UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

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

Commission file number: 0-22340

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

(781) 993-2300
(Issuer’s telephone number, including area code)

Securities registered pursuant to Section 12 (b) of the Act: None

Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.01 par value

         Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such 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 pursuant 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. |_|

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes |X|     No |_|

         The aggregate market value of the voting and non-voting common equity (based upon the closing price reported by Nasdaq on June 30, 2004) of Palomar Medical Technologies, Inc., held by nonaffiliates was $204,869,095. For purposes of this disclosure, shares of common stock held by entities and individuals who own 5% or more of the outstanding common stock and shares of common stock held by each officers and directors have been excluded in that such persons may be deemed to be "affiliates" as that term is defined under the rules and regulations of the Securities Exchange Act of 1934. This determination of affiliate status is not necessarily conclusive.

        As of March 9, 2005, 16,708,069 shares of common stock were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the registrant's definitive proxy statement to be filed prior to April 30, 2004, pursuant to Regulation 14A of the Securities Exchange Act of 1934, are incorporated by reference into Part III of this Form 10-K.

TABLE OF CONTENTS

PART I

Item 1. Business

Introduction

        Palomar Medical Technologies, Inc. (“Palomar”) is a leading researcher and developer of light based systems for hair removal and other cosmetic procedures. Throughout its history, Palomar has remained on the forefront of technology:

Palomar is continuously researching, developing and testing new and exciting innovations to further advance the hair removal market and other cosmetic applications, including fat reduction, acne treatment and skin rejuvenation. With its unique focus on both the professional and consumer markets, Palomar is positioned to capitalize on the ever expanding market for improving personal appearance.

        Palomar was organized in 1987 to design, manufacture, market and sell lasers and other light based products and related disposable items and accessories for use in medical and cosmetic procedures. In December 1992, Palomar filed its initial public offering. Subsequently, Palomar pursued an acquisition program, acquiring companies in its core laser business as well as others, principally in the electronics industry, in order to spread risk and bolster operating assets. By the beginning of 1997, Palomar had more than a dozen subsidiaries. At the same time, having obtained FDA clearance to market its EpiLaser® ruby laser hair removal system in March 1997, Palomar was well positioned to focus on what it believed was the most promising product in its core laser business. Hence, under the direction of a new board and management team, Palomar undertook a program in 1997, which was completed in May of 1998, of exiting from all non-core businesses and investments and focusing only on those businesses, which it believed, held the greatest promise for maximizing stockholder value. Palomar’s exclusive focus then became the use of lasers and other light based products in dermatology and cosmetic procedures.

        In December 1997 and January 1998, respectively, Palomar was the first company to receive FDA clearance for a diode laser for hair removal and for leg vein treatment, the LightSheer™ diode laser system manufactured by Star Medical Technologies, Inc. (“Star”), a former subsidiary of Palomar. The LightSheer was the first generation of high-powered diode lasers designed for hair removal, and like Palomar’s EpiLaser and other prior hair removal products, the LightSheer incorporated technology protected by patents licensed exclusively to Palomar from The Massachusetts General Hospital Corporation (“Massachusetts General Hospital”).

        On December 7, 1998, Palomar entered into an Agreement with Coherent, Inc. (Coherent Medical Group, a former subsidiary of Coherent, was subsequently sold to ESC Medical, now known as “Lumenis, Inc.” and hereinafter referred to as “Lumenis”) to sell all of the issued and outstanding common stock of Palomar’s subsidiary, Star. Palomar completed the sale of Star to Lumenis on April 27, 1999.

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        On February 14, 2003, Palomar entered into a Development and License Agreement with The Gillette Company to complete development and commercialize a home-use, light based hair removal device for women. Palomar believes that this device will be protected by multiple patents within its patent portfolio. (See Note 12, “Development and License Agreement with Gillette” and exhibit 10.14, “The Development and License Agreement with The Gillette Company effective February 14, 2003 with redacted exhibits.”) On June 28, 2004 Palomar and Gillette announced that they completed the initial phase of their agreement and that both parties would move into the next phase. In conjunction with entering this next phase, the parties amended the agreement to provide for additional development funding to further technical innovations.

        On February 18, 2004, Palomar announced that it was awarded a $2.5 million research contract by the Department of the Army to develop a light based self-treatment device for Pseudofolliculitis Barbae, or PFB, commonly known as “razor bumps.” Though the project was scheduled to last for nineteen months, Palomar now believes it will need several more months to complete the work.

