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                         SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, D.C.  20549
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                                     FORM 10-K
                                          
(X)     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                        THE SECURITIES EXCHANGE ACT OF 1934
                    FOR THE FISCAL YEAR ENDED DECEMBER 31, 19971998
                                          
                                         OR
                                          
(_)     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                       OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD OF _______          TO ________           
                                          
                           COMMISSION FILE NUMBER 1-11388
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                                   PLC SYSTEMS INC.
                (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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             BRITISH COLUMBIA,-------------------

      YUKON TERRITORY, CANADA                              04-3153858
   (STATE OR OTHER JURISDICTION OF                      (I.R.S. EMPLOYER
   INCORPORATION OR ORGANIZATION)                       IDENTIFICATION NO.)

                      
10 FORGE PARK, FRANKLIN, MASSACHUSETTS (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) 02038 (ZIP CODE) ------------------------------------------- (508) 541-8800 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) ------------------------------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(B)12(b) OF THE ACT:
NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- ------------------- --------------------- COMMON STOCK, NO PAR VALUE AMERICAN STOCK EXCHANGE
------------------------SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE ------------------- 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]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. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the last sale price for such stock on March 23, 1998,1999, was $262,345,727.$77,128,690. As of March 23, 1998, 18,973,1141999, 20,230,476 shares of Common Stock, no par value per share, were outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- DOCUMENTS INCORPORATED BY REFERENCE
PART OF FORM 10-K IN WHICH DOCUMENT DOCUMENT IS INCORPORATED -------- ------------------------ Registration Statement on Form S-1 Part IV (File No. 33-58258). Registration Statement on Form S-1 Part IV (File No. 33-48340).
COMPLIANCE WITH COMPANY ACT REGULATIONS (BRITISH COLUMBIA) This Annual Report on Form 10-K is intended to complyPortions of the registrant's preliminary proxy statement, which will be issued in connection with the requirements1999 Annual Meeting of Section 6 of the Company Act Regulations (British Columbia). ================================================================================ 2 PART I ITEM 1. BUSINESS.Shareholders (Part III), are incorporated by reference. FORWARD-LOOKING STATEMENTS This report (and information incorporated by reference) contains forward-looking statements regardingwithin the U.S. Food and Drug Administration ("FDA") approval, anticipated increases in revenues, marketingmeaning of products and proposed products, product performance, adequacySection 27A of the Company's facilities, patentsSecurities Act of 1933 and patent applications, competition and other matters.Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include statements in addition to statements made in conjunction with the words "anticipate," "expect," "intend," "believe," "seek," "estimate"Item 1. Business; Item 3. Legal Proceedings; Item 7. Management's Discussion and Analysis of Financial Condition and Result of Operations; and Item 7A. Quantitative and Qualitative Disclosures about Market Risk. Statements containing terms such as "believes", "plans", "expects", "anticipates", "intends", "estimates" and similar expressions contain uncertainty and are forward-looking statements that involve a number of risks and uncertainties. Suchstatements. Forward-looking statements are based on management's current plans and expectations and are subject to a number of factorsinvolve known and unknown risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such factors and uncertainties include, but are not limited to: approvalthe successful ability to secure any required financing; the ability to convince health care professionals and third party payers of the medical and economic benefits of the Company's products; the absence of reimbursement for health care providers who use the Company's products, or the risk that reimbursement, if provided, will be inadequate; restrictions imposed by regulatory agencies such as the U.S. Food and Drug Administration, ability to secure any required additional financing,Administration; competitive developments; business conditions, and growth in certain market segments, and economic conditions, competition, market acceptance of the Company's products and proposed products, reimbursement policies of government and insurance carriers, thegeneral economy; uncertainty that existing patents will be held valid, that any additional patents will be issued or that the scope of any patent protection will exclude competitors and other risks and uncertainties indicated from time to time inor that the Company's filings withproducts do not infringe any intellectual property rights of others; and, risk factors in Item 7, Item 7A, the SecuritiesCompany's other SEC reports, and Exchange Commission.the Company's press releases. PART I ITEM 1. BUSINESS. GENERAL PLC Systems Inc. ("PLC" or the "Company") has developed a patented high-powered carbon dioxide ("CO(2)"CO2") laser system known as The Heart Laser System(TM)(1)Laser-TM- System for broad applicationuse in the treatment of coronary artery disease in a surgical laser procedure, pioneered by the Company and its clinical investigators, known as transmyocardial revascularization ("TMR"). TMR is a revolutionary new way of relieving debilitating pain in patients suffering from severe coronary artery disease ("CAD"). The Company believes that TMR using the Heart Laser System may provide an alternative or adjunct therapyCompany's patented high-energy CO2 laser is used by a cardiovascular surgeon to conventional revascularization treatments, such as coronary bypass surgerycreate between 20 and balloon angioplasty or may be used to treat patients who cannot be helped by these treatments. TMR, using the Heart Laser System creates new40 tiny channels in the heart wall of a patient suffering from severe CAD. The Company's Heart Laser System was developed specifically for TMR and it is believed to be the only TMR system that permit oxygenated blood presentcan create a channel completely through the heart wall with a single laser pulse. In addition, the Company's Heart Laser System uses patented technology to fire this single laser pulse in the left ventriclefraction of a second between a patient's heartbeats. This patented "synchronization" technology ensures that The Heart Laser System will only fire at a relatively safe point in a patient's heartbeat cycle when the heart is relatively still and unresponsive to flow outwardly to the ischemic (oxygen starved) areas of the heart muscle affected by atherosclerosis. Throughstimuli. The procedure does not require a heart-lung bypass machine and is performed through a small incision made between the patient's ribs while the Heart Laser Systempatient's heart is usedbeating. A patient's recovery is therefore expected to drill approximately 20-40 tiny channels from the exterior of the heart muscle into the interior of the left ventricle. This procedure is performed on a beating heartbe quicker, less traumatic and does notless costly than in surgical procedures, such as bypass surgery, which require the use of a heart-lung machine. Clinical test results have indicatedThe Company estimates that througheach year approximately 120,000 patients worldwide are diagnosed with severe CAD which is not treatable by conventional revascularization techniques. CAD is a form of heart disease caused by the body's normal healing process, the endblockage of each hole on the exterior of the heart muscle closes, but the channels createdblood flow into the interior remain open resulting in oxygenatedcoronary arteries which supply oxygen-rich blood flowing outwardly from the left ventricle to the ischemic areasheart. Typically, severe CAD patients experience excruciating spasmodic attacks of the heart muscle. Studies conducted at the Max Planck Institut in Germany using myocardial contrast echocardiography (MCE)chest pain, or "angina", and often shortness of breath and fatigue. No longer candidates for traditional surgery, these patients are generally on maximum drug therapy. U.S. clinical studies have demonstrated patent (open) channels in the heart muscles of TMR patients which was further confirmed by a study conducted at University Hospital in Hamburg, Germany using a revolutionary ultrasound system. Under the Company's first indication for the Heart Laser System, for which PLC has submitted a PreMarket Approval application ("PMA"), the U.S. Food and Drug Administration ("FDA") has authorized the Company to utilize theThe Heart Laser System to treatbe safe and effective in decreasing angina by two or more classes (angina is measured in classes from one to four, one being the least painful and four being the most) in nearly 75% of the patients who were not suitable for conventional bypass surgery or other revascularization procedures. Management believes that clinical testing to date has been positive, with benefits including reduced length of hospital stays by patients, more efficient all-inclusive treatment costs, reduction of angina pain, increased activity level, improved quality of life and reduced incidents of adverse side effects and restenosis compared to alternative treatments. Management notes, however, thatstudied; in fact, TMR using theThe Heart Laser System is stilleliminated all angina in the testing stage and that at this time no assurance can be given regarding the ultimate safety or efficacyone-third of the device as treatment for cardiovascular disease. - --------------- 1The Heart Laser is a trademark of PLC Medical Systems, Inc. 1 3 Well over 3,500patients studied. Over 4,300 patients have been treated with TMR using the Company's Heart Laser System in the United States and overseas. The Heart Laser System has been shipped to 30 sites in the United States, andabroad. As of December 31, 1998, the Company had sold or placed (through December 31, 1997) 69shipped over 100 Heart Laser Systems overseas. At the same time, a number of studies and scientific conferences have been held favorably reporting on the use of TMR using the Heart Laser System as an adjunct or alternative to bypass and angioplasty procedures on patients that were not eligible for these procedures.worldwide. RECENT DEVELOPMENTS Since the Company's last annual report on Form 10-K, the following significant events and accomplishments have taken place: Review of PMA byoccurred: RECEIPT OF FDA Circulatory System Devices Advisory Panel. In July 1997, the circulatory systems devices panel of the FDA convened to review the Company's PMA application for TMR using the Heart Laser System. In a nine to two vote, the panel recommended that the PMA application not be recommended for approval pending further patient data. In September 1997,APPROVAL. On August 20, 1998, the Company received a letterapproval from the U.S. FDA which agreed with the panel's recommendation of non-approval and completion of the follow-up data. Included in this letter were 12 requests for further information relating to follow-up data, which when answered, would place the PMA application in "approvable form." PLC Systems Completes Data Submission to the FDA for The Heart Laser System. In December 1997, the Company submitted all of the requested data on TMR usingmarket The Heart Laser System throughout the U.S. for treatment of the estimated 80,000 domestic patients each year who suffer from severe CAD but cannot be treated with conventional coronary revascularization techniques such as bypass surgery or angioplasty. PLC was the first company to receive FDA approval to commercialize a product to perform TMR. As part of this approval process, the FDA conducted an inspection of the Company's manufacturing facility in June 1998. The FDA completed its inspection of PLC's manufacturing facility without finding any deficiencies in the Company's manufacturing and quality systems. MEDICARE REIMBURSEMENT FOR TMR FORTHCOMING. In February 1999, the Health Care Financing 1 Administration (HCFA) announced that Medicare will provide coverage for TMR procedures performed with devices approved by the FDA. The submissiondecision rescinds the national noncoverage instruction for TMR implemented by HCFA in May 1997 and sets a new coverage policy to allow payment for TMR consistent with FDA-approved uses of TMR devices. HCFA has not yet determined the effective date of this policy change. FAVORABLE ASSESSMENT OF TMR BY BLUE CROSS/BLUE SHIELD TEC. In January 1999, the Blue Cross and Blue Shield Association Technology Evaluation Center ("TEC") completed a favorable assessment of TMR. The TEC concluded that TMR meets all five criteria used to evaluate new medical technologies: (1) final approval from the FDA; (2) scientific evidence of improvement in health outcomes; (3) net benefit in health outcomes; (4) health outcomes at least as beneficial as any established alternative; and (5) improvements achievable outside investigational settings. The TEC's determination that TMR meets its criteria is a significant step in obtaining reimbursement for TMR by major payers. The TEC's conclusion was based upon a review of data showing the safety and effectiveness of TMR by the TEC program staff, and the TEC's assessment was approved by its panel of independent medical advisors. The TEC program is sponsored by the national Blue Cross and Blue Shield Association, whose members include local Blue Cross and Blue Shield plans nationwide, as well as other major managed care organizations including Kaiser Permanente. TEC assessments are released as reports to TEC program subscribers. Nearly all major payers in responsethe U.S., including governmental payers, private third party payers, and managed care organizations, subscribe to the listTEC program and receive TEC assessment reports for use in their own coverage and payment policy decision making. PLC ESTABLISHES CENTER OF EXCELLENCE. In 1998, PLC established a state of 12 requests received from the FDA following the July 1997 panel meeting.art training program at Rush Presbyterian Medical Center in Chicago to ensure that surgeons and medical staff who will use The 12 month data from the controlled randomized study of TMR versus medical management suggests that patients with end-stage or chronic coronary artery disease who undergo TMR using the CO(2) Heart Laser System fare significantly better than patientsare fully trained in the safe and effective use of the system. This comprehensive program focuses on medicalensuring the best possible patient outcomes, and includes intensive discussions on patient selection and management. Course participants view live, narrated procedures via closed circuit television. Actual hands on training is also provided during a laboratory session. PLC RECEIVES ISO 9001 CERTIFICATION. In addition to the 12 month data on the controlled randomized study,March 1999, PLC received ISO 9001 certification, allowing the Company also submitted favorable long-term, threeto place the CE Mark on its products. PLC OBTAINS FAVORABLE SETTLEMENT OF PATENT LITIGATION. In January 1999, the Company settled its outstanding patent infringement litigation with a competitor, CardioGenesis Corporation. Under the settlement, CardioGenesis agreed that key PLC patents are valid and enforceable. The PLC patents cover the Company's synchronization technology, a critical factor in ensuring the safety of TMR and PMR procedures. As part of the settlement, CardioGenesis must pay: - a minimum of $2.5 million to PLC over the next 42 months; and - license fees and ongoing royalties through at least the year angina data on more than 60 TMR patients from its earlier studies. New FDA Advisory Panel Scheduled2009 (so long as the patents remain valid). GE CAPITAL SIGNS EXCLUSIVE AGREEMENT WITH PLC. In September 1998, a unit of GE Capital, a leading vendor financing organization, entered into an exclusive agreement with the Company to Review TMR using Theprovide a broad array of financing alternatives to U.S. hospitals interested in acquiring the PLC Heart Laser System. In March 1998, the Company was advised that an FDA Advisory Panel would review the PMA applicationGE Capital Trans Leasing, a unit of GE Capital's Vendor Financial Services, which specializes in working with equipment manufacturers and dealer/distributors, agreed to work exclusively with PLC to provide financing for TMR using the Heart Laser System on April 24, 1998. Written notification of the advisory panel meeting is expected to be posted in the Federal Register approximately 15 days prior to the meeting. All FDA advisory panel schedules are subject to change. No assurance can be given