 (see Note 8).

   Interest expense attributable to a beneficial conversion feature resulting
from the excess of the fair market value of the Company's common stock over the
conversion price on the date of issuance of the debt, which amounted to
$408,594, has been recognized in interest expense in the accompanying financial
statements in accordance with the provision of EITF 98-5 ''Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios.''


                                     F-14

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

   The holders of the debentures are entitled to receive interest payments at
the rate of 10% per annum on the outstanding principal amount of the
debentures. At the option of the Company, interest may be paid when due by
adding the amount payable to the outstanding principal amount of the
debentures. The Company increased the principal of the 10% senior convertible
debentures in the amount of $256,464, $247,555, $241,082 and $243,886 of
accrued interest on March 31, June 30, September 29, and December 29, 2001,
respectively. Additionally, the Company recorded the beneficial conversion
feature associated with these additional debentures in the amount of $16,173 as
interest expense on June 29,2002. The principal amount of the debentures,
together with all accrued and unpaid interest, is due and payable on May 1,
2005. The holders of the debentures have the option, at any time prior to May
1, 2005, to convert the debentures, in whole or in part, into shares of the
Company's common stock at a price of $4.00 per share.

   On December 17, 2001, the company raised $5,000,000 in a private placement
of the 6% Debenture to PYC Corporation, whose advisor, Peter M. Nomikos, is the
Company's Chairman of the Board of Directors, President and Chief Executive
Officer. The Company is using the net proceeds of the private placement for
general and administrative expenses and for general corporate purposes,
including, without limitation, to fund intra-operative radiation therapy for
breast cancer clinical trials, for the sales and marketing of PRS400 system
cancer treatment products, for the development of an X-SEED intravascular
radiation therapy device, for brachytherapy product development, for the
general support of clinical trials, and for further development of industrial
applications and distribution alliances.

   PYC Corporation is entitled to receive interest payments at the rate of 6%
per annum on the outstanding principal amount of the 6% Debenture. At the
option of the Company, interest may be paid when due by adding the amount
payable to the outstanding principal amount of the 6% Debenture. The Company
increased the principal of the 6% Debenture in the amount of $9,863 of accrued
interest on December 29, 2001. The principal amount of the 6% Debenture,
together with all accrued but unpaid interest, is due and payable on May 1,
2005. The holder of the 6% Debenture has the option, at any time prior to May
1, 2005, to convert the 6% Debenture, in whole or in part, into shares of the
Company's common stock at a price of $3.25 per share. If any shares of common
stock or securities convertible into shares of common stock are issued at an
effective price lower than $3.25 per share (as adjusted and subject to certain
exclusions), then the conversion price of the 6% Debenture will be
automatically adjusted to that lower price.

   The Company may redeem any portion of the 6% Debenture at any time, provided
that the average closing bid price per share of the Company's common stock as
reported on the American Stock Exchange for the twenty (20) consecutive trading
days prior to the date of the redemption notice is at least 175% of the
conversion price. The redemption price will be 105% of the outstanding
principal amount of the 6% Debenture being redeemed, along with accrued but
unpaid interest. In addition, so long as 50% of the outstanding principal
amount of the 6% Debenture originally issued is outstanding and subject to
certain exceptions, the registrant may not incur more than $10,000,000 in
indebtedness after December 17, 2001.

   The securities sold in the offering have not been registered under the
Securities Act of 1933 or the securities laws of any state. The offering was
made in reliance upon the exemptions from the registration provisions afforded
by Section 4(2) of the Securities Act of 1933 and Rule 506 of Regulation D
thereunder. The Company has agreed to use its best efforts to file with the
Securities and Exchange Commission, no later than May 16, 2002, a registration
statement on Form S-3 with respect to the resale of shares of the Company's
common stock issuable upon conversion of the 6% Debenture.

                                     F-15

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(11)  Common and Preferred Stock

   In May 2000, the Company's stockholders approved an amendment to the
Company's Articles of Organization to increase the number of authorized shares
of Common Stock from 15,000,000 to 20,000,000 and to reduce the number of
authorized shares of Preferred Stock from 7,500,000 to 2,500,000. The Company's
Preferred Stock is a so-called "blank check" preferred stock, which authorizes
the Board of Directors of the Company from time to time to establish one or
more series of Preferred Stock and, to the extent permitted by Massachusetts
law, to designate variations in the relative rights and preferences between
different series. All of the Preferred Stock previously issued by the Company
in a series of private placements automatically converted into shares of Common
Stock at the closing of the Company's Initial Public Offering in 1997.

