<PAGE>

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                      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 January 1, 2000

                                      OR

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

                For the transition period from        to

                        Commission file number 0-21667

                           PHOTOELECTRON CORPORATION
            (Exact name of registrant as specified in its charter)

            MASSACHUSETTS                              04-3035323
   (State or other jurisdiction of          (IRS Employer Identification No.)
   incorporation or organization)

 5 FORBES ROAD, LEXINGTON, MASSACHUSETTS                  02421
 (Address of principal executive offices)              (Zip Code)

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

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          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>

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  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 16, 2000, there were 7,843,454 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
$24,224,650.

                      DOCUMENTS INCORPORATED BY REFERENCE

  Portions of the Proxy Statement for the Annual Meeting of Stockholders of
the Company on May 17, 2000 are incorporated by reference into Part III of
this Report.

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<PAGE>

                           PHOTOELECTRON CORPORATION

                        1999 ANNUAL REPORT ON FORM 10-K

<TABLE>
<CAPTION>
 Item                                                                                           Page
Number                                                                                         Number
------                                                                                         ------
<S>     <C>                                                                                    <C>
                                                PART I
1.      Business..............................................................................    3

2.      Properties............................................................................   17

3.      Legal Proceedings.....................................................................   17

4.      Submission of Matters to a Vote of Security Holders...................................   17

                                               PART II
5.      Market for Registrant's Common Equity and Related Stockholder Matters.................   18

6.      Selected Financial Data...............................................................   19

7.      Management's Discussion and Analysis of Financial Condition and Results of Operation..   19

8.      Financial Statements and Supplementary Data...........................................   23

9.      Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..   23

                                               PART III
10.     Directors and Executive Officers of the Registrant....................................   23

11.     Executive Compensation................................................................   23

12.     Security Ownership of Certain Beneficial Owners and Management........................   23

13.     Certain Relationships and Related Transactions........................................   23

                                               PART IV
14.     Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................   24
</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.

  Photoelectron Corporation (the "Company") does not expect to be able to
generate sufficient revenue in the near future for it to be able to continue
operations without raising additional capital. Accordingly, the Company is
currently considering alternatives by which to raise additional capital.
Should the necessary funds not be available to the Company on acceptable
terms, there is substantial doubt that the Company will be able to continue as
a going concern.

Overview

  The Company was founded in 1989 and soon after focused its development
efforts on miniature x-ray technology. From this technology, the Company
developed its PRS(TM) system. The Company's latest commercial version of the
PRS system is the PRS400(TM) system. The key component of the PRS 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 PRS system produces low energy photons that are rapidly absorbed in
the tissue immediately surrounding the probe, minimizing irradiation of
surrounding healthy body tissue. The PRS system is protected by thirteen U.S.
patents, with an additional nine patents pending. During 1999, the PRS400
system was integrated into new treatment systems designed to address an
expanding range of clinical applications. These new products, known as the
ACCUBEAM(TM) system and the INTRABEAM(TM) system, have been developed in
collaboration with Carl Zeiss Oberkochen ("Carl Zeiss"), the Company's
strategic partner.

  In August 1999, the Company entered into a strategic alliance with Carl
Zeiss, an international technology leader whose medical systems division
specializes in high technology equipment such as surgical microscopes for
various medical disciplines and state-of-the-art image-guided surgery
equipment. The Company appointed Carl Zeiss as its exclusive distributor for
the PRS system throughout the world (except for Japan where Toshiba Medical
Systems is the Company's distributor of the PRS system) for intracranial
applications and spinal radiotherapy and as its non-exclusive distributor for
the PRS system in the same territory for all other clinical applications. In
addition, Carl Zeiss agreed to assist the Company in the development of new
intraoperative radiotherapy products and to provide service and support for
the Company's products. The alliance with Carl Zeiss gives the Company access
to a global sales force with an established record of sales of high technology
equipment within the medical field.

  In November 1999, the Company announced the launch of two products jointly
developed with Carl Zeiss: (i) the ACCUBEAM system, a device for the treatment
of brain tumors that combines the Company's miniature x-ray source with Carl
Zeiss's stereotactic guided, motorized MKM(TM) surgical microscope system; and
(ii) the INTRABEAM system, a multi-purpose system for intraoperative
radiotherapy that combines the Company's miniature x-ray source with an
articulated support stand from Carl Zeiss.

  In addition to establishing its strategic alliance with Carl Zeiss, the
Company joined the Surgical Navigation Network ("SNN"), a consortium of
medical equipment companies that has established a shared, open-standard,

                                       3
<PAGE>

image-based software system to support their products. By participating in the
SNN consortium and utilizing its software system, the Company can integrate
its miniature x-ray source with the products of other SNN members, including
Philips, Agfa IMPAX, Aesculap and XLTEK. In addition, the SNN participants
agree to promote each other's products on a non-exclusive basis, thus
enhancing the Company's commercial visibility. The software used by SNN is
written and supported by Software Navigation Specialists ("SNS"). SNS is
currently working to integrate the Company's technology into the software
platform shared by the other SNN member companies.

  The primary focus of the Company's initial clinical development was the
treatment of solid brain tumors using stereotactic guidance systems. Surgeons
at the Massachusetts General Hospital (the "MGH") gave assistance and advice
on clinical applications, and the first patient was treated at the MGH in
1992. From 1992 to 1998, approximately 300 patients were successfully treated
at hospitals in the United States, Europe and Japan. In 1998, the United
States Food and Drug Administration (the "FDA") approved the Company's
application for market clearance under Section 510(k) of the Federal Food,
Drug and Cosmetic Act, as amended (the "FDC Act") for intracranial treatment
of tumors, and in 1999, the Company received Section 510(k) market clearance
to use the PRS400 system for the treatment of tumors anywhere in the body. The
British Standards Institute has issued certification necessary to affix the CE
marks to the PRS400 system, which permits it to be distributed in the European
Union. In Japan, the clinical trial phase necessary for government approval
has been completed under the guidance of Toshiba Medical Systems and the
Company anticipates receiving full approval to market the PRS400 system in
fiscal 2000.

  After completing the development of the PRS400 system, the Company's focus
turned toward the development of tools and mechanisms to expand the
established range of clinical applications. Treatments to date have included
brain, breast, colo-rectal, skin and gynecological tumors. More recently, the
Company, together with Carl Zeiss, has developed the ACCUBEAM system for
intraoperative radiotherapy in the brain, head and neck, and spine, and the
INTRABEAM system for intraoperative radiotherapy in other body sites. Both the
ACCUBEAM and INTRABEAM systems incorporate the Company's miniature x-ray
technology. The Company has also begun to explore applications of the
technology to treat non-malignant diseases, including the treatment of
ophthalmic diseases such as Age-Related Macular Degeneration.

  In 1999, the Company completed its development program of a range of
applicators designed to ensure a uniform radiation dose when the miniature x-
ray source is used inside a tumor cavity after 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.

  In November 1999, the Company entered into a loan agreement with PYC
Corporation, a Liberian corporation controlled and beneficially owned by Peter
M. Nomikos, the Company's Chairman and Chief Executive Officer. Under the
agreement, PYC Corporation established a $2.25 million line of credit to be
used by the Company for working capital purposes. Any amounts drawn under the
line of credit accrue interest at a rate equal to 8% per year. In addition,
the Company agreed to issue to PYC Corporation warrants to purchase one share
of the Company's Common Stock for each $5.00 drawn by the Company under the
line of credit. As of March 27, 2000, the Company had drawn down $2.0 million
under the line of credit and had issued to PYC Corporation warrants for the
purchase of 400,000 shares of the Company's Common Stock. The warrants were
issued to PYC Corporation in ten equal installments with an average exercise
price of approximately $3.24 per share.

Products

 Photon Radiosurgery System

  The first application of the Company's miniature x-ray source was the
treatment of brain tumors using radiosurgery. For this application, the
miniature x-ray source was attached to a "stereotactic frame,' a form of
guidance system commonly used by neurosurgeons. The system for delivery of
these stereotactically-guided radiosurgical treatments of brain tumors is the
PRS system, which enables the tip of the miniature x-ray source

                                       4
<PAGE>

to be accurately inserted into the center of brain tumors to destroy the
tumors from the inside. Since its development for the PRS system, the
miniature x-ray source has also been used to deliver focused radiation therapy
at body sites other than the brain. In 1999, the FDA granted Section 510(k)
market clearance for the latest version of the PRS system, the PRS400, to be
used for the treatment of tumors anywhere in the body. The PRS400 also forms
the key element of the Company's new products, the ACCUBEAM and INTRABEAM
systems.

  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 core system is also sold
with various accessories, such as applicators, to irradiate, for example, body
cavities or surfaces, and fixturing devices to support the x-ray probe during
patient treatment.

 THE ACCUBEAM and INTRABEAM SYSTEMS

  The Company has developed the ACCUBEAM system in conjunction with Carl
Zeiss. The ACCUBEAM system was introduced at the Congress of Neurological
Surgeons meeting in October 1999 and the Company believes that it represents a
new concept in the treatment of brain tumors. In the ACCUBEAM system, the
Company's miniature x-ray source is integrated with Carl Zeiss's robotic, MKM
microscope system. The MKM microscope system enables neurosurgeons to use
medical images displayed on a computer to guide removal of a brain tumor.
Integration with the Company's x-ray source allows image-guided removal of a
brain tumor to be accompanied by precisely directed and controlled irradiation
of the tumor bed (the region surrounding a tumor). The goal is that the
combination of precision surgery with precision intraoperative radiotherapy
will reduce the likelihood of the tumor re-growing. The Company believes that
the combined system is the first ever integrated x-ray and surgical guidance
system for the treatment of brain tumors.

  The Company has also developed the INTRABEAM system in conjunction with Carl
Zeiss. The INTRABEAM system was launched at the American Society for
Therapeutic Radiology and Oncology meeting in October 1999. The INTRABEAM
system is a multi-purpose system for intraoperative radiotherapy for the
treatment of many types of cancer. It consists of the Company's x-ray source
mounted on an articulated support stand from Carl Zeiss. For most treatments,
the point source of x-rays is enclosed in a treatment applicator, which is
placed inside a tumor cavity after surgical removal of the tumor, a concept
known as intraoperative radiotherapy. The combination of x-ray source and
applicators was first tested at the Middlesex Hospital in London, where they
were used to treat breast and rectal cancers. The INTRABEAM system
incorporates the treatment applicators which the FDA recently approved for
sale in the United States.

  The PRS, ACCUBEAM and INTRABEAM systems can deliver a range of radiation
treatments that can be categorized as follows:

  . Interstitial Treatments. Interstitial treatments are where the x-ray
    source is inserted directly into a tumor. Examples include the brain
    tumor treatments for which the x-ray source system was first designed,
    and image guided radiotherapy of small breast tumors. The x-ray source
    has also been used to treat other solid tumor targets, including
    gynecological tumors. Treatment programs for the liver, kidney and
    irresectable tumors of the pancreas are currently under development.