that the advisory panel will recommend approval for the Company's Heart Laser System at the April panel meeting, or at any future meeting.laser revascularization systems. These financing alternatives provide PLC Systems Completes $20 Million Convertible Debenture Financing. In August 1997, the Company completed, through Smith Barney, a $20 million financing from funds advised by Brown Simpson Asset Management, LLC. Under the terms of the financing, the Company received $20 million from the issuance of convertible debentures due July 17, 2002. All debentures were converted into Common Stock beginning September 10, 1997 and ending February 9, 1998. The money raised provides the Company with a solid cash positionnon-dilutive source of capital to continue its clinical studies of TMR in the U.S. and prepare the Company for the potential worldwide launchfinance placements of The Heart Laser System. William C. Dow Appointed PresidentRENEWAL OF JAPANESE DISTRIBUTION AGREEMENT. In early 1999, PLC renewed its distribution agreement 2 in Japan with Imatron Japan Inc. ("Imatron") to distribute The Heart Laser System in Japan and CEOcomplete the Japanese regulatory approval process. The agreement includes a commitment by Imatron to purchase a minimum of five Heart Laser Systems during 1999. Along with the United States and Germany, Japan is believed to be one of the three largest markets in the world for products used in the treatment of cardiovascular disease. Between 1995 and 1997, Imatron purchased 12 Heart Laser Systems from PLC Systems.to conduct clinical studies in Japan. PLC and Imatron submitted data from these studies to the Japanese Government in December 1998 in support of their application to market The Heart Laser System in Japan. The companies anticipate approval of their application during the second half of 1999. In August 1997, William C. Dow, joined the Company as President and CEO. Mr. Dow joined the Company after serving as President and CEO of Deknatel Snowden Pencer Worldwide, Inc.,early 1999, PLC also hired a $100 million medical device manufacturer and marketing subsidiary of Genzyme Corporation. Mr Dow hasdirect representative with more than 25 years of broad-based experience in the medical device and services industry. Mr. Dow holds a Bachelor of Science in Engineering from the United States Naval Academy and served as a Lieutenant in the U.S. Navy where he was a pilot and a supply officer. TMR Studies Underwayselling cardiovascular products in Japan Using PLC Systems CO2 Heart Laser System. In March 1997, The Heart Institute of Japan located at Tokyo Women's Medical Center performed the country's first TMR procedure as partto support development of the Ministry of Health and Welfare (MHW) approval process in that country. In compliance with the MHW approved protocol, a total of 60 patients will be enrolled in the Japanese study. To date, 54 patients have been enrolled in this study. The Company is working closely with its distributor IMATRON Japan to provide technical support and training in Japan during the clinical studies. The Company believes MHW approval for TMR using The Heart Laser System could be granted sometime in the 2 4 period beginning late 1998 through early 1999. No assurance can be given that an MHW approval will be granted in this timeframe, if at all. HCFA/Medicare Institutes a Non-Coverage Policy for TMR Patients in the United States. Effective May 1997, the Health Care Financing Administration (HCFA) instituted a non-coverage instruction for Medicare patients in the U. S. receiving TMR. The Company has been in regular contact with HCFA and continues to advise the agency of the Company's progress through the FDA regulatory approval process. The Company is hopeful that upon PMA approval, Medicare reimbursement for TMR using the Heart Laser System will be implemented as reimbursement policies will continue to impact the Company's business and revenues. No assurance can be given that Medicare reimbursement will be implemented after PMA approval and no assurance can be given that the FDA will grant a PMA approval for the Heart Laser System. PLC Systems Strengthens Team with Addition of New Executive Managers. In January 1998, the Company announced the addition of several new senior management positions. New senior managers include: Vincent Puglisi, Corporate Sales; Paul Levesque, Marketing and New Business Development; Cindy Crosby, Regulatory and Quality Assurance and Jennifer Miller, General Counsel. The Company has expanded its management team with executives with experience in transitioning businesses from research and development to commercialization.market. BACKGROUND In 1981, the Company's former Chairman, Dr. Robert I. Rudko, formed Laser Engineering, Inc. ("LEI"), now PLC Medical Systems, Inc., to develop and commercialize the development of sealed-off carbon dioxide ("CO(2)") lasers. Dr. Rudko, who holds a Ph.D. in electrical engineering from Cornell University, had spent over twenty-five years designing and developing CO(2) laser systems for Raytheon Company. In 1988,the late 1980s, a heart surgeon at the San Francisco Heart Institute, advanced $250,000 to assistDr. John Crew, was performing early studies of TMR on hearts that had been stopped and placed on a heart-lung machine. Although these early studies appeared promising, the Company inefficacy of the development of a high-powered CO(2) laser whichTMR treatment could not be proven unless the procedure could be used for TMRperformed on a beating heart. Since no laser existed at that time which could perform such a medical procedure, the San Francisco Heart Institute turned to Dr. Rudko and LEI to design and develop such a laser. The result of that effort was The Heart Laser System, a high-powered laser system capable of creating a channel completely through a human heart wall with a single laser pulse delivered in the fraction of a second between heartbeats. In November 1990, the Company received a Phase I Investigational Device Exemption ("IDE") for its Heart Laser System from the FDA. In grantingapproving the Phase I study, the FDA permitted the use of theThe Heart Laser System for patients considered not suitable for any other intervention. Phase I trials were performed by Dr. John Crew at Seton Medical Center in Daly City, California and were completed in October 1991. In April 1992, the Company received Phase II clearance from the FDA to perform TMR on 50 patients at four clinical sites. This clearance was periodically expanded to eventually include 201 patients at eight clinical sites. In 1995, the FDA grantedapproved three new IDE'sIDEs for studies of TMR using theThe Heart Laser System. The first was a 100 patient randomized study (Phase III) comparing TMR patients to patients receiving medical management. The study was later expanded to 200 patients. The second study iswas a 400 patient randomized trial comparing TMR patients to patients receiving a second bypass surgery. The third iswas a study comparing patients receiving TMR in conjunction with bypass surgery to patients receiving only bypass surgery. The Phase I, IICompany recently undertook an effort to gather long-term (more than 12 months) data on its clinical study patients. The long-term TMR analysis included 70 patients at eight hospitals. Each patient had been suffering from severe CAD, including chronic angina, before receiving treatment with The Heart Laser System. The average age of the patients at enrollment was 63. The average preoperative angina class for the group was 3.8. Angina is measured in classes ranging from one to four, with one being the least painful and III studies have been completedfour being the most painful. After an average of 34 months following the TMR procedure, the group's average angina class was significantly improved from 3.8 to 1.5. This was virtually unchanged from the 1.4 average angina class reported at 12 months postoperatively. In fact, three years after TMR with The Heart Laser System, 23% of the patients reported having no angina and a PMA application was filed58% were in February 1997. The PMA application was reviewed by the circulatory systems device panel in July 1997 which resulted in a recommendation for non-approval pending further patient data.class 1 or 2. Since April 1992, the Company has received 1114 U.S. patents relating to the underlying laser technology, the use of a laser on a beating heart, theThe Heart Laser System handpiece, and other laser accessories. The Company also has 12 U.S. patent applications pending that cover various aspects of the technology for theThe Heart Laser System and the process by which a laser is used to revascularize the 3 myocardium, as well as other laser technologies. The Company also holds a number of foreign patents and patent applications. The Company was incorporated pursuant to the Company ActCOMPANY ACT of British Columbia, Canada on March 3, 1987 and has1987. The Company transferred its jurisdiction of incorporation to the Yukon Territory of Canada in March 1999. The Company's principal offices and manufacturing facilities are at 10 Forge Park, Franklin, Massachusetts 02038. The Company's telephone number is (508) 541-8800. As used herein, the term "Company" means, unless the context requires otherwise, PLC and its subsidiaries, PLC Medical Systems, Inc., PLC Sistemas Medicos Internacionais Lda, PLC Sistemas Medicos Internacionais GmbH, PLC Medical Systems AG, PLC Medical Systems France, PLC Medical Systems Asia/Pacific Pte Ltd and PLC Medical Systems Australia Pty Ltd. 3 5 CARDIOVASCULAR DISEASE AND CURRENT THERAPIES Cardiovascular disease is the leading cause of death in the U.S. with more than 954,000950,000 deaths annually. This represents over 40% of all U.S. deaths. Over 13 million Americans suffer from coronary heart disease with 350,000 new cases every year. Atherosclerosis, the principal form of cardiovascular disease and primary cause of heart attacks, is characterized by a progressive accumulation of fatty deposits known as "plaque" in the walls of arteries and the resulting narrowing of the interior of the arteries. Atherosclerosis reduces blood flow to the muscle wall ("myocardium") of the heart, causing ischemia and resulting angina pain and can further lead to a complete occlusion of the artery causing a heart attack. According to the 1998 Heart and Stroke Facts Statistics published by the American Heart Association (the "AHA"), approximately 573,000 coronary bypass operations were performed on 360,000 patients and 434,000 balloon angioplasty procedures were performed in the U.S. on 408,000 patients in 1995. The AHA estimates the cost of cardiovascular disease in 1997 at $259.1 billion, including physician and nursing services, hospital and nursing home services, the cost of medications and lost productivity resulting from disability. Traditional treatment of atherosclerosis includes drug therapy, coronary bypass surgery and angioplasty. Drug therapy alleviates some of the symptoms of atherosclerosis but is often ineffective in serious cases. Conventional bypass surgery involves cutting open the patient's chest, cutting through the sternum, connecting the patient to a heart-lung machine, and stopping the heart, attaching a vein or artery removed from another part of the patient's body to create a bypass around the diseased blood vessel and restarting the heart. Hospital charges for bypass surgery are typically between $25,000 to $45,000 and bypass requires prolonged hospitalization and extensive recuperation periods. In addition bypass grafts eventually fail. Certain patients are not suitable for bypass procedures, including those who have previously undergone bypass surgeries,surgery, patients with extremely diffuse diseases, patients with vessels that are too small to graft, patients with chronic obstructive pulmonary disease, some diabetics, and others who are too ill to survive the use of a heart lung machine. A less invasive alternative to bypass surgery is balloon angioplasty. The most common form of angioplasty involves the use of balloon-tipped catheters insertedinserting into a diseased artery.artery a catheter with a balloon at the tip. By inflating the balloon at the site of blockage, ("lesion"), the arterial plaque can be pressed against the arterial walls and reshaped, resulting in increased blood flow. Metallic stents were developed to help prevent the sudden closures that sometimesometimes occur after angioplasty and to help reduce restenosis. These stents are inserted into the artery after balloon angioplasty to hold the expanded plaque in place. Because it is less traumatic and less costly, balloon angioplasty is preferred over bypass surgery when the blockages are not complicated and involve few coronary arteries. While offering certain benefits compared to bypass surgery, certain studies including the 1991 Coronary Artery Descriptors and Restenosis Study ("CADRE") and the 1993 Emory Angioplasty vs. Surgery Trial ("EAST") suggest restenosis or reocclusion is a serious problem with traditional angioplasty treatment. While stents have been shown to help reduce restenosis, and are used extensively, restenosis continues to occur at a significant rate. Atherectomy, another angioplasty-type treatment, involves the use of a catheter that contains a rotating mechanical device to cut, grind away and remove the plaque. 4 Management believes that TMR utilizing theusing The Heart Laser System may beis useful as a treatment for patients who have severe, stable angina and who are no longer candidates for either angioplasty or bypass because of either extensive disease or small coronary arteries. The U.S. FDA has approved The Heart Laser System for such patients. TMR is designed to be less invasive and less expensive than traditional bypass surgery, and may avoid the restenosis problem inherent with bypass surgery and balloon angioplasty by not targeting the coronary arteries for treatment. Also, with additional clinical research, TMR may be proven useful in conjunction with angioplasty or bypass to obtain more complete revascularization. In addition to the more conventional treatmenttreatments described above, there are a number of newer treatments and therapies including minimally invasive direct coronary artery bypass ("MIDCAB"), "trap door""off-pump" coronary artery bypass ("OPCAB") and the use of angiogenic growth factors. Some of these techniques and therapies may offer certain improvements in relation to conventional treatments. Management believes that with further clinical research, TMR canmay be usedfound useful in conjunction with these less invasive procedures to more effectively revascularize the heart muscle. 4 6heart. TMR UTILIZING THE HEART LASER SYSTEM The main challenge in treating atherosclerosis is to allow adequate blood to flow to the heart muscle without significantly damaging the heart. Conventional and newer techniques described above are used to bypass, reopen or widen blocked or narrowed arteries and could eventually fail due to restenosis or natural disease progression. TMR using theThe Heart Laser System involves a different technique where channels are created into the myocardium as a means of supplying oxygen-rich blood from the left ventricular chamber into the ischemic myocardium. TMR does not target the coronary arteries for treatment. Heart muscle, like all tissues of the body, must be constantly supplied with oxygen in order to function effectively. Oxygen is delivered to the myocardium by the blood, which is distributed to the myocardium through the right and left coronary arteries. If these arteries are narrowed or blocked as a result of atherosclerosis, sufficient oxygen-rich blood cannot supplymay be unable to reach the heart to satisfy the metabolic demanddemands of the myocardium. Cardiovascular disease eventually may cause myocardial ischemia, often evidenced by severe and debilitating angina or chest pains caused by lack of oxygen to the heart muscle, which can progress to myocardial infarction (the death of an area of the heart muscle). Advanced multi vesselmulti-vessel ischemic heart disease is typically treated with bypass surgery. During the TMR procedure, the patient is given general anaesthesia.anesthesia. An incision is made in the patient's side between the ribs, exposing the heart. The laser's outputHeart Laser System is computer synchronized with the patient's heartbeat, firing only when the left ventricle is filled with blood and is electrically insensitive. The Company believes that synchronization minimizes arrhythmiamay reduce the risk of arrhythmias (irregular heart beat)heartbeats) and their associated morbidity and mortality. In fact, researchResearch studies conducted by the Texas Heart Institute havein animal models indicated that failure to synchronizeperforming TMR without synchronization may lead to a significantbe associated with an increase in life threatening arrhythmias. The synchronization processtechnology is covered under a patent owned by the Company and is accomplished using an EKG monitor located on the laser and a computer used to control the laser system.Company. The Heart Laser System is capable of drilling a transmural channel in less than 0.05 seconds with a single laser pulse in a patient whose heart has not been stopped and who has not been placed on a heart lungheart-lung bypass machine. The surgeon can vary the pulse width of the laser using a touch key control panel to accommodate for the thickness of the patient's