(12)  Stock Option Plan

   In 1989, the Company adopted the 1989 Stock Option Plan (the "1989 Plan").
The 1989 Plan provided that options may be granted at any price determined by
the Board of Directors for key employees, directors and consultants. The Board
of Directors granted 733,225 non-qualified stock options under the 1989 Plan.
Options granted under the 1989 Plan expire seven to twelve years after the date
of grant and in general vest at 20% per year. When an optionee ceases to be an
employee, director or consultant of the Company, their options terminate either
upon or shortly after termination of employment. The Company's Board of
Directors voted on July 17, 1996 to terminate the 1989 Plan, and no further
options could be issued under the 1989 Plan after that date.

   On July 17, 1996, the Board of Directors of the Company adopted the 1996
Equity Incentive Plan (the "1996 Plan") for employees, officers, directors and
others of the Company and its subsidiary, and recommended approval of the plan
by the stockholders. The 1996 Plan provides for grants of incentive stock
options to employees (including officers) of the Company, and for grants of
non-qualified stock options to such employees as well as to directors and
others of the Company and its subsidiary. In addition, persons eligible to
receive non-qualified stock options can be awarded shares of Common Stock and
given the opportunity to purchase shares of Common Stock. A total of 1,041,775
shares of Common Stock may be issued under the 1996 Plan.

   A summary of stock option activity is as follows:

<TABLE>
<CAPTION>
                                   Fiscal 1999               Fiscal 2000                Fiscal 2001
                            ------------------------- -------------------------- --------------------------
                             Number   Range of Option  Number    Range of Option  Number    Range of Option
                            of Shares Price per Share of Shares  Price per Share of Shares  Price per Share
                            --------- --------------- ---------  --------------- ---------  ---------------
<S>                         <C>       <C>             <C>        <C>             <C>        <C>
Options outstanding,
  beginning of year........  913,092   $0.40--$9.75     911,717   $0.40--$9.00   1,113,817   $ 0.40--$9.00
Granted....................  263,000   $2.13--$4.88     401,000   $2.69--$5.94      85,000   $ 3.68--$4.85
Exercised..................  (64,500)  $0.40--$3.00    (126,500)  $0.40--$3.00     (65,500)  $ 0.40--$3.00
Forfeited.................. (199,875)  $2.13--$9.75     (72,400)  $2.13--$9.00    (210,610)  $ 2.68--$9.00

Options outstanding, end of
  year.....................  911,717   $0.40--$9.00   1,113,817   $0.40--$9.00     922,707   $2.125--$9.00
Options exercisable........  445,468   $0.40--$9.00     504,871   $0.40--$9.00     516,364   $2.125--$9.00
Options available for grant        0                    140,058                    157,518
Weighted average fair value
  of options granted during
  the year.................            $       1.28               $       1.81               $        2.06
</TABLE>


   The Company accounts for stock options under APB No. 25. Upon exercise of
the options, the net proceeds, including the tax benefit realized, are credited
to equity.

                                     F-16

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock Based Compensation", which sets forth a fair value
based method of recognizing stock based compensation expense. As permitted by
SFAS No. 123, the Company has elected to continue to apply APB No. 25 to
account for its stock based compensation plans. Had the compensation cost for
these plans been determined based on the fair value at the grant dates
consistent with the method set forth under SFAS 123, the Company's net loss and
basic and diluted net loss per share would have been the following pro forma
amounts:

<TABLE>
<CAPTION>
                                       Fiscal 1999  Fiscal 2000  Fiscal 2001
                                       -----------  -----------  -----------
  <S>                                  <C>          <C>          <C>
  Net Loss
     As Reported...................... $(7,548,642) $(7,777,252) $(9,108,551)
     Pro Forma........................ $(7,886,413) $(8,186,825) $(9,526,488)
  Basic and Diluted Net Loss Per Share
     As Reported...................... $      (.97) $      (.97) $      (.94)
     Pro Forma........................ $     (1.02) $     (1.02) $      (.98)
</TABLE>

   Pro forma compensation expense for options granted is reflected over the
vesting period, therefore future pro forma compensation expense may be greater
as additional options are granted. The fair value of each option grant is
estimated on the grant date using the Black-Scholes option-pricing model with
the following weighted average assumptions:

<TABLE>
<CAPTION>
                                   Fiscal 1999 Fiscal 2000 Fiscal 2001
                                   ----------- ----------- -----------
          <S>                      <C>         <C>         <C>
          Dividend Rate...........          0%          0%          0%
          Volatility..............         48%         48%         53%
          Risk Free Interest Rate.       5.00%       5.00%       4.60%
          Expected Life of Options 7.00 years  5.00 years  5.00 years
</TABLE>

   The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded option which have no vesting restrictions and are
fully transferable. In addition, option-pricing models require the input of
highly subjective assumptions including expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

(13)  Net Loss per Share

   Basic and diluted net loss per share were calculated as follows:

<TABLE>
<CAPTION>
                                          1999         2000         2001
                                       -----------  -----------  -----------
  <S>                                  <C>          <C>          <C>
  Net loss............................ $(7,548,642) $(7,777,252) $(9,108,551)
  Weighted average shares.............   7,749,040    8,001,204    9,706,836
                                       -----------  -----------  -----------
  Basic and Diluted net loss per share $     (0.97) $     (0.97) $     (0.94)
                                       ===========  ===========  ===========
</TABLE>

   The computation of diluted earnings per share for fiscal 1999, 2000 and 2001
excludes the effect of assuming the exercise of all outstanding stock options
and the conversion of convertible securities because the effect would be
anti-dilutive, due to the Company's net loss during these years.