  . Intraoperative Radiotherapy and Intracavity Radiotherapy
    Treatments. Intraoperative treatments are where the x-ray source is
    inserted into a tumor bed after removal of a tumor. Generally, these
    treatments make use of the Company's range of applicators to fill out the
    cavity and conform the target tissue to the radiation dose pattern.
    Examples include the breast, after lumpectomy, and the brain and colo-
    rectal tumors after tumor resection. Intracavity treatments are those
    where the x-ray source is inserted into a body cavity and include
    gynecological treatments.

                                       5
<PAGE>

  . Surface Radiotherapy. The Company has a range of applicators (currently
    for investigational purposes only), designed to confine radiation
    treatments to the surface of adjacent tissue. These were originally
    designed for treatment of skin disorders, but have since been proposed
    for intraoperative use where localized irradiation of small targets is
    thought to be beneficial.

  . Special Treatments. The Company's miniature x-ray source's geometry lends
    itself to certain special treatments. One application currently under
    investigation is the treatment of macular degeneration. A dedicated
    micro-collimation device (not available commercially) has been developed
    which, when placed on the miniature x-ray source, produces a forward
    projecting radiation beam of between 0.8 and 3 millimeters in diameter.

 Other Potential Product Applications

  In 1998, the Company initiated animal studies in collaboration with
physicians at Johns Hopkins University School of Medicine in Baltimore,
Maryland to characterize treatment of kidney and liver tumors and to test
specialized accessory positioning equipment designed for use with the
miniature x-ray system. These pre-clinical studies were completed in 1999 and
the Company believes the results were encouraging. The Company intends to
promote future development of clinical systems for this application at one or
more of the Company's established treatment centers. During 1999, the Company
initiated animal studies in collaboration with physicians at the Massachusetts
Eye and Ear Hospital in Boston, Massachusetts to characterize the use of its
miniature x-ray system for the treatment of Age-Related Macular Degeneration.
The Company intends to continue to support pre-clinical and clinical activity
in this area.

  The Company prioritizes the types of tumor applications it explores based on
several factors. Such factors include, among other things, potential market
size, physician interest in trials and available corporate resources.
Periodically, the Company reviews existing applications being pursued as well
as alternative applications. There can be no assurance that the applications
selected for study will lead to successful commercial applications of the x-
ray system.

                                       6
<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. These consultations provide general advice to
the Company on its business and products, including the PRS system. The
members of the Medical Advisory Board are 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>
<CAPTION>
                 Name                                  Position
                 ----                                  --------
 <C>                                   <S>
 Nicholas T. Zervas, M.D. (Chairman).. Distinguished Higgins Professor of
                                       Neurosurgery, Harvard Medical School,
                                       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 Medicine, Our Lady of Mercy
                                       Medical Center, New York Medical
                                       College, New York, 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. ............... Director of Northeast Proton Therapy
                                       Center, 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.

Marketing and Sales

  During 1999, the Company developed and implemented a new strategy for sales
and marketing. In May 1999, the Company downsized its sales force as part of a
general restructuring. In August 1999, the Company signed a distribution and
product development agreement with Carl Zeiss. Carl Zeiss now manages the
sales and distribution of a range of the Company's products, including the
PRS, ACCUBEAM and INTRABEAM systems. In addition to sales and distribution,
Carl Zeiss will also assist with service and support of the Company's
products, and participate in co-developments. The agreement is a worldwide
arrangement, with the exception of Japan where the Company has an arrangement
with Toshiba Medical Systems. Carl Zeiss is an international technology leader
whose medical systems division specializes in high technology equipment such
as surgical microscopes for various medical disciplines and its products
include state-of-the-art image-guided surgery equipment. The alliance with
Carl Zeiss gives the Company access to a global sales force with an
established

                                       7
<PAGE>

record of sales of high technology equipment within the medical field. A large
proportion of the Carl Zeiss sales force received the training needed to sell
the Company's products and new sales and marketing materials were prepared
reflecting the involvement of Carl Zeiss. The Company's products were
represented by Carl Zeiss at a number of major trade shows, including the
Congress of Neurological Surgeons' meeting in Boston in November 1999.

  In December 1999, the Company appointed Charles Vecoli as Vice President of
Marketing. Mr. Vecoli joined the Company in August 1999 as Product Manager.
Mr. Vecoli was previously employed by Radionics Inc., where he had served as
Product Manager of the radiation therapy product line. One of Mr. Vecoli's
primary tasks is to assist with the interface between the Company and Carl
Zeiss.

  The Company intends to identify other distribution partners as the range of
its products and clinical applications develop.

Clinical Trials

  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. There are, however, certain clinical
trials on-going using the technology that could markedly expand the range of
accepted uses of the system.

  . Breast Cancer: Over recent years, the Company's intraoperative
    radiotherapy product line has been used to provide an intraoperative
    radiation boost dose, following lumpectomy. One further development of
    this approach is being pioneered at the Middlesex Hospital (London, UK)
    where Professor Michael Baum has initiated a clinical trial to evaluate
    whether the INTRABEAM system can be used as the only radiation treatment
    for breast cancer. If positive results are obtained, this study could
    significantly change the established approach to treatment which uses a
    fractionated course of radiation treatment spread over several weeks. The
    time taken to complete this trial will depend on the rate of patient
    accrual but will certainly take several years to assess. Several U.S.
    hospitals have also expressed an interest in participating in similar
    trials.

  . Macular Degeneration: In 1999, the Company began funding pre-clinical
    studies at the Massachusetts Eye and Ear Hospital (Boston, MA) to
    evaluate the potential for its miniature x-ray source to be used in the
    treatment of Age-Related Macular Degeneration. These pre-clinical studies
    are expected to be completed during 2000, at which time patient
    treatments may begin.

Patents and Proprietary Rights

  A U.S. patent directed to the base the PRS400 system technology was issued
to the Company in October 1992. Two 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 use of the PRS system to treat
brain tumors were issued to the Company. A U.S. patent, directed to a flexible
probe PRS system 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 system. 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 system 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
patents in 1997 relating to accessory equipment, including the Company's CCD
microdensitometer. The Company has three additional patents and nine additonal
pending U.S. patent applications, and has foreign patent applications in
selected foreign countries which correspond to certain of its U.S. patent
applications. As of January 1, 2000, two patents corresponding to the
Company's initial U.S. patents have been issued in Australia, Canada and
Russia and two patents directed to the treatment of brain tumors have been
issued in Japan. The Company has thirty-five other foreign applications
currently pending.

                                       8
<PAGE>

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, over time, from the same vendors.
While the Company intends to negotiate supply contracts, where appropriate,
with certain of its key suppliers, 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 intends to implement the necessary operational systems to
support the successful commercial production of the PRS, ACCUBEAM and
INTRABEAM systems and any other products. Specifically, the Company intends to
continue to pursue 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. 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 European Community. 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.

Competition

  The medical 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 therapies. Many of these entities have substantially 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, the PRS, ACCUBEAM and
INTRABEAM systems will need 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, ACCUBEAM and
INTRABEAM systems 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.

  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.

                                       9
<PAGE>

Government Regulation

 U.S.

  The PRS, ACCUBEAM and INTRABEAM systems 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 system, can be marketed. The Company intends to
continue to pursue a strategy intended to result in marketing clearance of as
many products and components as possible as quickly as possible in order to
maximize flexibility in marketing.

  FDA authorization to commercially distribute a new device can be obtained in
either of two ways, depending on the device. The first process (which is the
more comprehensive of the two) applies to a new device that is not
substantially equivalent to an existing, legally marketed product, and
requires generally that the Company establish the safety and effectiveness of
the device through specific procedures. A Premarket Approval ("PMA")
application must be submitted to the FDA that contains, among other things,
the results of clinical trials performed pursuant to FDA-approved protocols.
The PMA application also contains other information required under the FDC Act
such as a full description of the device and its components, a full
description of the methods, facilities and controls used for manufacturing and
proposed labeling. Finally, the manufacturing site for the device subject to
the PMA must pass an FDA pre-approval inspection. The PMA process can be
expensive, uncertain and lengthy, often requiring several years to complete.

  The second of the two FDA processes is available for a new or significantly
modified device which is "substantially equivalent" to an existing legally
marketed device. Such a new device may be commercially introduced when, after
submission of a pre-market notification to the FDA under Section 510(k) of the
FDC Act, the FDA issues an order permitting commercial distribution. The FDA
has recently been requiring a more rigorous demonstration of substantial
equivalence than in the past, including in many instances the results of
clinical trials performed pursuant to FDA approved protocols. As between the
two sets of procedures (the PMA approval procedure and the Section 510(k)
clearance procedure), the PMA procedures are normally more complex and time
consuming than 510(k) Premarket Notification procedures, since the PMA
procedures are for products that are not comparable to any other product in
the market. However, even the Section 510(k) procedures are time-consuming and
expensive. The FDA may also require the ongoing monitoring of products which
have been cleared for commercialization under those procedures.

  On February 9, 1998 the Company filed a Section 510(k) pre-market
notification with respect to the current model containing the Company's core
technology, the PRS400 system, for the treatment of intracranial tumors. On
July 27, 1998, the FDA granted Section 510(k) marketing clearance for the PRS
system for use in the irradiation of intracranial tumors. In September 1999,
the FDA granted Section 510(k) marketing clearance for the PRS system for
radiation treatments, without restriction to particular body sites, and also
received clearance to utilize a range of applicators for use with the PRS
system in intraoperative radiotherapy. The Company believes that the Section
510(k) market clearance for the PRS system can also be applied to the
Company's new products, the ACCUBEAM and INTRABEAM systems.

  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 will
be sufficient to comply with the FDA's cGMP standards.

                                      10
<PAGE>

  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. Currently, all new
medical devices to be marketed in any European Union country must first obtain
a CE Mark. Obtaining a CE Mark with respect to a particular medical device
requires the accumulation 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 EC Medical Device Directives relating to manufacturing, quality
assurance and documentation under the BS EN ISO 9001:1994 series standards and
relating to the design, manufacture, quality control, safety and performance
of the particular device.

  In order to have the capacity to examine a large number of new products, the
National Competent Authorities have mandated "Notified Bodies" (non-
governmental organizations) to act as their agents and qualify manufacturers
equipment in accordance with EC standards. The Company is thereby able to
affix the CE Mark to its PRS products, including the ACCUBEAM and INTRABEAM
systems, and to freely distribute them within the European Community 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 marketing of the PRS,
ACCUBEAM and INTRABEAM systems 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, ACCUBEAM and INTRABEAM
systems 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 PRS400-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

                                      11
<PAGE>

time regardless of illness. To the extent that the PRS, ACCUBEAM and INTRABEAM
systems 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 health care products may take in response to any health care reform
proposals or legislation, the existence and pendency of such proposals could
have a material adverse effect on the Company in general.

  With respect to health care reimbursement in the European Community (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 January 1, 2000, the Company had 26 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.