        On September 1, 2004 Palomar entered into a Development and License Agreement with Johnson & Johnson Consumer Companies, Inc (“JJCC”), a Johnson & Johnson company, to develop, clinically test and potentially commercialize home-use, light based devices for (i) reducing or reshaping body fat including cellulite; (ii) reducing appearance of skin aging; and (iii) reducing or preventing acne. Palomar believes that these devices will be protected by multiple patents within its patent portfolio. (See Note 13, “Joint Development and License agreement with Johnson & Johnson Consumer Companies (“JJCC”), a Johnson & Johnson company” and exhibit 10.24, “Joint Development and License Agreement By and Between Palomar Medical Technologies and Johnson and Johnson Companies, Inc. dated September 1, 2004”).

        Palomar has one operating subsidiary, Palomar Medical Products, Inc. located at Palomar’s headquarters in Burlington, Massachusetts, which oversees the manufacture and sale of Palomar’s lamp and laser based systems currently on the market.

Financial Information About Industry Segments

        Palomar conducts business in one industry segment, medical and cosmetic products and services.

Principal Products

        Palomar researches, develops, manufactures, markets, sells and services light based products used to perform procedures addressing medical and cosmetic concerns. Palomar offers a comprehensive range of products based on proprietary technologies that include, but are not limited to:

        Market surveys report that the great majority of men and women in the United States, and many other parts of the world, employ one or more techniques to temporarily remove hair from various parts of the body, including waxing, depilatories, tweezing and shaving. Compared to these hair removal techniques, Palomar’s light based hair removal processes provide significantly longer-term cosmetic improvement. Compared to other light based hair removal devices, Palomar’s Lux platform is more versatile, treats larger areas in less time, are less painful and are more cost effective.

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        Lux Platform. With increasing market acceptance of light based treatments for new applications, Palomar recognized the need for a cost effective platform that could expand with the needs of customers. In 2001, Palomar announced the first product with the Lux Platform: the EsteLux® Pulsed Light System. The EsteLux was first sold with the LuxY™ handpiece for hair removal and treatment of pigmented lesions. In rapid succession, Palomar developed five additional handpieces: LuxG™, LuxR™, LuxRs™, LuxB™ and LuxV™, allowing customers to add additional applications to their treatment portfolio and provide specifically tailored procedures. In March 2003 at the American Academy of Dermatology tradeshow, Palomar introduced the higher priced MediLux™ Pulsed Light System with the same six handpieces, but also with higher power, faster repetition rate and a new snap-on connector for faster changes between handpieces. In October 2003, Palomar introduced the lower cost NeoLux™ Pulsed Light System with three handpieces, the LuxY, LuxR and LuxRs, specifically targeted at the beauty industry. In February 2004, Palomar enhanced the upgrade opportunities for its customers with the introduction of the StarLux™ Pulsed Light and Laser System with increased power, a computer controlled touch screen, instant handpiece recognition, active contact cooling, and a long pulse Nd:YAG laser handpiece, the Lux 1064. The StarLux began shipping in June of 2004. In January 2005, the Lux 1064 laser handpiece received FDA clearance, and in February 2005, Palomar introduced the VisiLux 1064™ handpiece with a digital camera and visualization screen for improved imaging and treatment. In February 2005, Palomar introduced a new infrared handpiece, the Lux IR.

        The Lux systems offer a suite of applications at a fraction of the cost of other competing systems. Customers can invest in their first Lux system with one handpiece then purchase additional handpieces as their practice grows and upgrade into a more powerful Lux system when ready. The Lux platform enables Palomar to custom tailor products to fit almost any professional medical office or spa location and provides customers with the comfort that the system is able to grow with their practice. The StarLux, MediLux, EsteLux and NeoLux systems are affordable and versatile cosmetic light based systems.

        In addition to being cost effective and upgradeable, the platform includes many technological advances. For example, the platform includes Palomar’s Smooth Pulse technology which sets a new standard in safe and comfortable treatments. The Smooth Pulse technology spreads power evenly over the entire pulse of light allowing Palomar to provide ideal wavelengths for faster results in fewer treatments. By contrast, competitive systems deliver a power spike at the beginning of each pulse which can cause injury at the most effective wavelengths. The Smooth Pulse technology also extends the life of the light source allowing Palomar to offer one year, unlimited pulse count warranties or up to 100,000 pulses which ever occurs first on most lamp handpieces. Palomar sells replacement handpieces to existing customers providing a reoccurring revenue stream.