heart muscle.wall. Transesophageal Echocardiography (TEE) ultrasound is used to determineconfirm that complete channels are made by the laser. Generally, 20-4020 to 40 new channels are drilledcreated during the procedure to create new alternative channels for blood flow to the ischemic heart muscle.procedure. Each TMR procedure requires a sterile, single use, TMR kit containing a lens cell, assorted TMR hand pieces, EKG electrodes, drapes and other disposable items. In accordance with the FDA protocol governing the multi-center non-randomized, Phase II clinical trial, all of the 201 study patients treated with the TMR procedure were critically ill with extensive coronary artery disease and were not suitable candidates for coronary bypass or angioplasty revascularization due to the severity of their coronary artery disease. Of the 201 study patients, 15 patients died within 30 days of the surgery and 17 died during the 12 months follow-up period. An additional seven patients died from other non-cardiac reasons. This mortality rate is well within the mortality rate for second bypass surgery despite the fact that the TMR patients tended to be much sicker than those who are typically eligible for a second bypass surgery. Physician reports indicate that none of these deaths were directly related to the TMR procedure. In July of 1995, the Company began a multi-center randomized control study comparing TMR using the Heart Laser System to continued medical therapy for the treatment of end stage coronary artery disease in patients who were not suitable candidates for coronary bypass or angioplasty revascularization. Following submission by the Company of preliminary study results, the FDA ended the randomization process of the study in September 1996, allowing all subsequent patients enrolled in the study to receive TMR treatment. Of the 192 patients randomized into the study, 91 patients have received TMR treatment and 101 were placed in the control arm of the study. Three of the 91 TMR patients died within 30 days of the surgery. Ten TMR patients died during the 12 month follow-up period. Twenty two of the 101 patients randomized to the medical management group died. The PMA application for the Heart Laser System was filed by the FDA in February 1997. In July 1997, the PMA application was reviewed by the circulatory systems device panel of the FDA. The panel voted 9 to 2 that the PMA application not be recommended for approval pending further patient data. In September 1997, 5 7 the Company received a letter from the FDA which agreed with the panel's recommendation and outlined 12 items which when completed, would place the PMA in "approvable form". In December 1997, the Company completed the submission of the data related to the 12 requested items. The information included all the follow-up data on the 192 patients enrolled in the randomized study. The Company is currently waiting for a subsequent advisory panel review which is tentatively scheduled for April 24, 1998. After the one year follow-up, the Company was no longer required by the FDA to ask patients to come in for regular testing, however, the Company recently undertook an effort to gather long-term (more than 12 months) data on the Phase I, II, and III patients. The Company was able to collect three year follow-up on 62 patients. The average angina class of these patients, which was 3.8 preoperatively, was down to 1.5 three years postoperatively. The three year survival rate for these patients was 73%. Based on these results, management believes that the possibility of a "placebo effect" being responsible for angina improvements, is unlikely as "placebo effects" typically do not last longer than six months. Recent technical advances in echocardiography technology have made it possible to visualize blood flow in TMR channels at follow-up. These clinical findings confirm previous postmortem examination on two TMR patients treated with the Heart Laser System which indicated that the TMR channels were still open after 3 and 12 months. These channels were active and collateral growth (growth of new blood vessels) had occurred. It also appears that additional mechanisms of action such as angiogenesis may be occurring. The exact mechanism of action has yet to be proven and it should be noted that defining the mechanism is not a requirement for FDA approval. In addition to the work on patients with no other alternative, the Company continues to enroll patients in its two other clinical trials; patients eligible for redo bypass and patients who are having a combination bypass-TMR procedure. The results of these studies indicate that TMR could potentially have expanded applications in the treatment of coronary artery disease. POTENTIAL BENEFITS OF TMR Based on clinical results to date, the Company believes that TMR using theThe Heart Laser System provides a number of benefits, although no assurance can be given that any of the mentioned benefits will 5 be received by patients and no assurance can be given that the FDA will approve theadditional indications for use of The Heart Laser System. These current anticipated benefits include: Potentially a Third Revascularization Option. InTHERAPY FOR PATIENTS NOT SUITABLE FOR CORONARY BYPASS. The U.S. FDA has approved the future, TMR may be used onuse of The Heart Laser System for patients as an alternative to bypass or angioplasty procedures. Therapy for Patients Not Suitable for Coronary Bypass. TMR may allow patients who have severe, stable angina and would otherwise not be suitable for coronary bypass surgery, and for whom other surgical or interventional techniques may not be available or advisable to alleviate the effects of atherosclerotic illness. Potential Use in Conjunction with Both Conventional and Minimally Invasive Coronary Bypass.POTENTIAL USE IN CONJUNCTION WITH BOTH CONVENTIONAL AND MINIMALLY INVASIVE CORONARY BYPASS. TMR may allow the surgeon to provide oxygenated blood to areas of the heart muscle that are not accessible by coronary bypass grafts. With the advent of the "trap-door"OPCAB procedure wherein which coronary artery bypass graft surgery is performed on a beating heart, management believes that with additional clinical research, TMR willmay be found to be an effective complement to this procedure. TMR can be performed on the anterior, posterior and lateral walls of the heart while the "trap-door"OPCAB procedure usually is only performed on the anterior wall of the heart. Potentially Lower Medical Costs.POTENTIALLY A THIRD REVASCULARIZATION OPTION. In the future, with additional clinical research, TMR may be found to be useful as an alternative to bypass or angioplasty procedures. POTENTIAL THERAPY FOR HEART TRANSPLANT PATIENTS. With additional clinical research, TMR could potentially be found useful for post-transplant patients suffering from chronic rejection atherosclerosis. Presently, the only treatment for this condition is re-transplantation. POTENTIALLY LOWER MEDICAL COSTS. Management believes the medical costs associated with TMR using theThe Heart Laser System will be less than the costs of traditional bypass surgery which requires a larger surgical team, more supporting equipment and a longer hospital stay. The cost of TMR in some situations may also be less than angioplasty when combinations of additional devices such as atherectomy catheters, stents or intravascular ultrasound are required. Potentially Quicker Recovery. SincePOTENTIALLY QUICKER RECOVERY. Because TMR using theThe Heart Laser System is less invasive and does not involve stopping and starting the heart, the patient may recover more quickly than if conventional bypass 6 8 techniques were used, with a potentially reduced riskrisks of complications compared with the risks associated with bypass surgery. Potentially Minimally Invasive Surgery. Management believes that development of a thoracoscopic delivery device, would allow TMR to be performed less invasively. Testing to date has been very encouraging. Management believes that a thoracoscopic delivery device could potentially reduce complication risks and the length of hospital stay as well as provide a further reduction in hospital and post operative costs. Not Dependent on Plaque Type or Location and Potentially Less Risk of Restenosis.complications. NOT DEPENDENT ON PLAQUE TYPE OR LOCATION AND POTENTIALLY LESS RISK OF RESTENOSIS. Unlike angioplasty, atherectomy devices and stents, which may be more or less effective, depending on the composition, extent or location of the plaque occluding the artery and which have evidenced high restenosis rates, TMR is not dependent upon plaque type or location. Preliminary results from patients treated with TMR suggest less risk that the new channels created by the laser will become narrowed or blocked due to restenosis. Potential Therapy for Heart Transplant Patients. TMR could potentially be used on post transplant patients suffering from chronic rejection atherosclerosis. Presently, the only treatment for this condition is re- transplantation. DEVELOPMENT OF MARKETING STRATEGY The Company's strategy is to establish TMR using theThe Heart Laser System as an appropriate meansa standard of care for treating patients suffering from coronary artery disease. Currently, the Heart Laser System is an investigational device in the U.S. and cannot be marketed as a commercial product. The Heart Laser System is commercially available outsidein the U.S. with, the exception of Japan, AustraliaEuropean Community (except France), China and certain countries in Southeast Asia, wherethat do not require governmental approval for commercialization is also required. In October 1997, thecommercialization. The Company was notified that the French Ministry of Health was instituting a commercial moratorium on lasers usedhas submitted applications for TMR pending further evaluation. This moratorium was placed on lasers whether or not they had received CE approval. (See "Government Regulation").government approval to sell The Heart Laser System in other countries including Japan, Taiwan and South Korea. The Company has also developed a number of single use surgical products to be used with theThe Heart Laser System in performing TMR to address concerns regarding the spread of infections. The Company sells sterile, single use, TMR procedure kits containing components such as a lens holder, a set of handpieces, drapes and other TMR single use items. The Company also intends to sell individual handpieces. The Heart Laser System handpieces have been incorporated under the IDE with the Heart Laser System. In addition, the Company is seeking patent protection on these handpieces.6 The Company has developed a marketing strategy to address the challenges of marketing high dollarcost capital equipment. In markets with minimal credit risk, economic stability, whereadequate health care is reimbursed,reimbursement, and whererequisite government regulations permit,approvals, the Company intends to market TMRhas offered The Heart Laser System on a usage basis whereby the hospital receives aobtains The Heart Laser System in exchange for payment of an initial installation chargefee and pays the Company for the use of the machineusage fees each time a TMR procedure is performed. The use of the machine is typically subject to contractual yearly minimums for a defined period of time with renewal options. The Heart Laser System remains the property of the Company and is depreciated. Repairs, maintenance, upgrades and disposables aredepreciated over the responsibilityterm of the Company.placement contract. The Company refers to this approach as a placement contract. Such placement contracts are appealing to hospitals when capital equipment funds are scarce or unavailable or when it is difficult to predict early usage as is the case with new technology such as TMR. In unstable economic markets where credit risks are high,The Company's agreement with GE Capital enables the Company's plan would beCompany to monetize future payment streams associated with certain domestic placements. If utilization becomes more predictable, the Company expects a significant number of new accounts to opt for conventional leasing, or direct purchase. The Company will also sell theThe Heart Laser System outright as capital equipment. The disposable sterile kits would be sold for each procedure, along with yearly maintenanceservice contracts after expiration of theany applicable warranty period. There is no single retail price for the Company's Heart Laser System. The Company has several different marketing strategies to sell this product lineor place The Heart Laser System and accessories depending upon the particular circumstances, including direct sales, sales through distributors, placement type sales, rentals, and placement (leasing) type sale.leasing. Pricing varies depending upon the particular marketing strategy used and the country in which theThe Heart Laser System is sold. 7 9 United States. It is critical to the Company's success to obtain PMA approval from the FDA for the Heart Laser System initially for patients who are not suitable for bypass surgery or other interventions. The Company submitted its PMA applicationplans to launch a new purchase program in 1999 that combines aggressive pricing, flexible financing arrangements, and trade-in allowances for this indication in April 1995 which subsequently received expedited review status in May 1995. This application was filed by the FDA in February 1997. In July 1997, the circulatory systems devices panel of the FDA reviewed the Company's PMA application and recommended non-approval of the PMA pending further patient data.customers who have purchased other TMR systems. No assurance can be given that such programs will be implemented successfully, or at all. UNITED STATES. The Company submitted the patient data requested by the FDA in November and December of 1997 and has been advised of an April 1998 panel meeting date. Given the current uncertainties on the time required by the FDA to approve a PMA application, the Company cannot project when, if at all, such approval would occur. In addition to PMA approval, reimbursement for the TMR procedure by government and private insurers will be required for rapid product commercialization. At present there is a significant pent-up demand for TMR that will only be satisfied when reimbursement is allowed. (See "Third Party Reimbursements"). While it is not possible to predict when or if PMA approval is forthcoming, the Company has developed a comprehensive product launch plan with built-in contingencies to reflect PMA approval. Such a launch plan has been developed in close association with a leading medical product marketing agency experienced in product introductions similar to the Company's Heart Laser System. In February 1998, the Company hired a Vice President of Marketing and Business Development to lead the Company launch and develop the necessary organization needed to support and promote the Company's products internationally and in the U.S. after PMA approval has been received. The Company presently intends to utilizeusing a direct sales force in the United States to market The Heart Laser System. The sales force is comprised of personnel with a high degree of professionalism and experience in the cardiovascular device business. The Company has invested considerable resources in recruiting and training of the sales force during 1998. Initial marketing efforts following FDA approval were directed at The Heart Laser System to hospitals. A sales management team was hireduser, the cardiothoracic surgeon, whose influence is critical in the fourth quarter of 1996.hospital decision to purchase The Company has hired 11 new direct territory representatives and a launch campaign is currently being established in anticipation of an FDA approval of the Heart Laser System. International.Subsequent marketing efforts are expected to shift to the hospital administration and the referring physician, with a focus on promoting the economics and viability of TMR as a new hospital technology and driving the growth of TMR procedures. No assurance can be given that such programs will be implemented successfully, or at all. Supporting the direct sales force is a promotional program that consists of media advertising, direct mail, trade shows and educational symposia, all focused on disseminating critical information to decision makers and key purchase influencers. In 1998, PLC established a state of the art training program at Rush Presbyterian Medical Center in Chicago to train new surgeons and medical staff who will use The Heart Laser System in the safe and effective use of the system and facilitate interaction and discussion among experienced users about best clinical practices. This comprehensive program focuses on ensuring the best possible patient outcomes, and includes intensive discussions on patient selection and management. Course participants view live, narrated procedures via closed circuit television. Actual hands on training is also provided during the laboratory session. INTERNATIONAL. The Company currently markets itsThe Heart Laser System overseas both directly and through distributors. In the fourth quarter of 1994, the Company incorporated an EC subsidiary, PLC Sistemas Medicos Internacionais Lda, in Madeira, Portugal and in the first quarter of 1996 a subsidiary was incorporated in Hamburg, Germany as a sales office to market the Heart Laser System throughout