Risk factors that may affect future results

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

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

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

  . Research and development of the PRS, ACCUBEAM and INTRABEAM systems and
    other potential products;

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

  . Marketing the PRS, ACCUBEAM and INTRABEAM systems and other products.

  The Company's 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, ACCUBEAM and INTRABEAM systems and any of
    the Company's other products;

                                      12
<PAGE>

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

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

  . Development of competing technologies.

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

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

  The Company was incorporated in January of 1989 and has thus had a
relatively short operating history. The Company is still in the process of
commercializing treatment systems based on the PRS400 system, the Company's
core technology. The Company may not succeed in completing commercialization
of its product range. The Company has received regulatory approval from the
FDA and clearance from the European Union to market the PRS system in the
United States and Europe, respectively. The Company believes that these
approvals can be extended to the ACCUBEAM and INTRABEAM systems. However, the
Company's assessment of the scope of these approvals are subject to the review
of the FDA and the European Union. In addition, the Company is still waiting
for approval from other countries in which the Company may market the PRS,
ACCUBEAM and INTRABEAM systems. The Company cannot be sure that any other
countries will grant it regulatory approval to market the PRS, ACCUBEAM and
INTRABEAM systems. In addition, the Company has only sold 7 PRS systems and
may not be able to sell any more PRS systems even if the Company receives all
necessary regulatory approvals and completes the commercialization of the PRS,
ACCUBEAM and INTRABEAM systems.

The Company may not be reimbursed by third party payors.

  The Company's ability to be reimbursed for the cost of its products and
related treatments from third party payors will have a significant impact on
the Company's ability to commercialize its products. Such third party payors
include, among others, private insurance companies, self-insured employers,
health maintenance organizations, and federal and state sources of payment
under the Medicare and Medicaid programs. There is no uniform policy on
reimbursement among third party payors, and the PRS, ACCUBEAM and INTRABEAM
systems or any of the Company's other products may not qualify for
reimbursement. In addition, foreign countries have their own health care
reimbursement systems, and the Company may not qualify for reimbursement from
such foreign third party payors.

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

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

  The Company has experienced significant operating losses in each year since
its incorporation, primarily due to the cost of substantial research and
development of the PRS system. As of January 1, 2000, the Company had an
accumulated deficit of approximately $38.5 million and expects to continue to
incur losses until the Company generates revenues to offset the funds spent on
commercializing the PRS system. The Company's ability to achieve profitable
operations will depend, in large part, on whether the Company can successfully
commercialize the PRS, ACCUBEAM and INTRABEAM systems and/or any other
products, and whether the Company can effectively make the transition to a
manufacturing and marketing company. It is possible that the

                                      13
<PAGE>

PRS, ACCUBEAM and INTRABEAM systems will never gain commercial acceptance, and
the Company may never generate significant revenues or achieve profitability.
For these reasons, the Company believes it will continue to incur substantial
operating losses for the foreseeable future, and that these losses may be
significantly higher than the Company's current losses.

The Company is still waiting for certain regulatory clearances in order to
market the PRS.

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

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

  Furthermore, the Company may not receive any necessary regulatory approvals
if the Company develops any additional products in the future, the length of
time for such approvals may be extensive, and the cost of attempting to obtain
any such approvals may be prohibitive. In addition, the Company's inability to
obtain or maintain requisite governmental approvals could delay or preclude
the Company from further developing and marketing the PRS, ACCUBEAM and
INTRABEAM systems and other products. Consequently, such delays could impair
the Company's ability to generate revenues and continue as a going concern.

The Company's products are subject to extensive ongoing government regulation.

  The Company may need to obtain additional approvals from the FDA if the
Company decides to change or modify the PRS400, ACCUBEAM and INTRABEAM
systems. In that case, the FDA may not grant any new approvals. In addition,
if the Company fails to comply with FDA regulatory standards, the FDA could
force the Company to withdraw its products from the market or impose sanctions
or fines, each of which could have a material adverse effect on the Company's
business, financial condition, and results of operations.

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

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

  The medical device industry is subject to rapid, unpredictable, and
significant technological change. The Company's business is subject to
competition in the U.S. and abroad from a variety of sources, including
universities, research institutions, and medical device, chemical, and
biotechnology companies. Many of these potential competitors have
substantially greater technical, financial, and regulatory resources than the
Company and are accordingly better equipped to develop, manufacture, and
market their products. If these companies

                                      14
<PAGE>

develop and introduce products and processes competitive with or superior to
the Company's products, the Company may not be able to compete successfully
against such competitors.

Risk of utilizing non-company distribution channels.

  As the Company makes the transition from a company with products in
development but no product sales to a manufacturing and marketing company, the
Company substantially relies upon Carl Zeiss, its strategic partner, to sell
and distribute its products. If Carl Zeiss is unsuccessful in selling our
products or is unable to distribute our products in a satisfactory manner, it
could have a material adverse effect on our business, financial condition and
results of operations.

Uncertain protection of intellectual property.

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

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

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

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

  As of March 16, 2000, Peter M. Nomikos, Chairman of the Board and Chief
Executive Officer of the Company beneficially owned approximately 47% of the
issued and outstanding shares of Common Stock, and the Company's principal
stockholders and certain affiliates of the Company (including Mr. Nomikos)
beneficially owned in the aggregate approximately 56% of the issued and
outstanding shares of Common Stock. Certain principal stockholders serve as
directors or have representatives who serve as directors of the Company. Due
to Mr. Nomikos's ownership of Common Stock coupled with the positions he holds
in the Company, Mr. Nomikos, either alone or with the other principal
stockholders, has the ability to significantly influence all matters requiring
approval by the stockholders of the Company, including the election of all
directors, acquisitions, sales of all or substantially all of the Company's
stock or assets, and other extraordinary transactions.

The Company depends on key personnel.

  The Company depends on the continued services and performance of its
scientific personnel and senior management. If the Company loses any key
personnel, it could significantly and adversely impact the Company's research
and development efforts or its strategic objectives. In addition, competition
among medical device

                                      15
<PAGE>

companies for highly skilled scientific and management personnel is
increasingly intense. In order to achieve and maintain the commercialization
of the PRS, ACCUBEAM and INTRABEAM systems, the Company will need to attract
and retain additional key personnel, and the Company cannot be sure that it
will be able to do so. The Company has no employment agreements with any of
its employees, nor has the Company purchased "key person" life insurance.

The Company may experience shortages of components for the PRS, ACCUBEAM and
INTRABEAM systems; the Company relies on a small number of suppliers.

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

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

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

Product liability risks.

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

Anti-takeover provisions; effects of issuance of preferred stock.

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

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

                                      16
<PAGE>

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

Volatile stock price.

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

Absence of dividends.

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

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 the PRS400 system. The Company believes that
its facility will be adequate to meet its foreseeable requirements through at
least the year 2002. The Company also has the right to extend the current
lease for an additional five years.

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 January 1, 2000.

                                      17
<PAGE>

                                    PART II

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

  As of January 4, 2000, there were 89 holders of record of the Company's
Common Stock. The Company believes that there are approximately 1,885
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 1998........................................... 9 7/8   5 3/4
   Second Quarter 1998.......................................... 9       5 3/4
   Third Quarter 1998........................................... 9 3/4   3 3/4
   Fourth Quarter 1998.......................................... 7 1/2   2 1/4
   First Quarter 1999........................................... 6       2 15/16
   Second Quarter 1999.......................................... 4       1
   Third Quarter 1999........................................... 6 3/8   2 1/4
   Fourth Quarter 1999.......................................... 5 15/32 2 1/8
</TABLE>

Sales of Unregistered Securities:

  On November 15, 1999, the Company and PYC Corporation entered into a six
month $2.25 million line of credit at an 8% annual interest rate. In
connection with the loan, the Company was required to issue to PYC Corporation
warrants to purchase up to 450,000 shares of the Company's Common Stock at the
rate of warrants to purchase one share for each $5.00 drawn by the Company.
The exercise price of the warrants is equal to the average closing price of
the Company's Common Stock for the ten trading days preceding the date of each
draw made under the line of credit. As of January 1, 2000, the Company had
drawn down $800,000 under the line of credit and had issued to PYC Corporation
warrants for the purchase of 160,000 shares of the Company's Common Stock. The
warrants were issued to PYC Corporation in four equal installments on November
18, 1999, November 30, 1999, December 14, 1999 and December 29, 1999 with
exercise prices of $3.76, $3.44, $2.94 and $2.74, respectively.

  The warrants were issued to PYC Corporation pursuant to Section 4(2) under
the Securities Act of 1933.

                                      18
<PAGE>

Item 6. Selected Consolidated Financial Data.

  The selected consolidated statement of operations data and consolidated
balance sheet data presented below as of January 2, 1999 and January 1, 2000
and the consolidated statement of operations data presented below as of
January 3, 1998, 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 December 30, 1995, and December 28, 1996 and
the consolidated balance sheet data presented below as of January 3, 1998, are
derived from the Company's Consolidated Financial Statements and Notes thereto
not included in this Form 10-K, which have 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
                         ----------------------------------------------------------
                         December 30, December 28, January 3, January 2, January 1,
                             1995         1996        1998       1999       2000
                         ------------ ------------ ---------- ---------- ----------
                                   (in thousands, except per share data)
<S>                      <C>          <C>          <C>        <C>        <C>
Consolidated Statement
 of Operations Data:
Revenues................   $    --      $    --     $    725   $    678   $    535
Cost of goods sold......        --           --          361        278        267
                           --------     --------    --------   --------   --------
Gross margin............        --           --          364        400        268
Operating expenses:
  Research and
   development
   expenses.............      3,226        3,577       4,626      5,434      4,426
  General and
   administrative
   expenses.............        866        1,512       2,306      3,107      3,426
                           --------     --------    --------   --------   --------
  Total operating
   expenses.............      4,092        5,089       6,933      8,541      7,852
                           --------     --------    --------   --------   --------
Operating loss..........     (4,092)      (5,089)     (6,569)    (8,141)    (7,584)
  Interest income
   (expense), net.......        (25)         130         713        467         35
                           --------     --------    --------   --------   --------
Net loss................   $ (4,117)    $ (4,959)   $ (5,856)  $ (7,674)  $ (7,549)
                           ========     ========    ========   ========   ========
Net loss per share......   $  (3.72)    $  (3.12)   $  (0.87)  $  (1.02)  $  (0.97)
                           ========     ========    ========   ========   ========
Weighted average basic
 and diluted shares.....      1,107        1,588       6,694      7,489      7,749

<CAPTION>
                         December 30, December 28, January 3, January 2, January 1,
                             1995         1996        1998       1999       2000
                         ------------ ------------ ---------- ---------- ----------
<S>                      <C>          <C>          <C>        <C>        <C>
Consolidated Balance
 Sheet Data:
Cash and cash
 equivalents............   $  7,191     $  2,537    $  2,287   $  3,686   $    134
Total assets............      8,703        5,117      16,425      9,135      2,864
Total long-term debt,
 including current
 portion................      1,940        2,043       1,686        719      1,566
Deficit accumulated
 during development
 stage..................    (12,425)     (17,383)    (23,239)   (30,913)   (38,462)
Total shareholders'
 equity.................   $  6,493     $  2,486    $ 14,012   $  7,453   $    247
</TABLE>

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

Overview

  The Company is engaged in the design, development and commercialization of
the PRS system, a proprietary, therapeutic device for the treatment of
cancerous tumors through the application of radiation directly into a tumor.
To date, the Company has not received any significant revenue from the sale of
its current PRS400 system model.