        The Lux pulsed light handpieces combine the latest technology with simple, streamlined engineering that is both effective and economical. Long pulse widths and SpectruMax™ filtering provide increased safety and efficacy. Efficacy is further improved through Palomar’s Photon Recycling process which increases the effective fluence by capturing light scattered out of the skin during treatments and redirecting it back into the treatment target. Offering the largest spot size on the market and high repetition rates allows for a fast coverage rate which is especially important when removing hair from large areas such as legs and backs. A back or a pair of legs can be treated in approximately thirty minutes, and a smaller area, such as the underarms, in even less time. The system’s simple operation opens its applications to a wider band of worldwide users.

    EsteLux. During 2001, Palomar received FDA clearance to market and sell the Palomar EsteLux™ Pulsed Light System. In 2002 and 2003, Palomar offered six handpieces for the EsteLux system: LuxY, LuxG, LuxR, LuxRs, LuxB and LuxV. These handpieces emit pulses of intense light to treat unwanted hair, solar lentigo (sunspots), rosacea, actinic bronzing, spider veins, birthmarks, telangiectasias, acne and more. The LuxY handpiece is used for hair removal for large body areas and for pigmented lesion treatments. The LuxG handpiece delivers the RejuveLux™ process — photofacial treatments that remove pigmented and vascular lesions to improve skin tone and texture. The LuxR handpiece can be used to remove hair on all skin types, from the fairest to the darkest, including deep tans. Likewise, the LuxRs handpiece can be used to remove hair on all skin types, but it has concentrated power in each pulse resulting in permanent hair reduction in fewer treatments. The LuxB handpiece provides effective treatment of lighter pigmented lesions on fair skin as well as leg and spider veins, and the LuxV handpiece treats pigmented lesions and mild to moderate acne. With these complimentary handpieces, the Lux Platform is one of the most affordable and multifaceted systems in the market.

    MediLux. In March 2003, Palomar launched the Palomar MediLux™ Pulsed Light System with the six handpieces also available on the EsteLux. The MediLux provides increased power, a faster repetition rate and a new snap-on connector making it easier to switch among handpieces and provide treatments tailored to each individual being treated.

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    NeoLux. In October 2003, Palomar launched the Palomar NeoLux™ Pulsed Light System, a less complex and less expensive system. The NeoLux is designed for the spa and salon market. A three button control panel enables easy operation and training. The NeoLux operates with the LuxY, LuxR and LuxRs handpieces to treat pigmented lesions and provide for hair removal on all skin types.

    StarLux. In February 2004, Palomar launched the Palomar StarLux™ Pulsed Light System, and in June 2004, Palomar began shipping this system. The StarLux has a single power supply capable of operating both lasers and lamps. The StarLux includes increased power, integrated contact cooling and a full color touch screen for easy operation. Currently, the StarLux operates five of the EsteLux / MediLux handpieces, namely the LuxY, LuxG, LuxR, LuxRs, and LuxV. In addition, the increased power of the StarLux allows for the operation of a long pulse Nd:YAG laser handpiece, the Lux1064™. In January 2005, the Lux 1064 laser handpiece received FDA clearance for a variety of applications, including but not limited to removal of pigmented and vascular lesions, including visible leg veins, tattoo and hair removal, treatment of wrinkles, removal of red pigmentation in hypertrophic and keloid scars and treatment of pseudofolliculitis barbae. The Lux1064 is a high power laser handpiece to feature Smooth Pulse technology and Active Contact Cooling while also providing multiple spot sizes. Palomar’s patented Active Contact Cooling technology sends a chilled water supply through the handpieces, thus cooling the skin before, during, and after treatment. This unique feature ensures maximum safety and comfort during treatment. The StarLux’s high-powered treatments deliver long-lasting and even permanent results. For the lamp handpieces, fluences up to 50 J/cm², the largest available spot size (up to 16 x 46 mm), and a wide spectrum of optimal wavelengths (400-1400 nm), provide outstanding efficacy. With fluences up to 700 J/cm², the Lux 1064 provides visible leg vein removal. The StarLux full-color screen allows easy finger-touch operation and instant handpiece recognition while providing constant feedback on operating parameters. In February 2005, Palomar introduced the VisiLux 1064™ handpiece which includes a digital camera and a visualization screen to provide enhanced imaging and magnification of the area of skin to be treated to increase ease of use and improve treatment. In February 2005, Palomar also introduced a new infrared handpiece, the Lux IR, for deep tissue heating for relief of muscle and joint pain (pending FDA clearance). Palomar expects to seek further FDA clearances for the Lux IR including skin tightening, skin lifting and wrinkle removal.