Germany. In the fourth quarter of 1996, the Company incorporated two additional subsidiaries in Switzerland and France. Sales, service and clinical support personnel are located throughout the European subsidiaries.7 PLC received the CE Mark for theThe Heart Laser System in the third quarter of 1995. The CE Mark approval indicates that a product conforms to mandatory European safety and efficacy requirements. The approval allows the Company to sell the Heart Laser System commercially in all European Community countries. In October 1997,countries (except in France). Despite receiving the Company was notified thatCE Mark, the French Ministry of Health was institutinginstituted a commercial moratorium on lasers used for TMR pending further evaluation. (See "Governmentprocedures in France in October 1997 ("See Government Regulation"). In the spring of 1996,March 1999, PLC received ISO 9001 certification, allowing the Company began to pursue ISO 9001 as set out byself certify and place the International Standards Organization which will be required byCE Mark on its products itself. The Company installed a new Managing Director, Vincent Puglisi, for the European Communityregion in 1998. The Company hired a Managing Director for the Far East and Australia in February 1995August 1998 to increase sales and marketing efforts of thefor The Heart Laser System in this part of the world through both direct sales and the use of distributors. The Company incorporated a subsidiary in Singaporeregion. Mr. Puglisi also assumed responsibility for operations in the fourth quarter of 1996 and a second subsidiaryAsia Pacific region in Australia was incorporated in the second quarter of 1997 to handle sales and service for these areas of the world.late 1998. In the third quarter of 1995,early 1999, the Company signed a distributorrenewed its distribution agreement in Japan with IMATRON JapanImatron to manage, fund and distribute theThe Heart Laser System in accordance with Ministry of HealthJapan and Welfare ("MHW") clinical trials to be conducted in Japan. The first TMR procedure in Japan was performed in March 1997, which begancomplete the 60 patient clinical study required by the MHWJapanese regulatory approval process. The Companyagreement includes a commitment by Imatron to purchase a minimum of five Heart Laser Systems during 1999. Along with the United States and Germany, Japan is working closely with IMATRONbelieved to provide technical supportbe one of the three largest markets in the world for products used in the treatment of cardiovascular disease. Imatron also distributes medical equipment in Japan for its parent, Imatron, Inc. a U.S. based manufacturer of diagnostic imaging equipment. Between 1995 and training during these clinical trials. To date,1997, Imatron purchased 12 Heart Laser Systems have been soldfrom PLC to IMATRONconduct clinical studies in Japan. PLC and 54 patients have received TMRImatron submitted data from these studies to the Japanese Government in December 1998 in support of their application to market The Heart Laser System in Japan. The Company believes that MHWjoint application is believed to be the first submitted by a laser revascularization company seeking to market its product in Japan. The companies anticipate approval for TMR could be granted sometime inof their application during the later partsecond half of 1998 or 8 10 early in 1999. No assurance can be given that an MHWJapanese regulatory approval will be granted to The Heart Laser System in this timeframe, ifor at all. IMATRON Japan is just one among several distributors working with PLC also hired a direct representative, Hiroshi Nikko, to support development of the Japanese market. Mr. Nikko brings to PLC more than 25 years of experience selling cardiovascular products in Japan. Prior to joining PLC, Mr. Nikko worked for Nissho Corporation, which distributes the Asia/Pacific territory.left ventricle assist systems developed by Thermo Cardiosystems and manufactures a hemodialysis filter. As of December 31, 1997,1998, the Company had shipped 69over 70 Heart Laser Systems to the international markets which include 35 to Europe and Middle East, 27 to the Asia/Pacific area and seven to South America.markets. Foreign sales may be subject to certain risks, including foreign medical, electrical and safety regulations, export and import restrictions, tariffs and currency fluctuations. PRODUCTS AND CUSTOMERS The Company operates indevelops and markets one industry segment: the development, manufacture and sales of medical lasers and related products.principal product: The Heart Laser System. Approximately 20%89.5% of the Company's revenuesrevenue in Fiscalthe fiscal year ended December 31, 1998 and 93.2% in the fiscal year ended December 31, 1997 camewas derived from one customer, while no oneThe Heart Laser System. No single customer accounted for more than 10% of the Company's revenues in Fiscal 1996, and one customer accounted for more than 43% of revenues in Fiscal 1995.fiscal 1998. In 1997, and 1995, the customer was the Company's exclusive distributor in Japan. Management does not believe thatJapan accounted for approximately 20% of the possible lack of future relationships with any of these customers will have a material adverse effect on futureCompany's revenues. MANUFACTURING The Company manufactures and tests its products at its 37,000 square foot facility in Franklin, Massachusetts, approximately 40 miles west of Boston. The Company moved to this facility in September 1996 and believes that its manufacturing capacity will be sufficient to meet the market demands anticipated upon PMA approval.in the coming year. The Company purchases components for its laser systems and its related disposables from a number of sources and management believes that most components are available from multiple sources. For those components that are purchased from a single sourced,source, management has entered into exclusive supplier agreements which provide access to technologies, processes and bills of material to enable the Company to 8 manufacture the components or to have the components manufactured elsewhere. The Company's manufacturing facilities are subject to periodic inspection by regulatory authorities to ensure compliance with FDA and European Community quality regulations. The Company's business is not subject to seasonal fluctuations. GOVERNMENT REGULATION The Heart Laser System, as well as other medical devices that have been and are being developed by the Company, are subject to extensive regulation by the FDA. Pursuant to the Federal Food, Drug, and Cosmetic Act, as amended, the FDA regulates design, development, manufacturing, and the clinical testing, manufacture,installation, servicing, labeling, distribution and promotion of medical devices in the U.S. The Company's laser products are subject to additional FDA regulation under the Radiation Control for Health and Safety Act of 1968 ("Radiation Act"), which imposes labeling and other safety requirements related to radiation hazards. In addition, various foreign countries in which the Company's products are or may be sold impose additional regulatory requirements. On August 20, 1998, the Company received approval from the U.S. FDA to market The Heart Laser System requires a PMA. The first step inthroughout the PMA application process isU.S. to treat the submission to the FDA of the results of product tests, laboratory and animal studies and a request for permission to clinically evaluate the device in humans under an IDE. Initiation of the study requires the approval of the Institutional Review Board of the hospitals participating in the clinical trials and written, informed consent from all participating patients. In March 1990, the Company submitted to the FDA its first Heart Laser System IDE application consisting of product information and bench and animal test results and requested permission to evaluate the device in humans. The Company received agency permission to conduct a Phase I clinical evaluation of the Heart Laser System in November 1990. Authorization was limited to one clinical site and 15 patients. Dr. John Crew, a member of the Company's Medical Advisory Board, performed all of the Phase I tests of TMR using the Heart Laser System at Seton Medical Center in Daly City, California. In December 1991, the Company requested permission from the FDA to initiate Phase II of the clinical study and obtained authority to proceed in April 1992. Under Phase II, up to 16 sites were permitted to use the Heart Laser System which led to the treatment of 201estimated 80,000 domestic patients with TMR, rather than the one site used for Phase I on 15 patients. The 9 11 Phase II study protocol involved patientseach year who suffer from severe coronary artery disease and who were not candidates forbut cannot be treated with conventional CABGcoronary revascularization techniques such as bypass surgery or angioplasty procedures.angioplasty. PLC was the first company to receive FDA approval to commercialize a product to perform TMR. As part of this approval process, the FDA conducted an inspection of the Company's manufacturing facility in June 1998. The sites for Phase II testing are sites which perform a large numberFDA completed its inspection of open heart procedures and are experienced in taking part in clinical trials. The second stepPLC's manufacturing facility without any adverse findings or observations of deficiencies in the approval process requires submission to theCompany's manufacturing and quality systems. FDA of a comprehensive PMA application which includes results of all the human clinical testing performedimposed certain post-approval requirements as well as detailed product manufacturing, quality controls and facility descriptions. In May 1995, the Company submitted its PMA application and was assigned expedited review status. The FDA grants expedited review status for medical devices intended for use in the following circumstances; life threatening or irreversible debilitating condition with no alternative modalities, or for which the device provides an earlier diagnosis, a revolutionary breakthrough device, or a device whose availability is in the best interest of public health. In December 1994, the Company requested permission from the FDA to initiate Phase IIIconditions of its existing clinicalAugust clearance. These requirements include a 600 patient post-market study to further assess mortality, a specific "TMR" surigical informed consent, and obtained authority to proceed in June 1995. The Phase III study was a randomized study designed to specifically compare the use of the Heart Laser System to a control treatment, medical management,certain disclaimers placed on end stage cardiac patients. Authorization was granted to permit up to 20 clinical sitesall promotion and 350 patients. Based on early results of this study submitted by the Company to the FDA in August 1996, the FDA granted permission to no longer require the control treatment. Therefore, all future patients enrolled in the study could receive TMR with the Heart Laser System. Efforts towards finalizing the market approval of the Heart Laser System continue. In December 1996, the Company submitted an amendment to its PMA application to provide the most current clinical test results from the Phase II and Phase III studies. In February 1997, the FDA, under its administrative policies, agreed to file the Company's PMA and to undergo a substantive review of the application. Since that time, the Company has received multiple requests from the FDA for additional information, indicating the continuation of this substantive review process. In July 1997, a public meeting with the FDA circulatory systems device advisory panel resulted in a decision to not recommend approval of the Heart Laser System at that time, pending further patient data. The Company submitted the patient data requested by the FDA in November and December of 1997 and has been advised of an April 1998 panel meeting date. Pre-approval inspections of the Company and its clinical sites have taken place in 1997 and 1998 with one more waiting to be scheduled by the Company.advertising materials. Once a product obtains market approval, any modifications to the existing design or manufacturing process as well as any desire to change its labeling (i.e., intended use) must proceed throughbe approved by the FDA approval process once again.FDA. The Company intends to continuously improve theThe Heart Laser System after market introduction and may therefore intends to submit future IDE, PMA and PMA supplement applications to the FDA. No assurance can be given that approval of thesesuch new IDE's, PMA'sIDEs, PMAs or PMA supplements will be received from the FDA on a timely basis, ifor at all. International shipments of investigational medical devices are subject to FDA export requirements. Investigational devices may be freely exported to any Tier 1 country (European Economic Area member states, South Africa, Australia, Canada, Israel, Japan, New Zealand and Switzerland), without receiving FDA export approval provided a valid market authorization from one of these countries is obtained. FDA requires notification only at the time of the first shipment. In September 1995, the Heart Laser System was afforded an EC Type examination certificate, which allows the Company to place the CE Mark on each Heart Laser System and list its devices after inspection by a notified body. The CE Mark permits market distribution of the Heart Laser System throughout member states of the European Union. For all other countries outside of this list, FDA export approval must be obtained and is contingent upon obtaining an approval letter or a letter of no objection from a regulatory authority of the importing country. Theinternational regulatory approval process varies from country to country and thereis subject to change in a given country as regulatory requirements change. There is no assurance that this information can be obtained in a timely manner, in a manner thatforeign regulatory authorities will satisfy the FDAallow use or that a foreign agency will authorize the usesale of theThe Heart Laser System in such country.a particular country on a timely basis, or at all. In October 1997, the Company was notified thataddition, regulatory authorities can suspend or modify approvals previously granted in certain circumstances. For example, the French Ministry of Health was institutinginstituted a commercial moratorium on lasers used for TMR asprocedures in their opinion,France in October 1997. The French Ministry of Health deemed the procedure was considered to be experimental and should"experimental", although The Heart Laser System had been approved for commercial distribution in the European Community since 1995. As a result, TMR can only be performed within the context of a clinical study.study in France. An evaluation of the safety 10 12 of TMRThe Heart Laser System is currently under review by a panel of French experts and the results of this review will determine the status of TMR.experts. The Company has provided a dossier of its clinical results to the panel and is actively working with the Ministry to have thisthe moratorium lifted. No assuranceThere can be given as to whetherno assurance that the Company will be successful in its efforts to have this situation modified.having the moratorium lifted or that other countries will not impose restrictions on use of the Company's products. As a device manufacturer, the Company is also required to register with the FDA. As such, the Company is subject to inspection on a routine basis for compliance with the FDA's Quality Systems 9 regulations. These regulations require that the Company manufacture its products and maintain its documents in a prescribed manner with respect to manufacturing, testing and control activities. Further, the Company is required to comply with various FDA requirements for reporting. The Medical Device Reporting Act regulations require that the Company provide information to the FDA on death or serious injuries alleged to have been associated with the use of its laser systems,products, as well as product malfunctions that would likely cause or contribute to death or serious injury if the malfunction were to recur. The FDA also prohibits an approved device from being marketed for unapproved applications. In addition to the requirements generally applicable to devices, there are additional regulatory requirements specifically applicable to lasers under the Radiation Control for Health and Safety Act of 1968 ("Radiation Act") and FDA regulations thereunder. The Company's laser products are subject to periodic inspection under the Radiation Act for compliance with labeling and other safety regulations. If the FDA believes that a company is not in compliance with the law, proceedings can be instituted to detain or seize products or force notification and correction of hazards or defects (including a recall), enjoin future violations and assess civil and criminal penalties against the Company, its officers or its employees. Failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial conditions and results of operations. THIRD PARTY REIMBURSEMENTSREIMBURSEMENT Heath care providers, such as hospitals and physicians, that purchase medical devices such as theThe Heart Laser System for use on their patients generally rely on third party payors,payers, principally Medicare, Medicaid