                                     F-17

<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(14)  Quarterly Financial Information (Unaudited)

<TABLE>
<CAPTION>
                                                                     Three Months Ended
                                           ----------------------------------------------------------------------
                                           April 1  July 1   Sep. 30  Dec. 30  March 31 June 30  Sep. 29  Dec. 29
                                            2000     2000     2000     2000      2001    2001     2001     2001
                                           -------  -------  -------  -------  -------- -------  -------  -------
                                                            (In thousands, except per share data)
<S>                                        <C>      <C>      <C>      <C>      <C>      <C>      <C>      <C>
Statement of Operations Data:
Revenues.................................. $   423  $   530  $   168  $   308  $    85  $   518  $   158  $   236
Gross Profit..............................     313      300      106      192       25      189       67      118
Income (loss) before extraordinary items
 and cumulative effect of changes in
 accounting...............................  (1,495)  (2,277)  (1,843)  (2,161)  (2,261)  (2,118)  (2,512)  (2,217)
    Net loss.............................. $(1,495)  (2,277)  (1,843)  (2,161)  (2,261)  (2,118)  (2,512)  (2,217)
                                           =======  =======  =======  =======  =======  =======  =======  =======
Basic and diluted income (loss) per share:
    Net loss..............................    (.19)    (.29)    (.23)    (.25)    (.25)    (.22)    (.25)    (.22)
                                           =======  =======  =======  =======  =======  =======  =======  =======
Weighted average common shares
 outstanding..............................   7,787    7,844    7,874    8,500    9,202    9,768    9,912    9,944
                                           =======  =======  =======  =======  =======  =======  =======  =======
</TABLE>

                                     F-18

<PAGE>

   Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized on March 28, 2002.

                                               PHOTOELECTRON CORPORATION

                                               By:     /s/  PETER M. NOMIKOS
                                                   -----------------------------
                                                         Peter M. Nomikos
                                                   President and Chief Executive
                                                              Officer

   KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Peter M. Nomikos and Timothy W. Baker,
and each of them, his true and lawful proxies, attorneys-in-fact and agents,
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to (i) act on, sign and title with
the SEC any and all amendments to this Annual Report on Form 10-K, together
with all exhibits thereto, (ii) act, sign and file such certificates,
instruments, agreements and other documents as may be necessary or appropriate
in connection therewith, and (iii) take any and all actions which may be
necessary or appropriate in connection therewith, granting unto such agents,
proxies and attorneys-in-fact, and each of them and his and their substitute or
substitutes, full power and authority to do and perform each and every act and
thing necessary or appropriate to be done in connection therewith, as fully for
all intents and purposes as he might or could do in person, hereby approving,
ratifying and confirming all that such agents, proxies and attorneys-in-fact,
any of them or any of his or their substitute or substitutes may lawfully do or
cause to be done by virtue hereof.

   In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.

          Signature                       Title                  Date
          ---------                       -----                  ----

    /s/  PETER M. NOMIKOS     President, Chief Executive    March 28, 2002
-----------------------------   Officer and Chairman of the
      Peter M. Nomikos          Board of Directors
                                (Principal Executive
                                Officer)

    /s/  TIMOTHY W. BAKER     Executive Vice President,     March 28, 2002
-----------------------------   Chief Financial Officer and
      Timothy W. Baker          Chief Operating Officer
                                (Principal Financial
                                Officer and Principal
                                Accounting Officer)

  /s/  ROGER D. WELLINGTON    Director                      March 28, 2002
-----------------------------
     Roger D. Wellington

     /s/  LEONARD LASTER      Director                      March 28, 2002
-----------------------------
     Dr. Leonard Laster

    /s/  THOMAS J. MILLER     Director                      March 28, 2002
-----------------------------
      Thomas J. Miller

<PAGE>

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
  Exhibit
    No.                                              Description
  -------                                            -----------
<C>           <S>

       *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   Convertible Note and Warrant Purchase Agreement between the Company and Peter M.
              Nomikos dated as of May 13, 1992, and Exhibits thereto.

       *4.3   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.