        Q-YAG 5. During 2001, Palomar received FDA clearance to market and sell the Palomar Q-YAG 5™ system for tattoo and pigmented lesion removal. The Palomar Q-YAG 5 is a Q-switched, frequency-doubled Neodymium laser. This laser system allows users to switch between a 1064-nm single-wavelength beam and a 1064/532-nm mixed-wavelength beam. The combination of wavelengths allows users to treat a full spectrum of colors and inks, and the system’s design lowers costs and allows broader use of the instrument. The single 1064-nm wavelength is ideal for treating darker tattoo inks and dermal-pigmented lesions, such as Nevi of Ota common in Japan and other Pacific Rim countries. The mixed 1064/532-nm wavelength is better suited for brighter colors and epidermal-pigmented lesions, such as solar lentigines. In addition, the mixed wavelength permits brighter, more superficial and deeper and darker target areas to be treated simultaneously. The Palomar Q-YAG 5 incorporates the laser into the handpiece making it smaller and lighter than competitive systems, which is especially desirable for mobile and/or small physician offices. These attributes reduce the cost, increase the reliability of the system and eliminate costly optics and service problems that are common with other high power Q-Switched lasers.

        Legacy Products. Palomar no longer sells the EpiLaser™ or E2000™ hair removal laser systems, the RD-1200™ Q-switched ruby laser or SLP1000® Diode Laser System. However, Palomar continues to service these systems. During 1996, using Palomar’s core ruby laser technology, originally developed for tattoo removal and pigmented lesions, Palomar developed a long pulse ruby laser, the EpiLaser, that was specifically configured to allow the appropriate wavelength, energy level and pulse duration to be absorbed effectively by the hair follicle without being absorbed by the surrounding tissue. That, combined with a cooling handpiece, allowed for safe and effective hair removal. In March 1997, Palomar was the first company to receive FDA clearance to sell and market a ruby laser (the EpiLaser system) in the U.S. for hair removal. The Palomar EpiLaser was cleared by the FDA for permanent hair reduction in March 1998. During 1998, Palomar introduced its second-generation ruby laser, the Palomar E2000™ hair removal laser system; a product that was superior to hair removal lasers then available in a number of respects, including speed and efficacy. The FDA cleared the E2000 for permanent hair reduction. The RD-1200™ is a Q-switched ruby laser for tattoo removal and treating pigmented lesions. The SLP1000 is a high-powered diode laser that delivers energy over a relatively long time period using a technology called “Super Long Pulse Technology”. The SLP1000 is the first diode laser using Super Long Pulse Technology and interchangeable handpieces to provide hair removal and vascular lesion treatments to virtually all skin types. In addition, the SLP1000 is compact and easy to use.

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Sales, Marketing and Distribution

        As of December 31, 2004, Palomar’s sales and marketing organization consisted of 41 employees. Palomar’s direct sales representatives operate within their respective regions and engage customers directly and employ targeted lead generation programs such as regional seminars. Palomar also manages customer opportunities through Palomar’s strategic distribution relationships with exclusive distributors.

Direct Sales Force

        Palomar sells products in the U.S. primarily through its direct sales force to dermatologists, cosmetic surgeons and general practitioners as well as to other licensed practitioners. Palomar’s domestic direct sales force is organized into regions and each region is managed by a regional sales manager. Palomar’s direct relationships with its customers are generally governed either by customer purchase orders and Palomar’s acknowledgement of those orders or by purchase contracts.

Global Distribution

        In Palomar’s international sales and marketing efforts, Palomar employs a global network of strategic distributors. Palomar has established distribution relationships throughout Europe, Japan, Australia, South and Central America, the Far East, and the Middle East. As of December 31, 2004, Palomar utilized 35 distributors in 45 countries. Generally, Palomar’s distributors enter into a one to two year agreement not to sell our competitor’s products. Palomar’s sales strategy is to choose the most productive and practicable distribution channel within each of its geographic markets.

        The following table shows product revenue relating to Palomar’s international sales activities during each of the last three fiscal years by geographic region:

Customer Service and Support

        Palomar believes that a broad range of support services is essential to the successful deployment and ongoing support of its products. In most cases, Palomar’s customer service and support organization provides front line product support and is the problem resolution interface. Palomar firmly believes that quick and effective delivery of service is essential to Palomar’s customers. Palomar offers the following services: technical assistance, hardware repair and replacement, loaner equipment to minimize end user disruption, and professional and educational services.

        Palomar’s customer service center and depot repair facility is located at Palomar’s Burlington, Massachusetts headquarters. Certain independent distributors also maintain service centers and parts depots at their facilities and are required to attend Palomar’s formal training to become certified in the repair and maintenance of each of Palomar’s products.