and private health insurance plans, to reimburse all or part of the costs and fees associated with the procedures performed with these devices. In November 1995, the FDA designated the Company's IDE for TMR with the Heart Laser System as Category B forFebruary 1997, the Health Care Financing Administration ("HCFA"), the agency responsible for administering the Medicare program. This classification meant that procedures performed with the Heart Laser System were eligible for Medicare reimbursement during the clinical trials. The Rule allowing coverage for Category B devices left the coverage determination for procedures involving those devices to the discretion of local Medicare contractors in the absence of a national coverage instruction. In February 1997, HCFA published a national non-coverage instruction for TMR based on its belief that scientific evidence substantiating the safety and effectiveness of TMR was not currently available. It is not unusual for HCFA to deny reimbursement for procedures performed using devices that have not yet received FDA approval. The non-coverage instruction applied to procedures performed on or after May 19, 1997 on Medicare beneficiaries. The Company has been working withIn February 1999, HCFA staff to seek withdrawal of the non-coverage instruction. HCFA has agreed to look at the Company's safety and effectiveness data at the time of the FDA panel review in April 1998, possibly leading to a withdrawal ofrescinded the national non-coverage instruction. The Company isinstruction for TMR implemented in the process of notifying HCFA of the scheduled FDA Panel date in AprilMay 1997 and announced that Medicare will request a meeting to further discuss the modification or withdrawal of the non-coverage instruction. The Company believes, although no assurance can be given, that FDA approval may be granted in 1998, and that the data submitted to support an FDA approval may warrant a withdrawal of the non-coverage instruction made by HCFA. The Company is not sure if any reversal in theprovide coverage instruction will be product specific to the Heart Laser System or will apply to the TMR procedure in general. The Company has also discussed the benefits of TMR and the potential adverse effects of HCFA's non-coverage instruction on the Medicare population with some members of Congress. No assurance can be given that the non-coverage instruction will be withdrawn and no assurance can be given that the FDA will grant a PMA approval for the Heart Laser System in 1998, if at all. 11 13 Even if a device has FDA clearance, Medicare and other third party payors may deny coverage if they conclude that TMR is not a reasonable and necessary procedure. No assurance can be given that, even if coverage is granted, the payors' reimbursement levels will not adversely affect the Company's ability to sell its products. Private insurance companies and HMO's have already made reimbursement for TMR procedures performed with devices approved by the FDA. The decision set a new coverage policy to allow payment for TMR consistent with FDA-approved uses of TMR devices. HCFA has not yet determined the effective date of this policy change. In January 1999, the Blue Cross and Blue Shield Association TEC completed a favorable assessment of TMR. The TEC concluded that TMR meets all five criteria used to evaluate new medical technologies: (1) final approval from the U.S. Food and Drug Administration; (2) scientific evidence of improvement in some cases during clinical trials.health outcomes; (3) net benefit in health outcomes; (4) health outcomes at least as beneficial with any established alternative; and (5) improvements achievable outside investigational settings. The TEC's determination that TMR meets its criteria is a significant step in obtaining reimbursement for TMR by major payers. The TEC's conclusion was based upon a review of data showing the safety and effectiveness of TMR by the TEC program staff, and the TEC's assessment was approved by its panel of independent medical advisors. The TEC program is sponsored by the national Blue Cross and Blue Shield Association, whose members include local Blue Cross and Blue Shield plans nationwide, as well as other major managed care organizations. TEC assessments are released as reports to TEC program subscribers. Nearly all major payers in the US, including governmental payers, private third party payers and managed care organizations, subscribe to the TEC program and receive TEC assessment reports for use in their own coverage and payment policy making. Economic data derived from the IDECompany's clinical studies indicates that thereTMR using The Heart Laser System may beresult in a significant reduction in the cost of treating the patient population of the studies.patients with severe CAD. Potentially, this could mean that TMR performed with theThe Heart Laser System is a procedure that offers real economic advantageadvantages to the managed care market, in particular, in which over 70% of all privately insured 10 Americans are covered at least in part. The Company has begun an effort to educate the different segments of the market concerning TMR reimbursement. It is importantNo assurance can be given that the hospital and physician providers, the insurance industry, the health plan underwriters, employers and patients understand the clinical andsuch economic benefits ofwill be realized by customers. Certain private insurance companies and HMOs currently provide reimbursement for TMR as indicated by the IDE studies. Study results are concurrent with the quality of care and economic issues currently driving theprocedures. No assurance can be given, however, that additional payers will reimburse health care market. It shouldproviders who perform TMR procedures or that reimbursement, if provided, will be noted thattimely or adequate. In addition, the market for the Company's products also could be adversely affected by future legislation to reform the nation's health care system or by changes in industry practices regarding reimbursement policies and procedures. PRODUCT LIABILITY AND INSURANCE The Company's business involves the risk of product liability claims. No claims have been made against theThe Heart Laser System to date. The Company maintains product liability insurance with aggregate coverage limits of $4$10 million. No assurance can be given that product liability claims will not exceed such insurance coverage limits, which couldthat such claims will not have a material adverse effect on the Company, or that such insurance will be available aton commercially reasonable terms or at all. PROPRIETARY PROCESSES, PATENTS, LICENSES AND OTHER RIGHTS The Company's policy is to file patent applications to protect technology, inventions and product improvements. The Company also relies on trade secret protection for certain confidential and proprietary information. Since April 1992, the Company has received 14 U.S. patents, of which 1112 involve theThe Heart Laser System and its related technologies. The first patent, which was issued in April 1992, provides patent protection until 2009 and relates to the underlying laser technology needed to create a pulsed, fast flow laser system (allowing the laser gas to flow through the laser to the vacuum at high speed).system. The second patent, which was issued in June 1992, provides patent protection until 2009 and relates to the use of a laser on a beating heart to revascularize the heart using TMR. The third patent, which was also issued in June 1992, provides patent protection until 2009 and relates to the system used to time the heart's contractions to synchronize the laser firing at the correct time. The fourth patent, which was issued in April 1993, provides patent protection until 2010 and relates to theThe Heart Laser System handpiece, which is used to deliver the laser energy to the heart. The fifth patent, which was issued in June 1993, provides patent protection until 2010 and relates to a specialized laser beam manipulator used for conventional laser surgery. The sixth patent, which was issued in October 1993, provides patent protection until 2010 and relates to a self-aligning coupler for a laser endoscope. The seventh patent, which was issued in August 1994, provides patent protection until 2011 and relates to the synchronization of a surgical smoke evacuator to a laser system or other medical device. The eighth patent, which was issued in April 1996, provides patent protection until 2013 and relates to the use of an ECG monitor. The ninth patent, which was issued in September 1996, provides patent protection until 2013 and relates to medical laser technology. The tenth patent, which was issued in January 1997, provides patent protection until 2014 and relates to theThe Heart Laser System handpiece. The eleventh patent, which was issued in April 1997, provides patent protection until 2014 and relates to the lens cell for theThe Heart Laser System. The twelfth patent, which was issued in November 1997, provides patent protection until 2014 and relates to a thoracoscopic cannula system. The thirteenth patent which was issued in December 1997, provides patent protection until 2014 and relates to a thoracoscopic TMR handpiece. The fourteenth patent, which was issued in March 1998, provides patent protection until 2015 and relates to ultrasound detection of 12 14 revascularization. The Company also has tentwelve U.S. patent applications pending relating to theThe Heart Laser System handpiece, other technology used in theThe Heart Laser System, technology associated with minimally invasive surgical techniques and technologies associated with percutaneous TMR. 11 In April 1996, the Company received patents from the European Patent Office and the Japanese Patent Office providing patent protection on its heart synchronization technology. A patent covering this technology was issued in April 1997 in Canada. Additional Japanese issued patents cover a TMR handpiece, a self-aligning coupler for a laser endoscope, laser beam manipulation and a laser beam status indicator. In December 1996, a patent was issued in Canada covering a self aligning coupler for a laser endoscope. The Company has over 30numerous patents pending related to theThe Heart Laser System and its components in various international patent offices. The Company intendsexpects to file additional patent applications overseas in the next year. The Company expects to continue to file domestic and foreign patent applications on various features of the Heart Laser System,year, although there can be no assurance that any additional applications will be filed or that any additional patents will be issued. In September 1996, CardioGenesis Corporation ("CardioGenesis") filed, a civil lawsuit incompetitor of the United States District Court forCompany, agreed to the Northern Districtvalidity and enforceability of California seeking to havecertain of the Company's patents in connection with a settlement of all outstanding litigation between the companies. The patents, U.S. Patent No. 5,125,926 and related international patents, cover the Company's proprietary synchronization patent declared invalid, or, alternatively, askingtechnology, a critical factor in ensuring the courtsafety of TMR and PMR procedures. PLC granted CardioGenesis a non-exclusive worldwide license to determine whetherthe patents in exchange for payment of a license fee and ongoing royalties over of the life of the patents. A minimum of $2.5 million will be paid by CardioGenesis infringes on this patent. In October 1996,to the Company filed an answer and counterclaim alleging that CardioGenesis infringes onin connection with this patent. The counterclaim seeks both injunctive relief and monetary damages against CardioGenesis. In October 1997, CardioGenesis filed an amended complaint seeking to have the Company's synchronization patent declared unenforceable. CardioGenesis is not seeking monetary damages from the Company.license agreement. (See "Item 3. Legal Proceedings") In February 1998, the Company filed an application with the United States Patent Office to reissue the Company's synchronization patent with 32 additional claims directed to various features of its synchronized laser system technology including the use of a fiber optic laser delivery device. In January 1997, CardioGenesis Corporation, filed a challenge to the Company's European synchronization patent in the European Patent Office and in March 1997 the Company filed its response. In addition, in April 1997, the Company filed an infringement lawsuit against CardioGenesis in the Munich District Court alleging infringement of its synchronization patent. An oral hearing has been scheduled in the Munich District Court on October 1, 1998. (See "Item 3. Legal Proceedings"). Although the Company believes its patents to be strong, successful litigation against these patents by a competitor could have a material adverse effect on the Company's business, financial condition and results of operations. No assurance can be given that the existing patents will be held valid if challenged, that any additional patents will be issued or that the scope of any patent protection will exclude competitors. The breadth of claims in medical technology patents involve complex legal and factual issues and therefore can be highly uncertain. Further, no assurance can be given that the scope of the claims of the Company's synchronization patent will remain unchanged during the patent office review of the Company's reissue application, or that any claims will be approved. The Company also relies upon unpatented proprietary technology and trade secrets that it seeks to protect, in part, through confidentiality agreements with employees and other parties. No assurance can be given that these agreements will not be breached, that the Company will have adequate remedies for any breach, that others will not independently develop or otherwise acquire substantially equivalent proprietary technology and trade secrets or disclose such technology or that the Company can meaningfully protect its rights in such unpatented technology. In addition, others may hold or receive patents which contain claims that may cover products developed by the Company. The Company believes its patents to be valid and enforceable. However, there has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. Litigation, which could result in substantial cost to and diversion of effort by the Company, may be necessary to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company, to defend the Company against claimed infringement of the rights of others and to determine the scope and validity of the proprietary rights of others. Adverse determinations in litigation could subject the Company to significant 13 15 liabilities to third parties, could require the Company to seek licenses from third parties and could prevent the Company from manufacturing, selling or using its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. In February 1996, PLC Medical Systems, Inc. filed suit against Eclipse Surgical Technologies, Inc. ("Eclipse") in the United States District Court for the District of Massachusetts alleging copyright infringement of certain copyrighted works and unfair and deceptive trade practices. The Company is seeking injunctive relief and damages for, among other things, any profits derived by Eclipse, attorney's fees, treble damages and other relief.COMPETITION The Company believes that trademarks maythe majority of TMR procedures completed worldwide to date have been performed using The Heart Laser System. As of December 31, 1998, over 4,300 TMR procedures had been performed using The Heart Laser System. In addition, the Company believes that the majority of peer reviewed medical journal articles on TMR report results of TMR procedures performed with The Heart Laser System. 