     ***4.4   Loan Agreement between the Company and PYC Corporation dated November 15, 1999 and
              Exhibits thereto

    ****4.5   Warrant Agreement dated May 1, 2000 by and between the Company and KSH Strategic
              Investment Fund I, LP and exhibits thereto.

    ****4.6   Warrant Certificate to purchase 11,000 shares of the Company's common stock issued to KSH
              Strategic Investment Fund I, LP.

    ****4.7   Warrant Agreement dated June 30, 2000 by and between the Company and KSH Investment
              Group, Inc. and exhibits thereto.

    ****4.8   Warrant Certificate to purchase 184,000 shares of common stock issued to KSH Investment
              Group, Inc.

   *****4.9   Stock Purchase Agreement by and between Photoelectron Corporation and Johnson & Johnson
              Development Corporation dated as of February 5, 2001.

*******4.10   Form of 10% Senior Convertible Debenture issued by the Company.

 ******4.11   Form of 6% Senior Convertible Debenture issued by the Company.

      *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   1989 Employee Stock Option Plan of the Company and forms of Stock Option Agreements.

      *10.4   1996 Equity Incentive Plan of the Company.

      *10.5   Form of Stock Purchase Warrant issued to certain security holders of the Company and
              Schedule of Substantially Identical Documents from Exhibits.

      *10.6   Stock Option Agreements variously dated between certain directors and officers of the
              Company and the Company.

      *10.7   Technology Cross License Agreement dated as of January 4, 1989 between the Company and
              Thermo Electron Corporation.

      *10.8   International Distributor Sales and Service Agreement dated December 13, 1995, as amended,
              between the Company and Toshiba Medical Systems Co., Ltd.
</TABLE>

<PAGE>

<TABLE>
<C>           <S>
      *10.9   Agreement dated as of February 1, 1991, as amended, between the Company and the General
              Hospital Corporation.

     *10.10   Clinical Trial Agreement dated as of August 1, 1992, as amended, between the General
              Hospital Corporation, Nicholas T. Zervas, M. D. and the Company.
     *10.11   Investigational Treatment Agreement dated as of September 1, 1994 between the General
              Hospital Corporation, Rees G. Cosgrove, M.D. and the Company.
     *10.12   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.
     *10.13   Clinical Trial Agreement dated as of January 1, 1995 between the Tokyo Women's Medical
              College, Kintomo Takakura, M.D. and the Company.
     *10.14   Clinical Trial Agreement dated December 13, 1995, as amended, between the Company and
              Toshiba Medical Systems Co., Ltd.
     *10.15   Clinical Research Agreement dated as of November 1, 1995 between The Royal Free
              Hampstead (NHS), Felix Senanayake, M.D. and the Company.
     *10.16   Forms of Medical Advisory Board Agreements between the Company and members of its
              Medical Advisory Board.
   ***10.17   Development and Distribution Agreement between the Company and Carl Zeiss Oberkochen
              dated August 21, 1999 and exhibits thereto (portions of Page 2 of Schedule 1 and Pages 1-8 of
              Schedule 4.3(a) of this exhibit have been omitted pursuant to a request for confidential
              treatment and have been filed separately with the SEC).
   ***10.18   SNN Member Agreement between the Company and Surgical Navigation Specialists Inc.
              dated June 30, 1999 and exhibits thereto.
 *****10.19   Agreement between Cordis Corporation and Photoelectron Corporation dated February 5,
              2001 (Portions of Section VIIIA, Section IXA, Section XIV, Exhibit B, Exhibit C, Exhibit D
              and Exhibit G of this exhibit have been omitted pursuant to a request for confidential
              treatment and have been filed separately with the SEC).
      *21.1   Subsidiaries of the Company.
*******23.1   Consent of independent accountants.
*******24.1   Power of Attorney (including in signature page to this Form 10-K).
*******99.1   Letter to Commission pursuant to temporary note 3T.
</TABLE>
--------
      * Filed as an exhibit to the Company's Registration Statement on Form S-1
        (Reg. No. 333-14541) and incorporated herein by reference.
     ** Filed as an exhibit to the Company's Annual Report on Form 10-K for the
        fiscal year ended January 3, 1998 and incorporated herein by reference.
    *** Filed as an exhibit to the Company's Annual Report on Form 10-K for the
        fiscal year ended January 2, 1999 and incorporated herein by reference.
   **** Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for
        the quarterly period ended July 1, 2000 and incorporated herein by
        reference
  ***** Filed as an exhibit to the Company's Annual Report on Form 10-K for the
        fiscal year ended December 30, 2000 and incorporated herein by
        reference.
 ****** Filed as an exhibit to the Company's Current Report on Form 8-K filed
        with the SEC on December 27, 2001 and incorporated herein by reference.
*******  Filed herewith.