        Product maintenance and repair following the warranty period provides an additional recurring source of revenue. Customers may elect to purchase a service contract or purchase service on a time-and-materials basis. Palomar’s service contracts vary by the type of system and the level of service desired by the customer and typically last for one year. Initial warranties on most products cover parts, service and shipping charges for twelve months. Customers have the option to purchase an extended warranty (beyond the normal one year coverage) as part of the purchase.

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        Palomar’s customer service center not only provides technical assistance for each product line but also provides the option to the end user to purchase additional service contracts, replacement Lux handpieces, end-user marketing materials, and other complementary accessory items. Palomar expects that as the Lux product installed base expands, product revenue generated from the sale of replacement Lux handpieces will increase.

Products Under Development

        Palomar is engaged in developing products for the dermatology and cosmetic market. Products under development include lasers, lamps and other light based products for the removal of unwanted hair, tattoos, pigmented lesions, leg vein and other vascular lesions, acne, fat, cellulite, and skin rejuvenation, including wrinkles and skin tone and texture. Palomar performs its own research as well as with partners, including The Massachusetts General Hospital Corporation (“Massachusetts General Hospital”). Product development is performed by scientists and engineers at Palomar’s headquarters. Palomar directs resources at both new products for existing markets such as the removal of unwanted hair, vascular and pigmented lesions and tattoos, acne and wrinkle removal, and other products for new markets, such as fat reduction, including treatment of cellulite.

        On February 14, 2003, Palomar entered into a Development and License Agreement with Gillette to complete development and commercialize a home-use, light based hair removal device for women. Palomar believes that this device will be protected by multiple patents within its patent portfolio. This consumer hair removal device is expected to be safe and effective for use on women’s legs, underarms, bikini line and other areas where a woman might find it necessary to shave, apply hair-removal creams, or undergo waxing, electrolysis, or laser or other light based professional treatments in a doctor’s office, clinic, spa or salon. The parties have completed the first phase and have decided to move into the next phase. The original agreement provided up to $7 million in initial development support funding to be paid by Gillette to Palomar over approximately the first 30 months of the agreement. Under a June 2004 amendment, Gillette agreed to provide $2.1 million in additional development funding over a 9-month extension of the development phase, which is now planned to be completed by August 31, 2006. In 2004, Gillette provided $3.1 million in funded product development. (See Note 12, “Development and License Agreement with Gillette” and exhibit 10.14, “The Development and License Agreement with The Gillette Company effective February 14, 2003 with redacted exhibits”)

        On February 18, 2004, Palomar announced that it was awarded a $2.5 million research contract by the Department of the Army to develop a light based self-treatment device for Pseudofolliculitis Barbae or PFB, commonly known as “razor bumps”. Though the project was scheduled to last for nineteen months, Palomar believes it will need several more months to complete the work. PFB is called “the most significant dermatologic disease in the US Army” in an article by Brauner GJ, Flaudesmeyer KL. entitled “Pseudofolliculitis barbae: Medical consequences of interracial friction in the US Army”, Cutis, 1979, 23:61-66. PFB affects combat readiness, unit cohesion, and individual morale of over 50% of African American and Hispanic military personnel according to an article by Perry PK, Cook-Bolden FE, et al. entitled “Defining pseudofolliculitis barbae in 2001", JAAD, 2002, 46:S113-S119. The importance of a solution to the PFB problem is increasing along with the changing demographics of the military. According to Semiannual Race/Ethnic/Gender Profile by Service/Rank, Sept. 2000 the percentage of African-Americans and Hispanics in the services is currently twice that in the civilian population and growing. Palomar believes that this device will be protected by multiple patents within its patent portfolio.