12 A number of other companies have entered or are attempting to enter the TMR market. These companies are believed to be important to its business.using other types of lasers such as holmium and excimer lasers. Holmium and excimer lasers have different physical properties and interact differently with human tissue than the Company's carbon dioxide laser. The Company believes that The Heart Laser System is the only TMR product that can create a channel completely through the heart wall with a single laser pulse. Research conducted at the Texas Heart Institute in animal models has indicated that the Company's synchronized, single pulse CO2 laser may cause significantly less damage to the heart than a U.S. registered trademarkholmium laser used to perform TMR. Holmium lasers currently used for "THE HEART LASER AND DESIGN" which was issued on December 19, 1995TMR are not capable of creating a patent channel in one pulse, and three foreign registered trademarks for "THE HEART LASER," which were issued on September 9, 1991 in France, on March 29, 1993 in Switzerland and on March 31, 1994 in Japan. Additionally,must therefore use a fiber-optic probe that "drills" its way from the Company has three pending U.S. trademark applications for "TMR and DESIGN," "HEART DESIGN," "TMR TRANSMYOCARDIAL REVASCULARIZATION and Design" which were filed on July 13, 1995, July 20, 1995 and July 24, 1995, respectively. In 1996, Eclipse filed oppositionsoutside of the heart to eachthe blood-filled left ventricle. The presence of these trademark applicationsthe probe within the heart muscle may contribute to an increased risk of arrhythmias. Moreover, since four to seven firings are required to create a channel, channels formed in the United States Trademark Office. Thereheart wall by such holmium systems have been observed to be jagged and segmented. The Company believes that there is one pending foreign trademark application for "THE HEART LASER AND DESIGN" in Germany.ample opportunity to successfully differentiate its CO2 laser and plans to implement an appropriate marketing effort accordingly. No assurance can be given that the Company's trademarkssuch a marketing effort will be registeredimplemented successfully, or that others do not have prior rights to such marks. COMPETITION Many treatments are available for coronary artery disease. The Company believes that if the Heart Laser System receives approval for expanded indications, the Heart Laser System should be able to successfully compete with some of these technologies. The Company is aware of number of other companies who have entered the TMR market or have announced their intention to enter the TMR market. The majority of these companies are using holmium lasers, two are using excimer lasers and one company is developing a short pulsed CO(2) laser for TMR. Most of these companies are in the early stages of clinical tests or in the development of clinical testing. Based on public information and published results, the Company has performed the highest number of TMR procedures and has the most published data and peer reviewed articles. To date, only two of the Companies using a holmium laser have presented data on their results, which show reduction in angina and improvement in quality of life. The Company is investigating whether these competitors violate in any way, existing patents issued to the Company and has brought claims against CardioGenesis in both the U.S. and in Europe. (See "Proprietary Processes, Patents, Licenses and Other Rights" and "Legal Proceedings")at all. Several of the companies who have entered the TMR market are developing percutaneous"percutaneous" methods of performing TMR. To date there has been very little information presented on patient outcomes other than claims that benefits derived may be equivalent to surgical treatment.TMR, known as "PMR". PMR procedures are performed via a catheter inserted through an incision in a patient's leg. The Company is currently developinghas a proprietary percutaneous program.PMR development program underway. PMR may provide a less invasive method of creating channels in a human heart if it can be proven safe and effective. No assurance can be given that the Company's PMR development program will be successful. The Company's two principal competitors, Eclipse and CardioGenesis, merged on March 17, 1999. Both companies have holmium laser systems undergoing clinical studies. In February 1999, Eclipse received FDA approval to market its holmium laser in the U.S. to perform TMR. According to public information, the laser revascularization systems developed by Eclipse and CardioGenesis can be used to perform both TMR and PMR procedures. Many treatments are available for coronary artery disease. The Company believes that the primary competitive factors in the medical treatment of coronary artery disease are clinical safety and efficacy, product safety and reliability, regulatory approval, availability of reimbursement from insurance companies and other payers, product quality, innovation, price, reputation for quality, customer service and ease of use. The Company believes that its competitive success will be based on its ability to create and maintain scientifically advancedeffective and safe technology, obtain required regulatory approvals, obtain third party reimbursement for use of its products, attract and retain scientific personnel, obtain patent or other protection for its products, obtain required regulatory approvals and manufacture and successfully market its products either directly or through outside parties. If a PMA is granted under expedited review in the current year, management expects that the Heart Laser System would be the first FDA approved TMR device and should enjoy a market lead time over its competitors. No assurance can be given however that a PMA will be granted in the current year, if at all, and if granted, that it would necessarily be in advance of any competitors or provide the Company with a sustainable competitive advantage. 14 16 If the FDA grants a PMA for TMR using the Heart Laser System, theThe Company believes that the primary competitive factors within the interventional cardiovascular market are the ability to treat safely and effectively various types of coronary disease, physician familiarity with and acceptance of the procedure, third party reimbursement policies, and to a lesser extent, ease of product use, product reliability, and price. The medical care products industry is characterized by extensive research efforts and rapid technological progress. New technologies and developments are expected to continue at a rapid pace in both industry and academia. Competition in the market for surgical lasers and for the treatment of cardiovascular disease is intense and is expected to increase. Management believes that theThe Heart Laser System if approved for general sale by the FDA, willmust compete primarilynot only with currentTMR and PMR systems, but with medical management (drugs) as well as conventionaland other coronary procedures (e.g. coronary bypass, balloon angioplasty, and new coronary procedures (including atherectomy, laser angioplasty, and metallic stents). Many of the companies manufacturing these devicesproducts have substantially greater capital, as well as greater research and development, regulatory, manufacturing and marketing resources and experience than the Company and represent significant competition for the Company. Such companies may succeed in developing products that are more effective or less costly in treating coronary disease than theThe Heart Laser System, and may be more successful than the Company in manufacturing and marketing their products. No 13 assurance can be given that the Company's competitors or others will not succeed in developing technologies, products or procedures that are more effective than any being developed by the Company or that would render the Company's technology and products obsolete or noncompetitive. Although the Company will continue to work to develop new products and advance existingimproved products, the advent of either new devices or new pharmaceutical agents could hinder the Company's ability to compete effectively and have a material adverse effect on its business, financial condition and results of operations. RESEARCH AND DEVELOPMENT Research and development expenses were $4,468,000, $5,158,000, $2,835,000 and $2,246,000$2,835,000 for the years ended December 31, 1998, 1997 1996 and 1995,1996, respectively. Although the initial design of theThe Heart Laser System is now completed, management expectsplans to continue to refine theThe Heart Laser System design, to develop new less invasive methods for use of the Heart Laser System inperforming TMR procedures, including endoscopic and percutaneous delivery systems and to fund clinical trials. The Company intends to continue to monitor all technologies that may be applicable to TMR to maintain itsa leadership position as a technology leader in this marketplace.market. No assurance can be given that the Company's research and development goals will be implemented successfully or that the Company will maintain its leadership position in this market. EMPLOYEES As of March 23, 1998,22, 1999, the Company had 8168 full-time domestic employees, including its executive officers. Of these, 1516 are employed in general and administrative activities, 22 are involved in sales and marketing, 1913 are involved in research and development and 2517 are involved in manufacturing. The Company also employs one part-time employee. None of the Company's employees are represented by a union. In addition, the Company has 1412 full time employees/consultants for its international operations. Management considers its relations with employees to be satisfactory. ITEM 2. DESCRIPTION OF PROPERTY. In September 1996, the Company moved into its current 37,000 square foot facility in Franklin, Massachusetts where it maintains its principal executive offices and manufacturing operations. The premises are leased from an independent third party under a lease which expires in August 2001. The lease provides for two renewal periods of three years each. The total base rental payments for the term of the lease are approximately $296,400 per year plus operating and maintenance costs and real estate taxes. ITEM 3. LEGAL PROCEEDINGS. In September 1996, CardioGenesis filed a civil lawsuit in the United States District Court for the Northern District of California asking the court to declare the Company's synchronization patent (U.S. Patent No. 5,125,926) invalid and unenforceable, or, alternatively, to find that CardioGenesis' TMR and PMR lasers do not infringe this patent. The Company filed a counterclaim alleging that all of CardioGenesis' TMR and PMR lasers infringe U.S. Patent No. 5,125,926. In January 1997, CardioGenesis filed an opposition in the European Patent Office to have the Company's German synchronization patent declared invalid. In April 1997, the Company filed an infringement lawsuit against CardioGenesis and one of its distributors in the Munich District Court alleging that CardioGenesis' TMR and PMR lasers infringe the Company's German synchronization patent. The PLC patents at issue in these lawsuits cover the Company's synchronization technology, a critical factor in ensuring the safety of TMR and PMR procedures. In January 1999, the Company settled its outstanding patent infringement litigation with CardioGenesis. Under the settlement, CardioGenesis agreed that U.S. Patent No. 5,125,926 and related international patents of the Company are valid and enforceable. PLC granted CardioGenesis a non-exclusive worldwide license to the patents in exchange for 14 payment of a license fee and ongoing royalties over the life of the patents (at least 10 years unless the patents are all held invalid in future lawsuits). As part of the settlement, CardioGenesis must pay the Company: - a minimum of $2.5 million over the next 42 months; and - license fees and ongoing royalties on sales of all covered products for at least 10 years (unless the patents are all held invalid in future lawsuits). In July 1997, an FDA advisory panel recommended against approval of the Company's application to market The Heart Laser System in the United States. Following this recommendation, the Company was named as defendant in 21 purported class action lawsuits filed between August 1997 and November 1997 in the United States District Court for the District of Massachusetts. The lawsuits seek an unspecified amount of damages in connection with alleged violations of the federal securities laws based on the Company's failure to obtain a favorable FDA panel recommendation in 1997. Nineteen of these complaints have been consolidated by the court into a single action for pretrial purposes. Two of these suits have been dismissed. The Company moved to dismiss all of the remaining claims. On March 26, 1999, the court issued an order dismissing some, but not all of the remaining claims. The Company has also been named as a defendant in a lawsuit filed in Massachusetts Superior Court in September 1998. This suit seeks over $2 million in damages for alleged negligent misrepresentations and fraud arising from the Company's failure to obtain a favorable FDA recommendation in 1997. The Company cannot make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of these lawsuits, but an unfavorable outcome could have a material adverse affect on the Company's business, financial position and results of operations. The Company believes that it has valid defenses to these litigation matters and it continues to vigorously defend itself in these matters. In August 1997, the Company received from the United States Securities and Exchange Commission (the "Commission") an informal request for information relating to the decision by the FDA Advisory Panel not to recommend approval of The Heart Laser System in July 1997. The Company has responded and has not received any further communication from the Commission regarding this matter since June 1998. In February 1996, PLC Medical Systems, Inc. filed suit against Eclipse Surgical Technologies, Inc. ("Eclipse") in the United States District Court for the District of Massachusetts alleging copyright infringement of certain copyrighted works and unfair and deceptive trade practices.practices based on Eclipse's misappropriation and copying of one of PLC's confidential clinical study protocols. The Company is seeking 15 17 injunctive relief and damages, for, among other things,as well as any profits derived by Eclipse as a result of the misappropriation, attorney's fees, and treble damages and other relief. (See "Proprietary Processes, Patents, Licenses and Other Rights"damages. In November 1998, a hospital in France, Centre Medico Chirurgical Foch ("Foch Hospital") In September 1996, CardioGenesis Corporation, ("CardioGenesis") filed a civil lawsuit in the United States District Court for the Northern District of California seeking to havesued the Company's synchronization patent declared invalid, or, alternatively, asking the court to determine whether CardioGenesis infringes on this patent. In October 1996, the Company filed an answerPortuguese subsidiary, PLC Sistemas Medicos Internacionais Lda., and counterclaima third party, Johnson & Johnson Leasing GmbH in Paris, France alleging that CardioGenesis infringes on this patent. The counterclaim seeks both injunctive relief and monetary damages against CardioGenesis.breach of contract. In October 1997, CardioGenesis filed an amended complaintthe French Ministry of Health suspended commercial use of TMR devices in France. Foch Hospital is seeking to have the Company's synchronization patent declared unenforceable. CardioGenesis is not seeking monetary damages from the Company but will seek reimbursement of its legal expenses if successful in the lawsuit. Trial has been scheduled to begin in January 1999. (See "Proprietary Processes, Patents, Licenses and Other Rights") In January 1997, CardioGenesis Corporation, filed a challenge to the Company's European synchronization patent in the European Patent Office and in March 1997 the Company filed its response. In addition, in April 1997, the Company filed an infringement lawsuit against CardioGenesis in the Munich District Court alleging infringement of its synchronization patent. An oral hearing has been scheduled in the Munich District Court on October 1, 1998. (See "Proprietary Processes, Patents, Licenses and Other Rights") The Company and certain of its officers have been named as defendants in 21 purported class action lawsuits filed between August 1997 and November 1997 in the United States District Courtlease payments made for the District of Massachusetts.Heart Laser System. The suits allege violations of the federal securities laws. The plaintiffs are seeking damages in connection with such alleged violations. Nineteen of these complaints have been consolidated by the court into a single action for pretrial purposes. A motion has been filed to consolidate the other two suits with each other. These matters are in the earliest stages of litigation and the Company intends to seek motions to dismiss all of these claims. There can be no assurance that the motions to dismiss these claims will be successful. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of these pending litigation matters. It is possible that the Company's result of operations or cash flows in a particular quarter or annual period or its financial position could be materially affected by an ultimate unfavorable outcome of this pending litigation. The Company believes that it has valid defenses to these class action litigation matters and intends to vigorously defend itself in these matters. In August 1997,this matter. This matter is in the Company received from the Securitiesearliest stage of litigation and Exchange Commission an informal request for information relating to the decision by the FDA Advisory Panel to not recommend approvala meaningful estimate of the Heart Laser System. The Company has responded and to dateloss that could result from this matter has not received any further communication with the Commission regarding this matter.been made. The Company is not involved in any other litigation of a material nature. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. 1615 18 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Since September 17, 1992, the Company's Common Stock has traded on the American Stock Exchange ("AMEX") under the symbol "PLC". From March 3, 1992 through September 16, 1992, the Company's Common Stock was traded on the over-the-counter market through the National Association of Securities Dealers Automated Quotation System ("NASDAQ"). On March 23, 199822, 1999 the closing sale price of the Company's Common Stock as reported by the AMEX was $14.75$2.94 per share. For the periods indicated, the following table sets forforth the range of high and low saleclosing prices for the Common Stock as reported by AMEX from January 1, 1996.1997.