  The Company has experienced significant operating losses in each year since
its inception, due primarily to substantial research and development
expenditures. As of January 1, 2000, the Company had an accumulated

                                      19
<PAGE>

deficit of approximately $38.5 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 PRS400 system will ever gain commercial
acceptance, or that the Company will ever generate significant revenues or
achieve profitability. The Company's ability to achieve profitable operations
will be dependent in a large part on whether it can successfully commercialize
the PRS, ACCUBEAM and INTRABEAM systems and make the transition to a
manufacturing and marketing company. The Company anticipates that its sales
and marketing efforts with Carl Zeiss will begin to generate sales of the PRS,
ACCUBEAM and INTRABEAM systems in the upcoming year. The Company anticipates
that its research and development, sales and general and administrative
expenses will increase minimally during 2000.

  The Company does not expect to be able to generate sufficient revenue in the
next year to support the continuing operations of the organization and will
need to raise the necessary capital to offset this short fall. Should the
necessary funds not be available to the Company on acceptable terms, there is
substantial doubt that the Company will be able to continue as a going
concern.

  The Company obtained a Section 510(k) marketing clearance for the PRS400
system on July 21, 1998, which the Company developed for introduction as its
first commercial product. Simultaneous with completion of PRS400 system
product development, the Company completed the implementation of programs
designed to ensure compliance with the FDA's cGMP standards. The Company also
completed the process of seeking certification to the Medical Device Directive
Annex II, enabling self-certification of the European Community Mark (CE). On
December 18, 1998, the Company initiated commercial distribution of the PRS
system. In September 1999, the Company obtained a Section 510(k) marketing
clearance from the FDA to market the system for radiotherapy treatments,
regardless of treatment site.

  In August 1999, the Company entered into a strategic alliance with Carl
Zeiss, an international technology leader whose medical systems division
specializes in high technology equipment such as surgical microscopes for
various medical disciplines and state-of-the-art image-guided surgery
equipment. The Company appointed Carl Zeiss as its exclusive distributor for
the PRS system throughout the world (except for Japan where Toshiba Medical
Systems is the Company's distributor of the PRS system) for intracranial
applications and spinal radiotherapy and as its non-exclusive distributor for
the PRS system in the same territory for all other clinical applications. In
addition, Carl Zeiss agreed to assist the Company in the development of new
intraoperative radiotherapy products and to provide service and support for
the Company's products. The alliance with Carl Zeiss gives the Company access
to a global sales force with an established record of sales of high technology
equipment within the medical field.

  In November 1999, the Company announced the launch of two products jointly
developed with Carl Zeiss: (i) the ACCUBEAM system, a device for the treatment
of brain tumors that combines the Company's miniature x-ray source with Carl
Zeiss's stereotactic guided, motorized MKM surgical microscope system; and
(ii) the INTRABEAM system, a multi-purpose system for intraoperative
radiotherapy that combines the Company's miniature x-ray source with an
articulated support stand from Carl Zeiss.

  In addition to establishing its strategic alliance with Carl Zeiss, the
Company joined the SNN, a consortium of medical equipment companies that has
established a shared, open-standard, image-based software system to support
their products. By participating in the SNN consortium and utilizing its
software system, the Company can integrate its miniature x-ray source with the
products of other SNN members, including Philips, Agfa IMPAX, Aesculap and
XLTEK. In addition, the SNN participants agree to promote each other's
products on a non-exclusive basis, thus enhancing the Company's distribution
capabilities. The software used by SNN is written and supported by SNS. SNS is
currently working to integrate the Company's technology into the software
platform shared by the other SNN member companies.

                                      20
<PAGE>

  On December 13, 1995, the Company and Toshiba entered into an agreement
pursuant to which Toshiba is helping to develop and support clinical trials of
the PRS400 system in Japan. The development and support of the clinical trials
included purchasing two complete systems of the PRS system for use in the
clinical trials, installing and maintaining the PRS system, and providing
assistance to the physicians and hospitals conducting the trials, including
collection and analysis of clinical data. The Company and Toshiba expect to
submit to the Japan Ministry of Health an application for product approval
(shonin) of the PRS system in the first quarter of fiscal 2000. The Company
and Toshiba expect to obtain product approval (shonin) in Japan for the PRS
system in the second half of 2000. Once regulatory approvals for the PRS
system are obtained in Japan, Toshiba will serve as the Company's exclusive
distributor in Japan.

Results of Operations

 Fiscal Year Ended January 1, 2000 and January 2, 1999

  Revenues: Revenues decreased by $143,366 from $678,000 in 1998 to $534,634
in 1999. The 1998 revenues reflect the initial sales of the PRS400 system. The
1999 revenues reflect the Company's continuing sales of the PRS400 system.
Cost of Goods Sold decreased by $11,598 from $278,251 in 1998 to $266,653 in
1999.

  Research and development expenses: Research and development expenses
decreased by $1.0 million from approximately $5.4 million in 1998 to $4.4
million in 1999. The principal costs in research and development were
attributed to the development of the PRS400 system for commercialization, and
the development of the ACCUBEAM and INTRABEAM systems. The variation also
reflects the restructuring of the Company from the middle of 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
as well as macular degeneration. Finally, additional costs were incurred in
complying with regulatory agencies in the U.K. concerning breast cancer
research and trial protocol.

  General and administrative expenses: General and administrative expenses
increased by $319,281 from approximately $3.1 million in 1998 to approximately
$3.4 million in 1999. A portion of this increase is attributable to expenses
incurred in connection with the Company entering into a distribution agreement
with Carl Zeiss. The remaining portion of this increase is related to legal
and professional fees associated with the Company's reporting requirements and
other obligations under the Securities Exchange Act of 1934, general corporate
representation, and the protection of intellectual property rights.

  Interest income: Interest income decreased by $419,701 from $550,328 in 1998
to $130,627 in 1999. The change resulted from a reduction in amounts invested
as net proceeds from the Company's initial public offering were used for
research and development and general and administrative expenses and for
working capital.

 Fiscal Year Ended January 2, 1999 and January 3, 1998

  Revenues: Revenues decreased by $47,374 from $725,374 in 1997 to $678,000 in
1998. The 1997 revenues reflect the sale of two Model 3 PRS systems to
Toshiba. The 1998 revenues reflect the Company's initial sales of the PRS400
system. Cost of Goods Sold decreased by $83,285 from $361,536 in 1997 to
$278,251 in 1998.

  Research and development expenses: Research and development expenses
increased by $807,081 from approximately $4.6 million in 1997 to $5.4 million
in 1998. The principal costs in research and development were the completion
of the development of the PRS400 system for commercialization. The variation
also reflects significant increases in expenses related to the Company's
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 as well as macular degeneration. Finally, additional costs
were incurred in complying with regulatory agencies in the U.K. concerning
breast cancer research and trial protocol.

  General and administrative expenses: General and administrative expenses
increased by $800,705 from approximately $2.3 million in 1997 to approximately
$3.1 million in 1998. The increase is attributable to a

                                      21
<PAGE>

growth in personnel from 38 in 1997 to 48 employees in 1998 and related costs.
Additional increases related to legal and professional fees related to the
Company's reporting requirements and other obligations under the Securities
Exchange Act of 1934, general corporate representation, and the protection of
intellectual property rights.

  Interest income: Interest income decreased by $269,347 from $819,675 in 1997
to $550,328 in 1998. The change resulted from a reduction in amounts invested
as net proceeds from the Company's initial public offering were used for
research and development and general and administrative expenses and for
working capital.

Liquidity and Capital Resources

  The Company has expended substantial funds to research and develop the PRS,
ACCUBEAM and INTRABEAM systems 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,
ACCUBEAM and INTRABEAM systems. 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 $20.8 million. On February 4, 1997, the Company
completed an initial public offering of 2,275,000 shares of Common Stock,
including the underwriters' overallotment option, at a price of $8.50 per
share. Net proceeds to the Company from the offering were approximately
$16,818,854.

  Consolidated working capital was $(778,516) at January 1, 2000, compared
with approximately $6.2 million at January 2, 1999. Included in working
capital are cash and cash equivalents of $0.1 million at January 1, 2000,
compared with $3.7 million at January 2, 1999. During 1999, $6.3 million of
cash was used for operating activities.

  The Company used $300,836 of cash in 1999 for fixed assets and leasehold
improvements associated with its facility.

  The Company received $296,668 of cash in 1999 from the exercise of stock
options to purchase Common Stock.

  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.

  During 1998, the Company concluded settlement discussions with a physician
and his employer. The Company had been notified that such physician and his
employer believed that they had certain rights with regard to their
understanding of the Company's planned use of the PRS system for treatment of
tumors in body cavities. No formal legal proceedings were initiated and the
Company reached an agreement with the parties as to settlement of the matter.
The settlement of the matter did not have a material effect on the Company's
financial position or results of operations.

  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, ACCUBEAM and INTRABEAM systems 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

                                      22
<PAGE>

technologies. As of January 1, 2000, the Company estimates that its available
cash and cash equivalents, bridge financing from PYC Corporation and together
with the start of revenues in early 2000, from product sales, will allow the
Company to continue operations for approximately three to four months, and
that it therefore will be necessary for the Company to raise additional
capital in the immediate future. Any additional equity financings will be
dilutive to the Company's stockholders. No assurance can be given that the
necessary funds will be available to the Company on acceptable terms, if at
all. Should the Company be unable to raise additional capital on acceptable
terms, there is substantial doubt that the Company will be able to continue as
a going concern.

Forward-Looking Statements:

  Certain statements contained in this Report, including without limitations,
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.

                                   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 Annual Meeting of Stockholders on May 17, 2000 to be filed with the
Commission on or about April 19, 2000 (the "Proxy Statement"), under "Director
and Executive Officers" 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 "Security Ownership of Certain Beneficial Owners and
Management" 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.

                                      23
<PAGE>

                                    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) Financial Data Schedule is included as Exhibit 27 to this Form 10-K. All
other Schedules are not required under the instructions relating to the
applicable accounting regulations of the Securities and Exchange Commission or
are inapplicable, and therefore have been omitted.

  (c) Reports on Form 8-K

  None.