        As of September 1, 2004, Palomar entered into a Joint Development and License Agreement with Johnson & Johnson Consumer Companies, Inc. (“JJCC”), a Johnson & Johnson company, to develop and commercialize home-use, light based devices in the fields of (i) reducing or reshaping body fat including cellulite; (ii) reducing appearance of skin aging; and (iii) reducing or preventing acne. The agreement provides for JJCC to fund Palomar's research and clinical studies during an initial proof-of-principle phase. At the end of the proof-of-principle phase, JJCC will decide whether or not to continue with one or more of the devices in one or more of the fields into a development phase. Upon JJCC deciding to continue, JJCC will be obligated to fund the development of the selected devices. If JJCC decides not to continue, Palomar may proceed in fields not selected by JJCC to develop and commercialize these and other devices on our own or with a different party. At the end of the development phase, JJCC will decide whether or not to commercialize one or more of the devices in one or more fields. Upon JJCC deciding to commercialize one or more of the devices, JJCC will make payments to Palomar for each selected field. Upon commercial launch of the first device in each selected field, JJCC will make a payment to Palomar, and for all devices sold for use in each selected field, JJCC shall pay Palomar a percentage of sales of such devices and certain topical compounds. If JJCC decides not to commercialize or fails to launch a device, Palomar may proceed in fields not selected by JJCC to develop and commercialize these and other devices on our own or with a different party. Palomar recognized $318,000 of funded product development revenues from JJCC during the twelve months ended December 31, 2004. Any amounts received in advance of services performed are recorded as deferred revenue. Payments are not refundable if the development is not successful. (See Note 13, “Joint Development and License agreement with Johnson & Johnson Consumer Companies (“JJCC”), a Johnson & Johnson company” and exhibit *10.27 “Joint Development and License Agreement by and between Palomar Medical Technologies, Inc. and Johnson and Johnson Companies, Inc.”, dated September 1, 2004 (filed as Exhibit 99.1 to our Current Report on Form 8-K, filed with the SEC on September 7, 2004, and incorporated herein by reference)

Production, Sources and Availability of Materials

        Palomar’s manufacturing operations are located in Burlington, Massachusetts. Palomar maintains control of and manufactures most key subassemblies in-house. Manufacturing consists of the assembly and testing of components purchased from outside suppliers and contract manufacturers. Each fully assembled system is subjected to a rigorous set of tests prior to shipment to the customer or distributor. Palomar has obtained ISO 9001, ISO 13485, CDN MDR, and Council Directive 93/42/EEC. Palomar is registered with the Federal Food and Drug Administration.

        Palomar depends and will depend upon a number of outside suppliers for components used in its manufacturing process. Most of Palomar’s components and raw materials are available from a number of qualified suppliers. If Palomar’s suppliers are unable to meet Palomar’s requirements on a timely basis, production could be interrupted until an alternative source of supply is obtained. In 2002 and early 2003, Palomar experienced significant failures and delays in a critical raw material component required for the SLP 1000. Although the component vendor has rectified the problem, there can be no assurance that this situation will not re-occur in the future. Palomar has not experienced any other delays in raw material for its products.

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Patents and Licenses

        Palomar’s success and ability to compete are dependent on its ability to develop and maintain proprietary technology and operate without infringing on the proprietary rights of others. Palomar relies on a combination of patents, trademarks, trade secret and copyright laws and contractual restrictions to protect its proprietary technology. These legal protections afford only limited protection for its technology. Palomar is presently the exclusive licensee of two United States patents and the non-exclusive licensee of three United States patents and corresponding foreign patents and pending applications owned by Massachusetts General Hospital, and Palomar is also the joint owner with and exclusive licensee of Massachusetts General Hospital of three other United States patents and corresponding foreign patent and pending applications. In addition, Palomar is the sole owner of nine United States patents and corresponding foreign patent and pending applications, and Palomar has rights to other patents under exclusive and non-exclusive licenses.

        Palomar seeks to limit disclosure of its intellectual property by requiring employees, consultants and any third party with access to Palomar’s proprietary information to execute confidentiality agreements with Palomar and often agreements that include assignment of rights provisions to Palomar. Due to rapid changes in technology, Palomar believes that factors such as the technological and creative skills of its personnel, new product developments and enhancements to existing products are as important as the various legal protections of Palomar’s technology to establishing and maintaining a leadership position.

        Despite Palomar’s efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the products or to obtain and use information that Palomar regards as proprietary. Policing unauthorized use of Palomar’s products is difficult. Litigation may be necessary to enforce intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Any such resulting litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the business, operating results and financial condition. There can be no assurance that Palomar’s means of protecting proprietary rights will be adequate or that Palomar’s competitors will not independently develop similar technology. Any failure by Palomar to meaningfully protect Palomar’s proprietary rights could have a material adverse effect on its business, operating results and financial condition.

        Management believes that none of Palomar’s current products infringe upon valid claims of patents owned by third parties. However, there have been claims and there can be no assurance that third parties will not make further claims of infringement with respect to our current or future products. Any such claims, with or without merit, could be time-consuming to defend, result in costly litigation, divert management’s attention and resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all. A successful claim of intellectual property infringement against us and our failure or inability to license the infringed technology or develop or license technology with comparable functionality could have a material adverse effect on our business, financial condition and operating results. (See “Cautionary Statements.”)