SALES --------------------- HIGH LOW ------ ---------- --- 19961997 ---- First Quarter............................................... $34.88 $16.63 Second Quarter.............................................. $33.88 $20.38 Third Quarter............................................... $28.63 $13.25 Fourth Quarter.............................................. $27.25 $19.63 1997 First Quarter...............................................Quarter . . . . . . . . . . . . . . . . $27.63 $16.63 Second Quarter..............................................Quarter. . . . . . . . . . . . . . . . $22.88 $12.38 Third Quarter...............................................Quarter . . . . . . . . . . . . . . . . $26.81 $10.25 Fourth Quarter..............................................Quarter. . . . . . . . . . . . . . . . $14.38 $ 6.88$6.88 1998 ---- First Quarter . . . . . . . . . . . . . . . . $18.19 $8.00 Second Quarter. . . . . . . . . . . . . . . . $18.13 $9.25 Third Quarter . . . . . . . . . . . . . . . . $12.38 $3.75 Fourth Quarter. . . . . . . . . . . . . . . . $6.63 $3.06 1999 ---- First Quarter (through March 23, 1998)...................... $14.75 $ 7.8822, 1999). . . . $6.81 $2.94
As of March 23, 1998,1999, there were approximately 647751 record holders of the Company's Common Stock. Management believes that there are approximately 16,00019,000 beneficial owners of the Company's Common Stock. DIVIDENDS The Company has never paid cash dividends. The Company currently intends to retain all future earnings, if any, for use in its business and does not anticipate paying any cash dividends in the foreseeable future. 1716 19 ITEM 6. SELECTED FINANCIAL DATA. The following selected financial data with respect to the Company for the five years ended December 31, 1997,1998, are derived from the audited financial statements of the Company. The data should be read in conjunction with the financial statements, related notes and other financial information included herein. SELECTED FINANCIAL DATA
FOR THE YEARS ENDED DECEMBER 31 ------------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 1995 1994 1993 -------- ------- ------- ------- ----------- ---- ---- ---- ---- (ALL AMOUNTS ARE IN THOUSANDS EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenue: Product sales.........................sales. . . . . . . . . . . . . . $ 3,088 $ 5,687 $ 9,082 $11,938 $ 5,068 $ 3,322 Placement and service fees............fees . . . . . . . 2,605 3,254 2,790 1,407 111 -- Costs and expenses: Cost of product sales.................sales. . . . . . . . . . 1,945 2,721 2,911 4,177 2,851 2,982 Cost of placement and service fees....fees . . . 2,622 2,595 1,155 386 17 -- Selling, general and administrative...administrative. . . 13,718 13,049 7,023 5,035 3,030 2,637 Research and development..............development . . . . . . . . 4,468 5,158 2,835 2,246 2,211 1,930-------- -------- -------- ------- ------- ------- --------------- Income (loss) from operations...........operations. . . . . . (17,060) (14,582) (2,052) 1,501 (2,930) (4,227) Other income............................income . . . . . . . . . . . . . . 457 178 512 588 366 254-------- -------- -------- ------- ------- ------- --------------- Income (loss) before income taxes.......taxes . . . (16,603) (14,404) (1,540) 2,089 (2,564) (3,973) Provision for income taxes..............taxes . . . . . . . -- -- -- 85 -- ---------- -------- -------- ------- ------- ------- --------------- Net income (loss)........................ . . . . . . . . . . . $(16,603) $(14,404) $(1,540) $ 2,004 $(2,564) $(3,973) ======== ======= ======= ======= =======-------- -------- -------- ------- -------- -------- -------- -------- ------- -------- Net income (loss) per share -- Basic....- Basic. . . $ (.86) $ (.84) $ (.09) $ .13 $ (.18) $ (.31) ======== ======= ======= ======= =======-------- -------- -------- ------- -------- -------- -------- -------- ------- -------- Net income (loss) per share --Diluted...- Diluted. . $ (.86) $ (.84) $ (.09) $ .12 $ (.18) $ (.31) ======== ======= ======= ======= =======-------- -------- -------- ------- -------- -------- -------- -------- ------- -------- Shares used to compute net income (loss) per share -- Basic....................- Basic . . . . 19,218 17,050 16,376 15,868 14,372 12,868 Shares used to compute net income (loss) per share -- Diluted..................- Diluted . . . 19,218 17,050 16,376 16,590 14,372 12,868
AS OF DECEMBER 31 ------------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 1995 1994 1993 -------- ------- ------- ------- ----------- ---- ---- ---- ---- BALANCE SHEET DATA: Working capital......................... $ 12,793capital . . . . . . . . . . . . $5,050 $12,793 $11,245 $13,541 $12,431 $ 5,873 Total assets............................assets . . . . . . . . . . . . . . 16,257 27,017 19,417 18,290 14,337 7,595 Long term obligations...................obligations. . . . . . . . . . 37 121 27 32 7 14 Stockholders' equity....................equity . . . . . . . . . . 10,662 19,009 16,467 15,508 13,059 6,658
The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128 "Earnings Per Share". For further discussion regarding the calculation of earnings per share, see Note 1 to the Consolidated Financial Statements. 1817 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. OVERVIEW Prior to Fiscal 1994, a significant portion of the Company's product sales, gross profit and operating expenses was related to its general purpose CO(2) surgical lasers, laser components and related accessories. The Company exited this part of its surgical laser business by the end of 1995offers placement, purchase and leasing alternatives to focus its full resources on thecustomers interested in acquiring The Heart Laser System. The exit strategy included fulfilling existing contracts and orders, and a sale of technologies associated with a part of this business. The Company has both aIn placement strategy and a direct/distributor sales strategy for Heart Laser System purchases. The placement program allows the Company to receive recurring revenues based on the usage of the Heart Laser System rather than one-time revenues for the sale of each Heart Laser System. Under the placement model,transactions, an installation fee is paid when theThe Heart Laser System is installedshipped and the Company then receives a procedure fee per use. Typically, customers commit to pay for a minimum number of procedures during the term of a placement agreement. Sterile handpieces and other disposables are included in the per procedure fee. Revenues from these contracts are classified as placement fees. The cost of theThe Heart Laser System, which is owned by the Company, is depreciated over the term of the contract. In the near term, it is expected that placement revenues will continue to be impacted by reimbursement policies until the U.S. Food and Drug Administration ("FDA") approval is granted. In foreign countries where credit risk is high or where health care is not reimbursed by the government or insurance, theagreement. The Heart Laser System is also sold as capital equipmentto customers, and the related sterile handpieces and other disposables are sold separately for each procedure. The Company sells The Heart Laser SystemsSystem directly and through distributors. These sales are classified as product sales. In September 1998, the Company entered into an exclusive agreement with GE Capital Trans Leasing ("GE Capital") to provide a broad array of lease financing alternatives to U.S. hospitals interested in acquiring The Heart Laser System. The lease financing alternatives available through GE Capital are expected to complement the Company's traditional placement and sales strategies. In addition, GE Capital agreed to monetize certain prospective domestic placement agreements by providing funding to the Company in an amount equal to the present value of minimum procedure payments contained in such agreements, subject to approval of creditworthiness and other terms. No revenue was recognized on such transactions in 1998. No assurance can be given that the Company will recognize any revenue as a result of its agreement with GE Capital. YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Total revenues of $5,693,000 for the year ended December 31, 1998 decreased $3,248,000 or 36% when compared to total revenues of $8,941,000 for the year ended December 31, 1997. For the year ended December 31, 1998, product sales of $3,088,000 decreased $2,599,000 or 46% when compared to product sales of $5,687,000 for the year ended December 31, 1997. The major factor in these decreases is the decline in the number of sales transactions. In 1998, the Company recorded revenue on six sales compared with revenue recognition on ten sales in 1997. Placement and service fees of $2,605,000 for the year ended December 31, 1998 decreased 20% from placement and service fees of $3,254,000 for the year ended December 31, 1997. Although the Company increased the number of its placement contracts in 1998, revenue from these contracts decreased. In May 1997, the Health Care Financing Administration ("HCFA") instituted a non-coverage policy for TMR procedures performed on Medicare patients in the United States. The HCFA announcement, coupled with delays in the FDA Pre-Market Approval ("PMA") process, caused the Company to examine its contractual requirements during 1997 and amend substantially all of its placement contracts, temporarily replacing contractual minimal billings with actual usage billings. Following receipt of the PMA from the FDA on August 20, 1998, placement contracts that provide for minimum billings were reinstated, and the Company is renegotiating those placement agreements that do not provide for minimum billings following FDA approval. In February 1999, HCFA announced its intention to provide coverage for TMR but did not specify an effective date for such coverage. Total gross profit decreased to $1,126,000 or 20% of total revenues for the year ended December 31, 1998 as compared with $3,625,000 or 41% of total revenues for the year ended December 31, 1997. This decrease has resulted from three factors. First, the decrease in revenue in 1998 generated fewer gross margin dollars as compared to 1997. Second, the Company produced fewer Heart Laser Systems than planned in 18 1998, resulting in unfavorable manufacturing variances. These unfavorable manufacturing variances are expected to continue until production increases to levels which will fully absorb manufacturing overhead. Third, depreciation on Heart Laser Systems shipped pursuant to placement contracts increased at a greater rate than the corresponding revenue generated from placement contracts. Selling, general and administrative expenses of $13,718,000 for the year ended December 31, 1998 increased $669,000 or 5% when compared with $13,049,000 for the year ended December 31, 1997. The increase in 1998 reflects sales and marketing expenses incurred to initiate rapid commercialization of The Heart Laser System upon receipt of the PMA. Research and development expenditures of $4,468,000 decreased $690,000 or 13% for the year ended December 31, 1998 when compared with $5,158,000 for the year ended December 31, 1997. The decrease in 1998 compared to 1997 reflects the reduced demands for clinical study compilation and data preparation following the FDA panel recommendation of approval for The Heart Laser System, offset in part by higher costs associated with the development of new products. Other income of $457,000 for the year ended December 31, 1998 increased $279,000 or 157% when compared to $178,000 for the year ended December 31, 1997, primarily because of gains recorded in connection with foreign currency transactions. There was no provision for income tax for the years ended December 31, 1998 or 1997 due to the net losses of $16,603,000 and $14,404,000, respectively. The Company incurred a net loss for the year ended December 31, 1998 of $16,603,000 compared with a net loss of $14,404,000 for the year ended December 31, 1997. The larger net loss resulted from lower total revenues and lower gross margin dollars in 1998 when compared with 1997. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Total revenues of $8,941,000 for the year ended December 31, 1997 decreased $2,931,000 or 25% when compared to total revenues of $11,872,000 for the year ended December 31, 1996. For the year ended December 31, 1997, product sales of $5,687,000 decreased $3,395,000 or 37% when compared to product sales of $9,082,000 for the year ended December 31, 1996. The major factors in both of these year to date decreases arewere declines in the number of Heart Laser Systems sold and the customer mix. In 1997, the Company recorded revenue on sales of ten Heart Laser Systems, under the sales strategy of whichincluding two were sold directly and eight were sold to distributors as compared todistributors. In 1996, the Company recorded revenue recorded on 13 Heart Laser Systems under thethirteen sales, strategy in 1996six of which six were sold directly and seven of which were sold to distributors. Heart Laser Systems sold directly to customers typically generate higher revenues than those sold to distributors. Placement and service fees of $3,254,000 for the year ended December 31, 1997 increased 17% over placement and service fees of $2,790,000 for the year ended December 31, 1996. Although the Company has increased its placement contract base, revenue dollars have not proportionately increased. The Company generates a revenue stream over the life of the placement contract. Typically, the revenue generated in the initial periods of the contract are less than in later periods when PreMarket Approval ("PMA") approval is anticipated and minimum contractual billings are increased. In May 1997, the Health Care Financing Administration (HCFA) instituted a non-coverage policy for TMR procedures performed on Medicare patients in the United States. The HCFA announcement coupled with the July 28, 1997 FDA Advisory Panel recommendation of non-approval caused the Company to reexamine its requirement of contractual minimum billings prior to FDA approval. As a result, the Company permitted a slowdown in the contractual minimum billings to an actual usage billing. Until PMA approval, of which no assurance can be given, the Company expects that future billings under placement contracts will be impacted similarly and the effect on future revenue on existing contracts cannot be predicted. Total gross1996 Gross profit decreased to $3,625,000 or 41% of total revenues for the year ended December 31, 1997 as compared with $7,806,000 or 66% of total revenues for the year ended December 31, 1996. Gross profit on product sales decreased to $2,966,000 or 52% of product sales for the year ended December 31, 1997 from $6,171,000 or 68% of product sales for the year ended December 31, 1996. This overallThe decrease has resulted primarily from three factors. First, in September 1996, the Company moved into a new facility to 19 21 accommodate higher levels of manufacturing in anticipation of FDA approval. In 1997, the Company continued to increase overall staffing and other related fixed manufacturing costs which in turn caused overall manufacturing spending to be higherincreased in 1997 than in 1996 coupled with lowerand production levels of production in 1997 than in 1996. The combination of these factors resulteddecreased, resulting in unfavorable capacity and manufacturing variances in 1997, which caused a deterioration in the gross margin. The Company anticipates that after PMA approval, of which no assurance can be given, production levels will increase to levels that will absorb manufacturing overhead and mitigate these variances. Secondly, as previously discussed,Second, the Company shippedsold fewer units under its sales strategy in 1997 than in 1996 and the mix was primarily to distributors in 1997 as compared to direct sales in 1996. Heart Laser Systems sold directly to customers typically carry a higher gross profit than those sold to distributors. Thirdly, the Company generated less gross margin dollars from placement contracts in 1997 than in 1996 as discussed below. Gross profit on placement and service fees of $659,000 or 20% of total revenues for the year ended December 31, 1997 decreased $976,000 when compared to $1,635,000 or 59% of total revenues for the year ended December 31, 1996. The Company's existing placement contracts are in the pre-PMA contractual minimum billings period, which are typically lower than minimums required after PMA approval, of which no assurance can be given, at which time annual minimums increase. The cost of the laser is charged on a straight-line basis over the life of the placement contract. The overallThird, depreciation on Heart Laser Systems under existingshipped pursuant to placement contracts is increasingincreased at a fastergreater rate than the corresponding revenue generated due to the lower pre-PMA minimum billings. This has resulted in a lower gross margin in 1997 as compared to 1996. Until such time that the Company sees an increase to its minimum billings on existing and futurefrom placement contracts, the gross margin is expected to be negatively impacted.contracts. Selling, general and administrative expenses of $13,049,000 for the year ended December 31, 1997 increased $6,026,000 or 86% when compared with $7,023,000 for the year ended December 31, 1996. The Company continuesincurred significant expenses to prepare for an FDA panel review of theits PMA application for theThe 19 Heart Laser System. In 1997,addition, the Company expanded its management team and as well as its sales force. The Company feels these additional expenditures are necessary and should enable the Company to be well positioned for the U.S. launch of the Heart Laser System upon approval from the FDA, of which no assurance can be given. Research and development expenditures of $5,158,000 increased $2,323,000 or 82% for the year ended December 31, 1997 when compared with $2,835,000 for the year ended December 31, 1996. The Company continues to makeThese expenditures were incurred in connection with itsthe Company's clinical study compilation and data preparation for FDA submissions.submissions and an FDA panel review. These activities have required additional staffing and consultants in 1997 for these growing demands. In addition, the Company continues its investments in the research and development of new products.consultants. Other income of $178,000 for the year ended December 31, 1997 decreased $334,000 or 65% when compared to $512,000 for the year ended December 31, 1996. Included in other income is interest income, interest expense and other expense. Interest income was $553,000 in 1997 and $594,000 in 1996. The slight decrease1996 primarily because of an increase in interest income is a result of a lower average cash and marketable securities balances in 1997 than in 1996. Interest expense was $207,000 in 1997 and $13,000 in 1996.expense. In July and August 1997, the Company received $18.8 million in net proceeds from the issuance of 5% Convertible Debentures. See Note 6 to the Consolidated Financial Statements. The Company recorded interest expense on the outstanding debentures throughout the year. Other expense was $168,000 in 1997 and $69,000 in 1996. Included in other expense are gains and losses from foreign currency transactions. There was no provision for income tax for the yearyears ended December 31, 1997 orand 1996 due to the net losslosses of $14,404,000 and $1,540,000, respectfully.respectively. The Company incurred a net loss for the year ended December 31, 1997 of $14,404,000 when compared to a net loss of $1,540,000 for the year ended December 31, 1996. This is a result ofThe increased loss resulted from lower total revenues in 1997 when compared with 1996, coupledcombined with higher overall expenses in 1997 related to preparation for an FDA panel review of The Heart Laser System. LIQUIDITY AND CAPITAL RESOURCES During 1997 and 1998 the PMA approval process.Company incurred significant operating losses and utilized significant amounts of cash to