                                      24
<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 January 2, 1999 and January 1, 2000.....  F-3

Consolidated Statements of Operations for the years ended January 3, 1998,
 January 2, 1999 and January 1, 2000......................................  F-4

Consolidated Statements of Cash Flows for the years ended January 3, 1998,
 January 2, 1999 and January 1, 2000......................................  F-5

Consolidated Statements of Shareholders' (Deficit) Equity at January 3,
 1998, January 2, 1999 and January 1, 2000................................  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 in
the development stage) as of January 2, 1999 and January 1, 2000, and the
related consolidated statements of operations, shareholders' (deficit) equity
and cash flows for each of the three years in the period ended January 1, 2000
and for the period from inception (January 4, 1989) to January 1, 2000. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Photoelectron Corporation and its subsidiary as of January 2, 1999 and January
1, 2000, and the results of their operations and their cash flows for each of
the three years in the period ended January 1, 2000 and for the period from
inception (January 4, 1989) to January 1, 2000, in conformity with generally
accepted accounting principles.

  The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has incurred losses from
operations for the year in the period ended January 1, 2000 and from inception
(January 4, 1989) to January 1, 2000, and anticipates operating losses and
other cash requirements in the next 12 months in excess of available cash.
Therefore, the Company will need to obtain additional funding or alternative
means of support or both, in order to continue as a going concern. At the
present time, the Company has not entered into an arrangement for additional
funding or financial support. Consequently, there is substantial doubt
concerning the Company's ability to continue as a going concern. Management's
plans in regard to these matters are discussed in Note 1. The accompanying
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.

                                          ARTHUR ANDERSEN LLP

Boston, Massachusetts
February 18, 2000

                                      F-2
<PAGE>

                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                     January 2,    January 1,
                                                        1999          2000
                                                    ------------  ------------
<S>                                                 <C>           <C>
                      ASSETS
Current Assets:
  Cash and cash equivalents........................ $  3,686,457  $    134,104
  Accounts receivable..............................      260,000        87,500
  Inventories......................................    1,454,706     1,437,557
  Prepaid expenses.................................      336,287       146,799
  Held to maturity investments (Note 2)............    1,993,056           --
  Other current assets.............................      115,803        32,272
                                                    ------------  ------------
    Total current assets...........................    7,846,309     1,838,232
                                                    ============  ============
Property and Equipment:
  Computer equipment...............................      899,085       960,324
  Laboratory and production equipment..............      926,352       975,408
  Clinical site equipment..........................      801,965       978,898
  Furniture and fixtures...........................      165,898       177,883
  Leasehold improvements...........................      804,263       805,886
                                                    ------------  ------------
  Property and equipment...........................    3,597,563     3,898,399
  Less--Accumulated depreciation and amortization..    2,308,683     2,872,636
                                                    ------------  ------------
  Net property and equipment.......................    1,288,880     1,025,763
                                                    ------------  ------------
    Total assets................................... $  9,135,189  $  2,863,995
                                                    ============  ============
       LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
  Accounts payable................................. $    346,363  $    256,982
  Accrued expenses (Note 3)                              561,650       630,495
  Accrued payroll and benefits.....................       55,409        75,690
  Deferred revenue.................................          --         87,500
  Convertible subordinated notes (Note 8)..........      719,100       761,770
  Convertible note payable (Note 9)................          --        804,311
                                                    ------------  ------------
    Total current liabilities......................    1,682,522     2,616,748
                                                    ============  ============
Commitments and Contingencies (Note 7)
Shareholders' Equity (Notes 8 , 9 and 10):
  Preferred stock, $0.01 par value--Authorized--
   7,500,000 shares issued and outstanding--none
   and none at January 2, 1999, and January 1,
   2000, respectively..............................          --            --
  Common stock, $0.01 par value--Authorized--
   15,000,000 shares issued and outstanding--
   7,704,254 and 7,768,754 at January 2, 1999, and
   January 1, 2000, respectively...................       77,042        77,688
  Capital in excess of par value--common stock.....   38,324,377    38,641,184
  Deferred compensation............................      (29,913)       (9,986)
  Subscription receivable..........................       (5,842)          --
  Deficit accumulated during development stage.....  (30,912,997)  (38,461,639)
                                                    ------------  ------------
    Total shareholders' equity.....................    7,452,667       247,247
                                                    ------------  ------------
    Total liabilities and shareholders' equity..... $  9,135,189  $  2,863,995
                                                    ============  ============
</TABLE>

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

                                      F-3
<PAGE>

                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                     Period
                                     Year Ended                  from Inception
                         -------------------------------------  (January 4, 1989)
                         January 3,   January 2,   January 1,     To January 1,
                            1998         1999         2000            2000
                         -----------  -----------  -----------  -----------------
<S>                      <C>          <C>          <C>          <C>
Revenues................ $   725,374  $   678,000  $   534,634    $  1,938,008
Cost of Goods Sold......     361,536      278,251      266,653         906,440
                         -----------  -----------  -----------    ------------
Gross Margin............     363,838      399,749      267,981       1,031,568
Operating Expenses:
  Research and
   development
   expenses.............   4,626,390    5,433,471    4,425,739      27,735,868
  Selling, general and
   administrative
   expenses.............   2,306,341    3,107,046    3,426,327      12,463,050
                         -----------  -----------  -----------    ------------
    Total operating
     expenses...........   6,932,731    8,540,517    7,852,066      40,198,918
                         -----------  -----------  -----------    ------------
    Operating loss......  (6,568,893)  (8,140,768)  (7,584,085)    (39,167,350)
                         -----------  -----------  -----------    ------------
Interest income.........     819,675      550,328      130,627       1,948,768
Interest expense........    (106,401)     (83,569)     (95,184)     (1,243,057)
                         -----------  -----------  -----------    ------------
Interest income, net....     713,274      466,759       35,443         705,711
                         -----------  -----------  -----------    ------------
Net loss................ $(5,855,619) $(7,674,009) $(7,548,642)   $(38,461,639)
                         ===========  ===========  ===========    ============
Basic and diluted net
 loss per share (Note
 12).................... $     (0.87) $     (1.02) $     (0.97)
                         ===========  ===========  ===========
Weighted average basic
 and diluted shares
 (Note 12)..............   6,693,689    7,489,038    7,749,040
</TABLE>


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

                                      F-4
<PAGE>

                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)

                      CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                      Period
                                      Year Ended                  from Inception
                         --------------------------------------  (January 4, 1989)
                          January 3,   January 2,   January 1,     To January 1,
                             1998         1999         2000            2000
                         ------------  -----------  -----------  -----------------
<S>                      <C>           <C>          <C>          <C>
Cash flows from
 operating activities:
 Net loss..............  $ (5,855,619) $(7,674,009) $(7,548,642)   $(38,461,639)
 Adjustments to
  reconcile net loss to
  net cash used in
  operating
  activities--
 Depreciation and
  amortization.........       733,834      676,722      563,953       2,881,227
 Noncash interest
  converted to notes...       106,401       83,562       46,981       1,107,539
 Noncash salary
  converted to common
  stock................           --           --           --          250,000
 Noncash research and
  development expense
  converted to
  subordinated notes...           --           --           --            9,000
 Noncash compensation
  expense..............         1,562       45,653       12,764       1,192,579
 Noncash interest
  expense on bridge
  financing............           --           --        33,790          33,790
 Changes in current
  accounts--
  Accounts receivable..           --      (260,000)     172,500         (87,500)
  Inventories..........       (59,337)  (1,071,655)      17,149      (1,437,287)
  Prepaid expenses.....       105,699       77,420      189,488         161,401
  Other current
   assets..............          (240)      (6,481)      83,531          47,939
  Accounts payable.....       (10,281)      48,849      (89,381)        256,982
  Accrued expenses.....       150,073      186,902       89,126         505,237
  Deferred revenue.....           --           --        87,500          87,500
                         ------------  -----------  -----------    ------------
   Net cash used in
    operating
    activities.........    (4,827,908)  (7,893,037)  (6,341,239)    (33,453,230)
                         ------------  -----------  -----------    ------------
Cash flows from
 investing activities:
 (Purchases) Maturation
  of held to maturity
  investments..........   (11,889,356)   9,896,300    1,993,056             --
 Purchases of equipment
  and leasehold
  improvements.........      (842,023)    (622,388)    (300,836)     (3,873,553)
 Loan to officer.......       (80,211)         --           --          (80,211)
 Proceeds from sale of
  equipment and
  leasehold
  improvements.........           --           --           --            9,845
                         ------------  -----------  -----------    ------------
   Net cash (used in)
    provided by
    investing
    activities.........   (12,811,590)   9,273,912    1,692,220      (3,943,919)
                         ------------  -----------  -----------    ------------
Cash flows from
 financing activities:
 Proceeds from issuance
  of common stock......    17,389,058      281,362      296,668      18,563,536
 Proceeds from issuance
  of preferred stock...           --           --           --       13,385,370
 Proceeds from issuance
  of convertible
  notes................           --           --       800,000       6,122,000
 Proceeds from issuance
  of warrants..........           --           --           --          236,453
 Offering expenses.....           --           --           --         (473,006)
 Payments under capital
  lease obligations....           --           --           --          (40,735)
 Payments of
  subordinated notes...           --      (262,363)         --         (262,363)
                         ------------  -----------  -----------    ------------
   Net cash provided by
    financing
    activities.........    17,389,058       18,999    1,096,668      37,531,255
                         ============  ===========  ===========    ============
Increase (decrease) in
 cash and cash
 equivalents...........      (250,440)   1,399,874   (3,552,353)        134,104
                         ------------  -----------  -----------    ------------
Cash and cash
 equivalents, beginning
 of period.............     2,537,023    2,286,583    3,686,457             --
                         ------------  -----------  -----------    ------------
Cash and cash
 equivalents, end of
 period................     2,286,583    3,686,457      134,104         134,104
                         ============  ===========  ===========    ============
Cash paid for:
 Interest..............  $        --   $   262,363  $    14,413    $    276,776
                         ============  ===========  ===========    ============
Noncash financing
 activities:
 Conversion of salary
  expense to common
  stock................  $        --   $       --   $       --     $    250,000
                         ============  ===========  ===========    ============
 Conversion of
  convertible
  subordinated notes to
  common stock.........  $    464,230  $   787,647  $       --     $  5,278,892
                         ============  ===========  ===========    ============
 Conversion of common
  stock to preferred
  stock................  $        --   $       --   $       --     $  3,846,015
                         ============  ===========  ===========    ============
 Capital lease
  obligation incurred
  for equipment........  $        --   $       --   $       --     $     40,383
                         ============  ===========  ===========    ============
 Conversion of
  preferred stock to
  common stock.........  $     28,923  $       --   $       --     $     28,923
                         ============  ===========  ===========    ============
 Conversion of
  convertible
  subordinated notes to
  warrants.............  $        --   $       --   $       --     $     47,000
                         ============  ===========  ===========    ============
</TABLE>

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

                                      F-5
<PAGE>

                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)

           CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY

<TABLE>
<CAPTION>
                                                 Common                                               Deficit
                         Preferred   Common       Stock       Preferred                             Accumulated
                          Stock,     Stock,    Capital in   Stock Capital                              During
                           $0.01      $0.01     Excess of   in Excess of    Deferred   Subscription Development
                         Par Value  Par Value   Par Value     Par Value   Compensation  Receivable     Stage
                         ---------  ---------  -----------  ------------- ------------ ------------ ------------
<S>                      <C>        <C>        <C>          <C>           <C>          <C>          <C>
Initial issuance of
 common stock........... $    --    $  7,475   $   291,525   $       --     $    --     $     --    $        --
 Net Loss...............      --         --            --            --          --           --        (414,045)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, December 28,
 1989...................      --       7,475       291,525           --          --           --        (414,045)
 Net Loss...............      --         --            --            --          --           --        (394,275)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, December 29,
 1990...................      --       7,475       291,525           --          --           --        (808,320)
 Net Loss...............      --         --            --            --          --           --        (973,773)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, December 28,
 1991...................      --       7,475       291,525           --          --           --      (1,782,093)
 Issuance of common
  stock.................      --       2,042       147,958           --          --           --             --
 Issuance of warrants...      --         --        121,453           --          --           --             --
 Net Loss...............      --         --            --            --          --           --      (1,586,239)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, January 2,
 1993...................      --       9,517       560,936           --          --           --      (3,368,332)
 Issuance of common
  stock.................      --         166        49,833           --          --           --             --
 Conversion of
  convertible
  subordinated notes and
  related accrued
  interest into common
  stock.................      --      12,820     3,833,195           --          --           --             --
 Issuance of warrants...      --         --        115,000           --          --           --             --
 Net Loss...............      --         --            --            --          --           --      (2,267,460)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, January 1,
 1994...................      --      22,503     4,558,964           --          --           --      (5,635,792)
 Issuance of common
  stock.................      --       1,376       411,625           --          --       (94,874)           --
 Conversion of common
  stock into preferred
  stock, Series A.......   12,820    (12,820)   (3,833,195)    3,833,195         --           --             --
 Issuance of preferred
  stock, Series B.......    5,000        --            --      3,930,771         --           --             --
 Issuance of warrants...      --         --         47,000           --          --           --             --
 Net Loss...............      --         --            --            --          --           --      (2,671,648)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, December 31,
 1994...................   17,820     11,059     1,184,394     7,763,966         --       (94,874)    (8,307,440)
 Issuance of common
  stock.................      --          64        49,938           --          --        21,870            --
 Conversion of
  convertible
  subordinated notes and
  related accrued
  interest into common
  stock.................      --       4,714       248,686           --          --           --             --
 Issuance of preferred
  stock, Series C.......   10,992                      --      9,338,608         --      (500,000)           --
 Extension of stock
  options...............      --         --        860,000           --          --           --             --
 Net Loss...............      --         --            --            --          --           --      (4,117,158)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, December 30,
 1995...................   28,812     15,837     2,343,018    17,102,574         --      (573,004)   (12,424,598)
 Issuance of common
  stock.................      --         142        64,106           --          --        15,073            --
 Proceeds from issuance
  of Series C Preferred
  Stock.................      111        --            --         99,889         --       500,000            --
 Extension of stock
  options...............      --         --        272,600           --          --           --             --
 Net Loss...............      --         --            --            --          --           --      (4,958,771)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, December 28,
 1996...................   28,923     15,979     2,679,724    17,202,463         --       (57,931)   (17,383,369)
 Issuance of common
  stock.................      --      22,750    16,796,104           --          --           --             --
 Anti-dilution,
  preferred stock,
  Series C..............      --         355          (355)          --          --           --             --
 Conversion of preferred
  stock, Series A.......  (12,820)    12,820     3,833,195    (3,833,195)        --           --             --
 Conversion of preferred
  stock, Series B.......   (5,000)     5,000     3,930,771    (3,930,771)        --           --             --
 Conversion of preferred
  stock, Series C.......  (11,103)    11,103     9,438,497    (9,438,497)        --           --             --
 Conversion of
  convertible
  subordinated notes and
  related accrued
  interest into common
  stock.................      --       4,135       460,095           --          --           --             --
 Exercise of stock
  options...............      --       1,480        63,370           --          --           --             --
 Recording of deferred
  compensation..........      --         --         18,743           --      (17,180)         --             --
 Payment of subscription
  receivable............      --         --            --            --                    32,348            --
 Net Loss...............      --         --            --            --          --           --      (5,855,619)
                         --------   --------   -----------   -----------    --------    ---------   ------------
Balance, January 3,
 1998...................      --      73,622    37,220,144           --      (17,180)     (25,583)   (23,238,988)
 Conversion of
  convertible
  subordinated notes and
  related accrued
  interest into common
  stock.................      --       2,262       785,385           --          --           --             --
 Exercise of stock
  options...............      --         485        59,135           --          --           --             --
 Exercise of warrants...      --         673       201,327           --          --           --             --
 Recording of deferred
  compensation..........      --         --         58,386           --      (12,733)         --             --
 Payment of subscription
  receivable............      --         --            --            --          --        19,741            --
 Net Loss...............      --         --            --            --          --           --      (7,674,009)
                         --------   --------   -----------   -----------    --------    ---------   ------------
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)
                         ========   ========   ===========   ===========    ========    =========   ============
</TABLE>
   The accompanying notes are an integral part of these financial statements.

                                      F-6
<PAGE>

                   PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

 Nature of Operations and Relationship to Principal Shareholders

  On January 4, 1989, Photoelectron Corporation (the "Company") was founded as
a joint financing by Thermo Electron Corporation ("Thermo Electron") and PYC
Corporation ("PYC"), which is owned by members of the immediate family of Mr.
Peter M. Nomikos. Since inception, the majority of the Company's time and
effort has been focused on the design, development and commercialization of a
miniature x-ray source which is a proprietary, therapeutic device for the
treatment of cancerous tumors through the application of radiation directly
into a tumor. The latest version of this x-ray system is the PRS400 system
which delivers radiation through a thin, minimally invasive, needle-like
probe. The probe emits from its tip precisely regulated x-ray photons. To
management's knowledge, no company has yet marketed a salable product using
technology similar to the PRS400 system that has been developed by the
Company. Even if marketing efforts are successful, substantial time will pass
before significant revenues will be realized, and the Company may require
additional funds during this period. These funds may not be readily available
to the Company.

  The Company has completed clinical studies of PRS treatment of brain tumors
under an Investigational Device Exemption (IDE) granted by the U.S. Food and
Drug Administration (FDA) and similar approvals in other countries. Based on
results of these clinical trials, the Company obtained a Section 510(k)
marketing clearance on July 21, 1998 for the PRS400 system for the treatment
of intra-cranial tumors, which the Company was developing for introduction as
its first commercial product. Simultaneous with completion of the PRS400
system product development, the Company was completing implementation of
programs to insure compliance with the FDA's cGMP standards. The Company also
completed the process of seeking certification to the Medical Device Directive
Annex II, enabling self-certification of the European Community Mark (CE). On
December 18, 1998, the Company initiated commercial distribution of the PRS400
system. In September 1999, the Company obtained a Section 510(k) marketing
clearance from the FDA to market the system for radiotherapy treatments,
regardless of treatment site.

  In the first quarter of 2000, the Company and Toshiba expect to submit to
the Japan Ministry of Health an application for product approval (shonin) of
the PRS400 system. Contingent upon that submission being made in timely
fashion, the Company and Toshiba expect to obtain product approval (shonin) in
Japan for the PRS400 system in the second half of 2000. Once regulatory
approvals for the PRS system are obtained in Japan, Toshiba will serve as its
exclusive distributor in Japan. In 1995, Toshiba invested approximately $2
million in equity of the Company's Series C Preferred Stock offering, which
converted to common stock upon the closing of the Company's initial public
offering (See Note 10).

  In August 1999, the Company entered into a strategic alliance with Carl
Zeiss, an international technology leader whose medical systems division
specializes in high technology equipment such as surgical microscopes for
various medical disciplines and state-of-the-art image-guided surgery
equipment. The Company appointed Carl Zeiss as its exclusive distributor for
the PRS400 system throughout the world (except for Japan where Toshiba Medical
Systems is the Company's distributor of the PRS400 system) for intracranial
applications and spinal radiotherapy and as its non-exclusive distributor for
the PRS400 system in the same territory for all other clinical applications.
In addition, Carl Zeiss agreed to assist the Company in the development of new
intraoperative radiotherapy products and to provide service and support for
the Company's products. The alliance with Carl Zeiss gives the Company access
to a global sales force with an established record of sales of high technology
equipment within the medical field.


                                      F-7
<PAGE>

  The Company has incurred a net loss for the year ended January 1, 2000, as
well as for the period since inception. The Company has funded these losses
principally through debt and equity financings. The Company is anticipating
operating losses and other cash requirements in the next 12 months in excess
of available cash. To sustain current operating costs, management will be
required to obtain additional funding or alternative means of financial
support, or both; however, there can be no assurances that such funding or
financial support will be available or adequate to allow the Company to
continue as a going concern. Management is currently pursuing various sources
of financial support including obtaining private funding. At the present time,
the Company has not entered into an arrangement for additional funding or
financial support. Consequently, there is substantial doubt concerning the
Company's ability to continue as a going concern.

 Fiscal Years

  The Company has adopted a fiscal year ending on the Saturday nearest
December 31. References to 1999 1998, and 1997 are for the fiscal years ended
January 1, 2000, January 2, 1999, and January 3, 1998, respectively. Fiscal
year 1997 included 53 weeks; 1999 and 1998 each included 52 weeks.

 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 in inventory which are intended to be used and
capitalized as part of the Company's PRS systems that will be used for
distribution and in clinical trials.

 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.

 Cash and Cash Equivalents

  As of January 1, 2000, 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

                                      F-8
<PAGE>

as held to maturity investments. Cash equivalents are carried at cost, which
approximate market value. The Company did not own any commercial paper at
January 1, 2000.

 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 if 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. As of January 1, 2000, the Company had no held to
maturity investments.

 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 its
estimated warranty upon the acceptance of its product by the customer.

 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.

  In connection with the Phase II FDA clinical trials, as well as the efforts
to obtain the CE Mark, PRS 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.


                                      F-9
<PAGE>

 Net Loss Per Share

  During the fourth quarter of 1997, the Company adopted SFAS 128, "Earnings
per Share" (Note 12). As a result, all previously reported loss per share data
have been restated. Basic loss per share have 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 which are all anti-dilutive given the operating losses of
the Company, and excluding the exercise of stock options and convertible
securities, which were deemed to be anti-dilutive.