        In August 1995, Palomar entered into an agreement with The Massachusetts General Hospital Corporation whereby Massachusetts General Hospital agreed to conduct clinical trials on a laser treatment technology for hair removal developed at Wellman Laboratories of Photomedicine (“Clinical Trial Agreement”). In July 1999, Palomar amended this agreement to extend its research relationship for an additional five years, until August 2004, and to cover the additional fields of non-invasive, electromagnetic targeting of subcutaneous fat, and treatment of sebaceous glands and related skin disorders (e.g., acne) using infrared light except when externally applied chromophores are used. On August 1, 2004 Palomar and Massachusetts General Hospital entered into a new agreement (the “Research Agreement”) whereby Massachusetts General Hospital agreed to conduct clinical and non-clinical research in the field of photo thermal removal or reduction of hair, using light (hereinafter referred to, as “hair removal,”). The Research Agreement has a term of three years, until August 2007, and Palomar will provide Massachusetts General Hospital at least $230,000 on an annual basis to cover the direct and indirect costs of the research.

        Palomar also entered into a license agreement with Massachusetts General Hospital in August of 1995 (“License Agreement”) through which Palomar is the exclusive licensee of certain U.S. and foreign issued patents and pending patent applications in the field of hair removal, including U.S. Patent Nos. 5,595,568 and 5,735,844, European Patent Nos. 0 806 913 B1 and EP 1 230 900 B1 and Chinese Patent No. ZL96191751.2. At an opposition hearing held December 1, 2004, EP 0 806 913 B1 was revoked and such revocation is being appealed by Palomar and Massachusetts General Hospital. Under the Clinical Trial Agreement and a joint patent agreement many joint patent applications have been filed. Palomar is a joint owner of such joint patent applications On February 18, 2003, Palomar and Massachusetts General Hospital signed a fourth amendment to the License Agreement, providing Palomar with exclusive licenses in all fields to existing and future joint patents and applications provided Palomar meets certain due diligence obligations.

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        Palomar has the right to sublicense patents licensed to it under the License Agreement. Palomar pays Massachusetts General Hospital royalties on sales of Palomar’s products covered by these licensed patents and a percentage of the royalties Palomar receives from its sub-licensees. Palomar currently sublicenses certain competitors to U.S. Patent Nos. 5,595,568 and 5,735,844 and foreign counterparts. One of these licensees is Lumenis, Inc. On June 17, 2004, Palomar and Lumenis settled their on-going litigation concerning both patent infringement and contractual matters and Lumenis agreed to pay $4.09 million over the next six quarters for royalties due on sales of its LightSheer system made between July 1, 2002 and December 31, 2003. Beginning on January 1, 2004, Lumenis agreed to pay Palomar a 5% royalty on sales of the LightSheer and other professional laser hair removal devices and modules. In addition, Lumenis granted Palomar a paid up license to a variety of Lumenis’ patents for Palomar’s light based devices and Palomar granted Lumenis a paid up license to the ‘568 and ‘844 patents for Lumenis’ lamp based devices. Importantly, both parties have agreed to the validity and enforceability of each others patents and not to challenge such validity and enforceability in the future.

        Palomar also licenses Gillette, to U.S. Patent Nos. 5,595,568 and 5,735,844 and foreign counterparts and other patents for the development and commercialization of a home-use, light based hair removal device for women. Palomar licenses JJCC to other patents for the development and commercialization of home-use, light based devices for reducing fat including cellulite, reducing appearance of skin aging, and reducing or preventing acne.

Dependence on a Single Customer

        For the years ended December 31, 2004, 2003 and 2002, Palomar had two customers that accounted for 9%, 20% and 35% of net sales, respectively. At December 31, 2004, 2003 and 2002, these customers accounted for 6%, 20% and 27% of trade receivables outstanding, respectively.

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Backlog

        Palomar generally does not maintain a high level of backlog. As a result, Palomar does not believe that its backlog at any particular time is indicative of future sales levels.

Competition

        The market in which Palomar is engaged is subject to intense competition and rapid technological change. Some of Palomar’s competitors have greater financial, marketing, and technical resources than that of Palomar. Moreover, some competitors have developed, and others may attempt to develop, products with applications similar to that of Palomar. Palomar expects that there may be further consolidation of companies within the light based industry via acquisitions, partnering arrangements or joint ventures. Palomar competes primarily on the basis of technology, product performance, price, quality, reliability, distribution and customer service and support. To remain competitive, Palomar will be required to continue to develop new products and periodically enhance its existing products. (See “Cautionary Statements.”)

Food and Drug Administration Regulations

        All of Palomar’s current products are light based devices, which are subject to FDA regulations for clinical testing, manufacturing, labeling, sale, distribution and promotion. Before a new product or a new use of or claim for an existing product can be marketed in the United States, Palomar must obtain clearance from the FDA. The types of medical devices that we seek to market in the United States generally must receive either “510(k) clearance” or “PMA approval” in advance from the U.S. Food and Drug Administration (“FDA”) pursuant to the Federal Food, Drug, and Cosmetic Act. The FDA’s 510(k) clearance process usually takes from three to twelve months, but it can last longer. The process of obtaining PMA approval is much more costly and uncertain and generally takes from one to three years or even longer. To date, the FDA has deemed Palomar’s products eligible for the 510(k) clearance process. Palomar believes that most of its products in development will receive similar treatment. However, Palomar cannot be sure that the FDA will not impose the more burdensome PMA approval process upon one or more of future products, nor can Palomar be sure that 510(k) clearance or PMA approval will ever be obtained for any product it proposes to market and failure to do so could adversely affect Palomar’s ability to sell products.

Number of Employees

        As of December 31, 2004, Palomar employed 161 persons. Palomar is not subject to any collective bargaining agreements, has never experienced a work stoppage and considers its relations with its employees to be good.

SEC Filings Available on Website

        Palomar’s internet website address is www.palomarmedical.com. Palomar’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 are available free of charge through Palomar’s internet website as soon as reasonably practicable after Palomar files such material with, or furnish it to, the Securities and Exchange Commission.

Item 2. Properties

        Palomar occupies approximately 44,000 square feet of office, manufacturing and research space in Burlington, Massachusetts under a lease expiring in August 2009. Palomar believes that this facility is in good condition and is suitable and adequate for its current operations.

Item 3. Legal Proceedings

        On February 15, 2002, Palomar commenced an action for patent infringement in the United States District Court for the District of Massachusetts against Altus Medical, Inc., now known as Cutera, Inc., seeking both monetary damages and injunctive relief. The complaint alleges Cutera’s CoolGlide and CoolGlide Excel laser systems willfully infringe U.S. patent No. 5,735,844, which is exclusively licensed to Palomar by the Massachusetts General Hospital. The Massachusetts General Hospital was added as a plaintiff in this lawsuit. Cutera answered the complaint denying that its products infringe the asserted patent and filed a counterclaim seeking a declaratory judgment that the asserted patent is invalid and not infringed. Palomar and the Massachusetts General Hospital filed a reply denying the material allegations of the counterclaims. Palomar and the Massachusetts General Hospital have further alleged that Cutera’s CoolGlide Vantage and CoolGlide XEO laser systems also willfully infringe the asserted patent. On June 4, 2003, Cutera amended their answer and asserted a counter claim alleging that the patent is unenforceable due to inequitable conduct. Palomar and the Massachusetts General Hospital believe that this claim is without merit and filed a reply denying the material allegations of this counterclaim. A claim construction hearing (often referred to as a Markman hearing) was held on June 12, 2003, and on February 27, 2004 the Judge issued her ruling. Palomar believes the ruling largely embraced Palomar’s position. On January 14, 2005, Cutera filed a motion for summary judgment that the patent claims being asserted are invalid and not infringed. Palomar and the Massachusetts General Hospital filed a response vigorously defending both the validity of the patent claims and the infringement of those claims by Cutera’s CoolGlide products. A trial date has not yet been set. (See “Cautionary Statements”)

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

Not applicable.

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PART II

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

        Palomar’s common stock is currently traded on the Nasdaq National Market (“Nasdaq”) under the symbol PMTI. The following table sets forth the high and low bid information on Nasdaq for the common stock for the periods indicated. Such quotations reflect inter-dealer prices, without retail markup, markdown or commission and do not necessarily represent actual transactions.

        As of February 28, 2005, Palomar had 3,943 holders of record of common stock. This does not include holdings in street or nominee names.

        Palomar has not paid dividends to its common stockholders since its inception and does not plan to pay dividends to its common stockholders in the foreseeable future. Palomar intends to retain substantially all earnings to finance the operations of the company. Palomar may buy back shares of its common stock on the open market from time to time.

Item 6. Selected Financial Data

        The following table sets forth selected consolidated financial data for each of the last five fiscal years. This data should be read in conjunction with the detailed information, financial statements and related notes, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein. The historical results are not necessarily indicative of the results of operations to be expected in the future.

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