 Fair Value of Financial Instruments

  The Company's financial instruments primarily consist of cash and cash
equivalents, held to maturity investments, accounts payable and convertible
subordinated notes. The fair value of the Company's convertible subordinated
notes is primarily determined by the ability to convert those notes into
common stock. The fair value of the convertible subordinated notes is
approximately $749,063, and approximately $761,770 at January 2, 1999 and
January 1, 2000, respectively, based upon the estimated fair value of the
underlying common stock. The fair value of the convertible note is
approximately $804,311 at January 1, 2000 based upon the estimated fair value
of 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 11). Accordingly, no accounting
recognition is given to stock options granted at fair market value until they
are exercised. Upon exercise, net proceeds including tax benefits realized, if
any, are credited to equity.

(2) Held to Maturity Investments

  Investments in commercial paper are classified as held to maturity as of
January 1, 2000. The amortized cost and fair values as of January 2, 1999 and
January 1, 2000 are as follows:

<TABLE>
<CAPTION>
                                                        Commercial Paper
                                                --------------------------------
                                                             Gross
                                                Amortized  Unrealized
                                                   Cost       Loss    Fair Value
                                                ---------- ---------- ----------
   <S>                                          <C>        <C>        <C>
   January 2, 1999............................. $1,993,056  ($1,396)  $1,991,660
   January 1, 2000............................. $      --   $   --    $      --
</TABLE>

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

(3) Accrued Liabilities

  Accrued expenses in the accompanying balance sheet includes the following
balances:

<TABLE>
<CAPTION>
                                                                1998     1999
                                                              -------- --------
   <S>                                                        <C>      <C>
   Warranty Accrual.......................................... $204,000 $266,000
   Annual Report Accrual.....................................   61,000   60,000
   Other Accrued Expenses....................................  296,650  304,495
                                                              -------- --------
                                                              $561,650 $630,495
                                                              ======== ========
</TABLE>


                                     F-10
<PAGE>

(4) Income Taxes

  The components of the deferred tax asset at January 2, 1999 and January 1,
2000 are as follows:

<TABLE>
<CAPTION>
                                                         1998          1999
                                                     ------------  ------------
   <S>                                               <C>           <C>
   Deferred tax asset--
     Federal tax loss carryforwards................. $  9,185,000  $ 11,846,000
     Federal tax credit carryforwards...............      871,000       965,000
     State tax loss carryforward....................    2,070,000     2,602,000
     State tax credit carryforward..................      781,000       904,000
     Other, net.....................................      728,000       694,000
                                                     ------------  ------------
                                                       13,635,000    17,011,000
   Valuation allowance..............................  (13,635,000)  (17,011,000)
                                                     ------------  ------------
     Deferred tax asset.............................          --            --
                                                     ============  ============
</TABLE>

  As of January 1, 2000, the Company had federal net operating loss
carryforwards of approximately $34,840,000, state net operating loss
carryforwards of approximately $27,383,000, federal tax credit carryforwards
of approximately $965,000, and state tax credit carryforwards of approximately
$904,000. Due to the fact that the Company has sustained cumulative losses,
the potential future benefit of these attributes, which expire in the years
2000 through 2014, 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 terminated its Simplified Employee Pension Plan
("SEPP") and adopted a 401(k) Plan. No obligations arose from the termination
of the SEPP. The impact of the SEPP was not material to the operating results
prior to termination. 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 1998 and 1999, the Company contributed approximately
$62,997 and $29,057, respectively.

(6) Related Party Transactions

 Thermo Electron Corporation

  On January 4, 1989, the Company entered into a corporate service agreement
with Thermo Electron. Under this agreement, Thermo Electron provided certain
administrative services, including legal advice and services, certain employee
benefit administration, tax advice and preparation, space allocation and
utilities. This agreement terminated on December 31, 1989. The Company has
continued to utilize Thermo Electron's resources since that date on an as-
needed basis without a formal contract and is charged at actual cost for such
services. The Company paid $3,253, $4,952 and $6,093 in 1997, 1998 and 1999,
respectively, for these services.

 Thermo Power Corporation

  The Company is provided with certain services by Thermo Power Corporation, 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 $113,582,
$229,953, and $147,315 in 1997, 1998 and 1999, respectively, for these
services. As of January 2, 1999, and January 1, 2000, $534, and

                                     F-11
<PAGE>

$7,284 respectively, was payable to Thermo Power Corporation and was included
in accounts payable in the accompanying consolidated balance sheets.

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

(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 a new operating lease for its office and
research facilities expiring in July, 2002. The minimum lease payments under
the new agreement are $587,820 in 2000, $599,689 in 2001 and $352,360 in 2002.
The total future minimum lease payments are $1,539,869. The accompanying
consolidated statements of operations include expenses for operating leases of
$307,975, $404,914, and $471,859 for 1997, 1998 and 1999, respectively.

(8) Convertible Subordinated Notes

  On January 4, 1989, the Company issued and sold $181,000 of 8% subordinated
convertible debenture to Thermo Electron, due in 1995. The debentures were
convertible into shares of the Company's Common Stock at a conversion price of
$0.30. On December 30, 1995, Thermo Electron elected to convert its $181,000
subordinated convertible debenture and accrued interest into 471,354 shares of
Common Stock. On May 22, 1990, the Company issued and sold $125,000 and
$175,000 principal amounts of 8% subordinated convertible debentures to Thermo
Electron and Mr. Peter M. Nomikos, respectively, due in 1998. The debentures
were convertible into shares of the Company's Common Stock at a conversion
price of $0.80. Also in 1990, the Company issued and sold $52,000 principal
amount of 8% subordinated convertible debentures to Mr. Peter M. Nomikos, due
in 1998. The note was convertible into shares of the Company's Common Stock at
a conversion price of $3.00. In 1991, the Company issued and sold $448,000
principal amount of 8% subordinated convertible debentures to Mr. Peter M.
Nomikos, due in 1998. The note was convertible into shares of the Company's
Common Stock at a conversion price of $3.00. All of these debentures also
provide for the conversion of accrued interest into Common Stock at maturity.
The accrued interest is convertible into common stock at a conversion price
equal to the average fair market value of the Company's Common Stock on the
first ten days of trading of the fiscal quarter in which the interest to be
converted accrued.

  On May 13, 1992, the Company entered into a $4,500,000 8% convertible
subordinated demand note and warrant purchase agreement with Mr. Peter M.
Nomikos. These notes are 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 is still outstanding. At January 1, 2000, the Company is not aware of
any intention by Mr. Peter M. Nomikos of converting these debentures into
shares of the Company's common stock. All earned but unpaid interest on the
subordinated demand loan is 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.

  The warrant purchase rights entitled 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 January 1, 2000, warrants to
purchase 810,000 shares of the Company's Common Stock were outstanding. These
remaining

                                     F-12
<PAGE>

warrants expire as follows 575,000, and 235,000 on September 29, 2000, and
January 27, 2002, respectively. All warrants purchased by Mr. Nomikos have
been accounted for as Capital in excess of par value--common stock.

  In 1993, 1,282,005 shares of Common Stock were issued upon the conversion of
$3,547,000 principal amount of subordinated convertible debentures and
$299,015 of related accrued interest. In 1994, these shares of Common Stock
were converted into Series A Convertible Preferred Stock and, upon the closing
of the Company's initial public offering in 1997, converted again into stock.
(See Note 10).

  In 1997, 171,257 and 242,334 shares of Common Stock were issued upon the
conversion of $125,000 principle amount and $65,210 of related accrued
interest and $175,000 principle amount and $99,020 accrued interest of
subordinated convertible debentures to Thermo Electron Corporation and Mr.
Peter M. Nomikos, respectively.

  In 1998, 226,170 shares of Common Stock were issued upon conversion of
$500,000 principal amount and $287,647 accrued interest of subordinated
convertible debentures to Mr. Peter M. Nomikos. Also in 1998, 67,333 shares of
Common Stock were issued for warrants exercised of $202,000 to PYC
Corporation.

(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 is
convertible into Common Stock at the holder's request within 30 days
subsequent to its maturity or upon full prepayment. The conversion price per
share will be equal to the average closing price of the stock for the ten
trading days prior to such conversion. As of January 1, 2000, the Company had
drawn down $800,000 under the line of credit and had issued to PYC Corporation
warrants to purchase an aggregate of 160,000 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 warrants were issued in four equal installments on
November 18, 1999, November 30, 1999, December 14, 1999 and December 29, 1999,
with exercise prices of $3.76, $3.44, $2.94 and $2.74 respectively. The fair
value of the warrants issued, in the amount of $33,790, has been recognized as
non cash interest expense.

(10) Common and Preferred Stock

  On January 4, 1989, the Company authorized 6,000,000 shares of $0.01 par
value Common Stock and issued 147,488 shares to Thermo Electron and 600,000
shares to PYC Corporation at $0.40 per share. The Company authorized an
additional 9,000,000 shares of Common Stock in 1994 to accommodate possible
stock issuance as a result of stock splits, note conversions and options
issued under the stock option plan and potential future stock offerings. In
1992, Mr. Peter M. Nomikos was granted stock in lieu of compensation for 1990,
1991 and 1992 in the cumulative amount of 204,167 common shares. In 1994, 1995
and 1996, Mr. Peter M. Nomikos was granted stock in lieu of compensation in
the amount of 16,667, 6,250 and 5,556 shares of Common Stock, respectively.
All such shares were recorded as compensation expense at the estimated fair
value per share on the date that such shares were granted to Mr. Nomikos. In
fiscal 1993, 1,282,005 shares of Common Stock were issued upon the conversion
of $3,846,015 of subordinated convertible debentures and accrued interest (See
Note 8).

  The Company has authorized 7,500,000 shares of $0.01 par value preferred
stock. On March 18, 1994, the Board of Directors approved the conversion of
1,282,005 shares of Common Stock held by Mr. Peter M. Nomikos into Series A
Convertible Preferred Stock on a one-for-one basis. These shares permit the
holder to convert his or her holdings into Common Stock on a one-for-one
basis, subject to certain anti-dilution provisions. The Series A Convertible
Preferred Stock had a liquidation preference of $3.00 per share (See Note 8).

  The Company sold 500,000 shares of Series B Convertible Preferred Stock at
$8.00 per share in 1994. These shares permit the holder to convert his or her
holdings into Common Stock on a one-for-one basis, subject to certain anti-
dilution provisions. The Series B Convertible Preferred Stock had a
liquidation preference of $8.00 per share, which is senior to the Company's
Common Stock and junior to the Series A Convertible Preferred

                                     F-13
<PAGE>

Stock. The purchase of the Series B shares also entitled the purchaser to
rights to participate in the Company's next offering of preferred stock at a
10% discount. The rights entitle the purchaser to this discount on an amount
of shares equal to the purchaser's pro rata participation in the Series B
offering.

  The Company sold 680,005 shares of Series C Convertible Preferred Stock at
$9.00 per share in 1995. The Company also sold 419,191 additional shares of
Series C Convertible Preferred Stock in exchange for $8.10 per share. This
latter, discounted price was paid by those stockholders who acquired such
right in the Series B offering as described above. These shares permit the
holder to convert his or her holdings into Common Stock on a one-for-one
basis, subject to certain anti-dilution provisions. The Series C Convertible
Preferred Stock has a liquidation preference of $9.00 per share, which is
senior to the Company's Common Stock and junior to the Series A and B
Convertible Preferred Stock.

  All of the Company's convertible preferred stock automatically converted to
Common Stock upon the closing of the Company's Initial Public Offering.

  In 1994, the Company sold 121,000 shares of Common Stock to employees of the
Company for $3.00 per share pursuant to a one-time employee stock purchase
offering. A total of 85,500 of those shares were paid for at the time of the
offering. Consideration for the remaining 35,500 shares was in the form of
promissory notes executed by employees in favor of the Company. The balance of
these notes is $25,583, $5,842 and $0 in 1997, 1998, and 1999 respectively,
and is described in the accompanying balance sheet as a subscription
receivable.

  On December 3, 1996, the stockholders of the Company approved a one-for-two
reverse stock split of the Company's Common Stock and Preferred Stock. All
share and per share information has been retroactively restated to reflect
this reverse stock split.

(11) 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 may 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 541,775
shares of Common Stock may be issued under the 1996 Plan.


                                     F-14
<PAGE>

  A summary of stock option activity is as follows:

<TABLE>
<CAPTION>
                                    1997                     1998                      1999
                          ------------------------- ------------------------ -------------------------
                           Number                   Number                    Number
                             of     Range of Option   of     Range of Option    of     Range of Option
                           Shares   Price per Share Shares   Price per Share  Shares   Price per Share
                          --------  --------------- -------  --------------- --------  ---------------
<S>                       <C>       <C>             <C>      <C>             <C>       <C>
Options outstanding,
 beginning of year......   817,475   $0.40--$9.00   701,892   $0.40--$9.75    913,592   $0.40--$9.75

Granted.................    61,417   $7.00--$9.75   265,650   $5.38--$8.38    263,000   $2.13--$4.88
Exercised...............  (148,000)  $0.40--$0.80   (48,500)  $0.40--$3.00    (64,500)  $0.40--$3.00
Forfeited...............   (29,000)  $0.40--$9.00    (5,450)  $0.80--$7.25   (199,875)  $2.13--$9.75

Options outstanding, end
 of year................   701,892   $0.40--$9.75   913,592   $0.40--$9.75    912,217   $0.40--$9.00
Options exercisable.....   408,395   $0.40--$9.00   466,874   $0.40--$9.00    445,468   $0.40--$9.00
Options available for
 grant..................   130,608                  145,408                    82,283
Weighted average fair
 value per share of
 options granted during
 the year...............             $       4.20             $       7.24              $       2.70
</TABLE>

  As of January 1, 2000, the options outstanding had a weighted average
remaining contractual life of 7 years.

  The Company accounts for stock options under APB No. 25. All stock options
granted to date have been at an exercise price equal to or greater than the
fair value of the Company's Common Stock on the date of grant. Upon exercise
of the options, the net proceeds, including the tax benefit realized, are
credited to equity.


  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>
                                            1997         1998         1999
                                         -----------  -----------  -----------
   <S>                                   <C>          <C>          <C>
   Net Loss
     As Reported........................ $(5,855,619) $(7,674,009) $(7,548,642)
     Pro Forma.......................... $(6,212,029) $(8,242,514) $(8,198,743)
   Basic and Diluted Net Loss Per Share
     As Reported........................ $     (0.87) $     (1.02) $      (.97)
     Pro Forma.......................... $     (0.93) $     (1.10) $     (1.06)
</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>
                                                1997        1998        1999
                                             ----------  ----------  ----------
   <S>                                       <C>         <C>         <C>
   Volatility...............................         51%        105%         48%
   Risk Free Interest Rate..................       5.64%       5.00%       5.00%
   Expected Life of Options................. 7.00 years  7.00 years  7.00 years
</TABLE>

  Because the pro forma compensation cost under SFAS 123 has not been applied
to option grants prior to January 1, 1995, the resulting pro forma
compensation cost may not be representative of that to be expected in future
years as it is reflected over the vesting period of the options.

                                     F-15
<PAGE>

  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.

(12) Net Loss per Share

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

<TABLE>
<CAPTION>
                                           1997         1998         1999
                                        -----------  -----------  -----------
   <S>                                  <C>          <C>          <C>
     Net loss.......................... $(5,855,619) $(7,674,009) $(7,548,642)
     Weighted average shares...........   6,693,689    7,489,038    7,749,040
                                        -----------  -----------  -----------
     Basic and Diluted net loss per
      share............................ $     (0.87) $     (1.02) $     (0.97)
                                        ===========  ===========  ===========
</TABLE>


  The computation of diluted earnings per share for 1997, 1998 and 1999
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-16
<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 31, 2000.

                                          Photoelectron Corporation

                                                  /s/ Peter M. Nomikos
                                          By: _________________________________
                                                      Peter M. Nomikos
                                              Chairman of the Board and Chief
                                                     Executive Officer

  KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Euan S. Thomson and Gerald J. Bojas, 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
Securities and Exchange Commission 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.

<TABLE>
<CAPTION>
              Signature                          Title                   Date
              ---------                          -----                   ----

<S>                                    <C>                        <C>
       /s/ Peter M. Nomikos            Chairman of the Board and    March 31, 2000
______________________________________  Chief Executive Officer
          (Peter M. Nomikos)            (Principal Executive
                                        Officer)

       /s/ Euan S. Thomson             President and Chief          March 31, 2000
______________________________________  Operating Officer
          (Euan S. Thomson)

       /s/ Gerald J. Bojas             Chief Financial Officer      March 31, 2000
______________________________________  and Treasurer (Principal
          (Gerald J. Bojas)             Financial Officer and
                                        Principal Accounting
                                        Officer)

    /s/ George N. Hatsopoulos          Director                     March 31, 2000
______________________________________
       (George N. Hatsopoulos)

     /s/ Roger D. Wellington           Director                     March 31, 2000
______________________________________
        (Roger D. Wellington)
</TABLE>

                                     F-17
<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  Subordinated Convertible Note Purchase Agreement among the Company,
         Thermo Electron Corporation and Photoelectron Investments Corporation
         of Liberia dated as of May 22, 1990, and Exhibits thereto.

   *4.3  Amendment and Waiver of Subordinated Convertible Note Purchase
         Agreement among the Company, Thermo Electron Corporation and
         Photoelectron Investments Corporation of Liberia dated as of August 1,
         1996, and Exhibits thereto.

   *4.4  Amended and Restated 8% Subordinated Note Due 1997 from the Company to
         Thermo Electron Corporation in the principal amount of $125,000 dated
         as of August 1, 1996.

   *4.5  Amended and Restated 8% Subordinated Note Due 1997 from the Company to
         Peter M. Nomikos in the principal amount of $175,000 dated as of
         August 1, 1996.

   *4.6  Amended and Restated Convertible Note Purchase Agreement originally
         dated as of July 11, 1991, among the Company, PYC Corporation
         (formerly known as Photoelectron Investments Corporation of Liberia)
         and Peter M. Nomikos, and Exhibits thereto.

   *4.7  8% Subordinated Convertible Note Due 1998 from the Company to Peter M.
         Nomikos in the principal amount of $500,000 dated as of August 8,
         1996.

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

   *4.9  Amendment and Waiver of Convertible Note and Warrant Purchase
         Agreement dated as of May 13, 1992 between the Company and Peter M.
         Nomikos, dated as of August 1, 1996 and Exhibits thereto.

   *4.10 Amended and Restated 8% Subordinated Convertible Note Due on Demand
         from the Company to Peter M. Nomikos in the principal amount of
         $705,000 dated as of August 1, 1996.

 ***4.11 8% Promissory Note dated as of November 15, 1999 between the Company
         and PYC Corporation in the principal amount of $2,250,000.

  *10.1  Lease Agreement dated June 12, 1996 between Lexington Development
         Company Trust and the Company.

  *10.2  Cash or Deferred Profit Sharing Plan and Trust dated April 1, 1995, as
         amended, of the Company.

  *10.3  Employee Stock Purchase Plan of the Company and form of Subscription
         Agreement.

  *10.4  1989 Employee Stock Option Plan of the Company and forms of Stock
         Option Agreements.

  *10.5  1996 Equity Incentive Plan of the Company.

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

  *10.7  Stock Option Agreements variously dated between certain directors and
         officers of the Company and the Company.
</TABLE>


                                       1
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
   No.                                 Description
 -------                               -----------
 <C>      <S>
   *10.12 Form of Registration Rights Agreement between the Company and holders
          of Series C Preferred Stock.

   *10.13 Registration Rights Agreement dated December 22, 1995 between the
          Company and Toshiba Medical Systems Co., Ltd.

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

   *10.15 International Distributor Sales and Service Agreement dated December
          13, 1995, as amended, between the Company and Toshiba Medical Systems
          Co., Ltd.

   *10.16 Agreement dated as of February 1, 1991, as amended, between the
          Company and the General Hospital Corporation.

   *10.17 Clinical Trial Agreement dated as of August 1, 1992, as amended,
          between the General Hospital Corporation, Nicholas T. Zervas, M. D.
          and the Company.

   *10.18 Investigational Treatment Agreement dated as of September 1, 1994
          between the General Hospital Corporation, Rees G. Cosgrove, M.D. and
          the Company.

   *10.19 Clinical Research Agreement dated as of April 1, 1995, as amended,
          between the Brigham and Women's Hospital Corporation, Peter Black,
          M.D. and the Company.

   *10.20 Clinical Trial Agreement dated as of January 1, 1995 between the
          Tokyo Women's Medical College, Kintomo Takakura, M.D. and the
          Company.

   *10.21 Clinical Trial Agreement dated December 13, 1995, as amended, between
          the Company and Toshiba Medical Systems Co., Ltd.

   *10.22 Clinical Research Agreement dated as of November 1, 1995 between The
          Royal Free Hampstead (NHS), Felix Senanayake, M.D. and the Company.

   *10.24 Forms of Medical Advisory Board Agreements between the Company and
          members of its Medical Advisory Board.

 ***10.25 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 Commission).

 ***10.26 SNN Member Agreement between the Company and Surgical Navigation
          Specialists Inc. dated June 30, 1999 and exhibits thereto.

 ***10.27 Loan Agreement between the Company and PYC Corporation dated November
          15, 1999 and exhibits thereto.

   *21.1  Subsidiaries of the Company.

 ***23    Consent of independent accountants.

 ***24.1  Power of Attorney (including in signature page to this Form 10-K).

 ***27    Financial Data Schedule.
</TABLE>
--------
  * Filed as same numbered exhibit to the Company's Registration Statement on
    Form S-1 (Reg. No. 333-14541) and incorporated herein by reference.
 ** Filed as same numbered exhibit to the Company's Annual Report on Form 10-K
    for the fiscal year ended January 3, 1998 and incorporated herein by
    reference.
*** Filed herewith.

                                       2