fund operations. The Company is reaching a critical stage in its growth as it transitions from a research and development company to a commercial company with complete sales, marketing and production capabilities. During this time the Company increased its overall operating expenses and overhead to be positioned to further increase its sale and production capabilities in anticipation of possible FDA approval. In order to be adequately positioned to meet these demands, the Company obtained equity financing. The Company continues to seek equity financing as its primary means of funding operations during this transition. On March 4, 1999, the Company announced that it had obtained a provisional equity financing commitment of $8 million from a major institutional investor. The commitment contemplates the sale by the Company of up to $2 million in common stock during consecutive 20 22day periods at prices based on the trailing volume weighted average price of the common stock on the American Stock Exchange on each day during such periods, less a seven percent discount. The $.84 and $.09 lossCompany is unable to use the commitment on any trading day to the extent that the volume weighted average price of the Company's common stock is less than $3.50 per share, forunless the years ended December 31, 1997Company and 1996, respectively, was calculated using only the weighted average numberinvestor mutually agree to a reduction in such price. If the Company is unable to use the commitment on any given trading day, the commitment amount is automatically reduced by $100,000 on such day. The use of the commitment is also dependent upon the Company being eligible to sell shares outstandingof its common stock under a Form S-3 Registration Statement under the Securities Act of 1933, as amended, which form requires, among other things, that the Company have a market capitalization of at least $75 million held by non-affiliates of the Company during the year. YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 Total revenuesimmediately preceding 60-day period. As of $11,872,000 for the year ended December 31, 1996 decreased $1,473,000 or 11% when compared to total revenues of $13,345,000 for the year ended December 31, 1995. For the year ended December 31, 1996, product sales of $9,082,000 decreased $2,856,000 or 24% when compared to product sales of $11,938,000 for the year ended December 31, 1995. The major factors in both of these year to date decreases are the number of Heart Lasers shipped and the method of sale. In 1996, there wereMarch 30, units shipped, 13 of which were sales, as compared with 23 shipped in 1995, 15 of which were sales. In addition, in 1995,1999, the Company had a significant salesold 323,231 shares of common stock under this commitment, resulting in net proceeds to a distributor IMATRON Japan ("IMATRON") of six Heart Lasers at approximately $5.7 million. In 1996, the Company did not haveof $885,000. As of March 31, 1999, the Company is unable to utilize this commitment due to its stock price. While the Company anticipates being able to utilize this commitment or obtain other sources of equity financing, there can be no assurance that the Company will be able to raise additional equity financing or that the Company will maintain its eligibility to use Form S-3. To the extent that the Company raises 20 additional capital by issuing equity or convertible securities, ownership dilution to the stockholders will result. During the second half of 1998, the Company implemented a comparable contractnumber of programs to reduce its consumption of cash, including operating expense reductions and the financing agreement with IMATRON or any other distributor. PlacementGE Capital, which enables the Company to obtain an upfront cash payment on certain domestic placement agreements. While the Company is encouraged by the recent developments with respect to FDA approval and service feesthe HCFA announcement that Medicare will provide coverage for TMR procedures performed with devices approved by the FDA, the historical absence of $2,790,000widespread reimbursement for the year ended December 31, 1996 increased 98% over placementTMR procedure by third party payers, principally Medicare, Medicaid, and service feesprivate health insurance plans, has limited demand for and use of $1,407,000 for the year ended December 31, 1995 which reflects an increaseThe Heart Laser System in the number ofUnited States. Although Medicare reimbursement is expected to begin in 1999 and some private insurance plans have begun reimbursing health care providers for TMR procedures using The Heart Lasers under placement contracts. In 1996Laser System, the Company hadbelieves that operating losses are likely to continue until such time as third party payers begin to provide widespread reimbursement to healthcare providers for use of The Heart Laser System. Recognizing the deliberate nature that accompanies a totalhighly regulated process such as the above, management of 27the Company has outlined a plan of appropriate action steps to attempt to ensure that the Company has adequate sources of cash to meet its working capital needs for at least the next twelve months. In March 1999, management of the Company received approval from the Board of Directors to implement this action plan. The key elements of the plan are as follows: - Further operating expense reductions to eliminate certain expenditures which are not critically essential to achieving critical business objectives at this time (e.g., discretionary spending, further development efforts) - Strategic realignment of the Company's international sales organization. - Pursuit of strategic alternatives related to the Company's domestic sales efforts that can help it further penetrate existing markets. - Pursuit of strategic financing alternatives including the sale of debt securities, bank financing, strategic alliances, joint ventures or by other means. While the Company has not yet finalized the specific details of its plan, management is committed to developing restructuring alternatives, which, if implemented, would result in a material charge to operations in 1999. As a result of implementing the above actions, management believes that its existing cash resources and cash from operations will meet working capital requirements over the next twelve months and improve operating results. However, unanticipated decreases in operating revenues, increases in expenses or further delays in the process of third party payers committing to provide reimbursement to healthcare providers, may adversely impact the Company's cash position and require further cost reductions. No assurance can be given that the Company will be successful in achieving broad commercial acceptance of The Heart Lasers under placement contracts as compared withLaser System or that the Company will be able to operate profitably on a total of 11 in 1995. Total gross profit decreased to $7,806,000 or 66% of total revenues for the year ended December 31, 1996 as compared with $8,782,000 or 66% of total revenues for the year ended December 31, 1995. Gross profit on product sales decreased to $6,171,000 or 68% of product sales for the year ended December 31, 1996 from $7,761,000 or 65% of product sales for the year ended December 31, 1995. The decrease in gross margin dollars is a function of lower product sales discussed previously. The gross margin percentage on product sales increased slightly in 1996 as compared with 1995.consistent basis. During the year ended December 31, 1995,1998, the Company expensed certain inventory related with the exit strategy of its general purpose CO(2) surgical laser product line, which had an unfavorable impact on the gross margin percentage in 1995. Gross profit on placement and service fees of $1,635,000 or 59% for the year ended December 31, 1996 increased $614,000 when compared to $1,021,000 or 73% for the year ended December 31, 1995. In 1996, the Company had a majority of its placement contracts in their first contract year. The first year of a placement contract generally produces lower annual minimum contractual revenues than in subsequent years. In addition, the Company records installation revenue at the commencement of the placement contract. In 1996, the timing of both of these factors reflected a lower gross margin percentage when compared to 1995. Selling, general and administrative expenses of $7,023,000 for the year ended December 31, 1996 increased $1,988,000 or 39% when compared with $5,035,000 for the year ended December 31, 1995. In 1996, the Company expanded its international sales and marketing efforts with the establishment of four international subsidiaries in Europe and Asia, which accounted for more than one-third of the overall increase. In addition to the expansion internationally, the Company has also strengthened its domestic marketing efforts, increased overall staffing, and moved its operations to a new 37,000 square foot facility. Research and development expenditures of $2,835,000 increased $589,000 or 26% for the year ended December 31, 1996 when compared with $2,246,000 for the year ended December 31, 1995. The increase is primarily related to increased staffing requirements associated with growing demands for clinical study compilation and the development of a second generation Heart Laser System. Other income of $512,000 for the year ended December 31, 1996 decreased $76,000 or 13% when compared to $588,000 for the year ended December 31, 1995. This decrease is the result of lower interest income due to lower interest rates throughout 1996 as compared to 1995. In addition, with the establishment of the Company's new subsidiaries in 1996, foreign currency transactions resulted in a $51,000 loss for the year ended December 31, 1996. There was no provision for income tax for the year ended December 31, 1996 due to the net loss of $1,540,000. Although the Company had sufficient net operating loss carryforwards to offset income taxes for 21 23 the year ended December 31, 1995, the provision for income taxes represents the tax liability under the alternative minimum tax regulations which cannot be offset by net operating loss carryforwards. The Company incurred a net loss forof $16,603,000, which resulted in the year ended December 31, 1996use of $1,540,000 when comparedapproximately $14,300,000 to net income of $2,004,000 for the year ended December 31, 1995. This is a result of lower total revenues in 1996 when compared with 1995, coupled with higher overall expenses in 1996support operations. Cash provided by investing activities was approximately $10,300,000 primarily related to both international and domestic expansion. The $.09 loss per share for the year ended December 31, 1996net maturities of approximately $12,800,000 of marketable securities, offset by an investment of $2,600,000 in fixed assets, primarily related to its placement contract activity. Cash provided by financing activities was calculated using onlyapproximately $5,400,000, primarily related to the weighted average number of shares outstanding during the year. Earnings per share of $.13 for the year ended December 31,1995 was calculated using the weighted average number of shares outstanding during the year. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1997, the Company had cash and cash equivalents of $3,484,000 and short-term investments of $12,845,000. In July and August 1997, the Company received $18,800,000 in net proceeds of $4,700,000 obtained through the issuance of 5% Convertible Debentures due July 2002convertible debentures and August 2002. In September 1997 $15,900,000$600,000 in proceeds from the sale of these debentures were converted into the Company's Common Stock. In January and February 1998, the remaining $4,250,000common stock, offset by principal payments on capital lease obligations of these debentures converted into the Company's Common Stock. See Note 6 to the Consolidated Financial Statements.$79,000. 21 During the year ended December 31, 1997, the Company incurred a loss of $14,404,000, which resulted in the use of approximately $10,050,000 to support operations. Cash used in investing activities was approximately $10,000,000 primarily related to the net purchase of $7,300,000$7,400,000 of marketable securities fromand the proceedsinvestment of the convertible debentures discussed previously. In addition, the Company invested $2,600,000 in fixed assets, primarily related to its placement contract activity. Cash provided by financing activities was approximately $20,800,000, primarily related to the net proceeds of $18,800,000 through the issuance of convertible debentures and $2,000,000 from proceeds of the sale of the Company's common stock. During the year ended December 31, 1996, the Company received approximately $2,499,000 in proceeds from the exercise of stock options and warrants, and $119,000 from the repayment of shareholder loans. An additional $1,030,000 of cash was generated from the maturities of short-term investments which were not reinvested. Cash provided from operating activities approximated $3,100,000, principally related to its collection in January 1996 of its $5,700,000 outstanding receivable from IMATRON, offset by investments in inventories, and increases in prepaid expenses and other assets. Approximately $4,200,000 was used to acquire capital equipment, principally Heart Lasers used for placement contracts coupled with leasehold improvements related to the Company's new facility. On September 3, 1996, the Company moved into its new facility in Franklin, Massachusetts under a five-year operating lease. In February 1997, the Company's PMA was filed by the FDA. In anticipation of a possible FDA approval, the Company had been increasing its overall operating expenses and overhead to be positioned to further increase its production capacities. In order to be adequately positioned to meet these demands, the Company secured financing in July 1997. On July 28, 1997, an FDA Advisory Panel recommended a non-approval at that meeting with the requirement of additional data to complete the randomized study. In December 1997, the Company submitted all of the data on the Heart Laser System to the FDA and its Advisory Panel from the request of the July 28, 1997 FDA Advisory Panel meeting. The Company has been notified of a scheduled FDA Advisory Panel date on April 24, 1998. Given this delay, the Company has monitored its operating expenses closely and minimized increases to expenses and overhead during this period. With the $16.3 million in cash and marketable securities at December 31, 1997, the Company believes that it has sufficient resources to meet its working capital demands for at least the next twelve months. The Company and certain of its officers have been named as defendants in 21 purported class action lawsuits filed between August 1997 and November 1997. See Note 5 to the Consolidated Financial Statement and Item 3 Legal Proceedings for further discussion. The Company has an insurance policy of which the maximum deductible has been recorded in the results of operations for the year ended 1997. 22 24 Unanticipated decreases in operating revenues, increases in expenses, or a further delay in the expected FDA approval, may adversely impact the Company's cash position. The Company may seek additional financing through the issuance and sale of debt or equity securities, bank financing, joint ventures or by other means. The availability of such financing and the reasonableness of any related terms in comparison to market conditions cannot be assured. For the reasons discussed above, the Company believes that operating losses are likely until after such time as the Company receives its PMA from the FDA for the Heart Laser System. Although the Heart Laser System has been granted "expedited review" status by the FDA, the Company cannot project when, if at all, such approval will be granted or that any approval will include desirable claims. Any failure or delay in receiving any such approval would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company must also convince health care professionals, third party payors and the general public of the medical and economic benefits of the Heart Laser System. No assurance can be given that the Company will be successful in marketing the Heart Laser System or that the Company will be able to operate profitably on a consistent basis. This report contains forward-looking statements regarding anticipated increases in revenues, marketing of products and proposed products and other matters. These statements, in addition to statements made in conjunction with the words "anticipate," "expect," "intend," "believe," "seek," "estimate" and similar expressions are forward-looking statements that involve a number of risks and uncertainties. The following is a list of factors, among others, that would cause actual results to differ materially from the forward-looking statements: approval by the FDA, successful ability to secure any required additional financing, business conditions and growth in certain market segments and general economy, an increase in competition, increased or continued market acceptance of the Company's products and proposed products, and other risks and uncertainties indicated from time to time in the Company's filings with the Securities and Exchange Commission. At December 31, 1997,1998, the Company had U.S. net operating loss carryforwards of approximately $19.2$34.5 million available to reduce future taxable income which expire at various dates through 2011,2012, and the Company had foreign net operating loss carryforwards of approximately $3.7$5.7 million. In addition, various other deferred tax assets have been generated related primarily to intercompany profit, accruals, and research and development tax credits. SinceBecause the Company believes that, as of December 31, 19971998, it is more likely than not, that all of the deferred tax assets will not be realized, no tax benefit for prior year losses and other deferred items has been provided. These amounts could provide a benefit to the Company in the future in profitable years, subject to the expirations noted. The Company and certain of its officers have been named as defendants in 21 purported class action lawsuits filed between August 1997 and November 1997. See Note 5 in the accompanying consolidated financial statements for further discussion. YEAR 2000 The Year 2000 Issue refers to potential problems withproblem is the result of computer systems or any equipment with computer chips or softwareprograms that uses dates where the date has been stored as justuse two digits (e.g., 97 for 1997).rather than four to define the applicable year. On January 1, 2000, any clockcomputer equipment and programs that have time-sensitive software may not be able to distinguish whether "00" means 1900 or date recording mechanism incorporating date sensitive software which uses only two digits to represent the year may recognize a date using 00 as the year 1900 rather than the year 2000. This could result incause a major system failure or miscalculations causing disruption of operations, including, among other things, a temporary inabilitycould create erroneous results. The Company could be unable to process transactions, send invoices, or engage in similar business activities. The Company may also be vulnerable to other companies' Year 2000 issues. In 1998, the Company formed a task force to determine what if any Year 2000 compliance issues the Company faces. The task force has developed and implemented a Year 2000 readiness plan that defines compliance and sets critical milestones to identify any deficiencies and correct them. The task force identified three basic operational areas that have been and will continue to be examined: - Products -- products the Company currently sells, products the Company sold previously, and products of the Company's most significant suppliers; - Business Systems -- computer hardware and software used to operate the Company's business, including purchasing, manufacturing, sales and finance; and - Peripherals -- the Company's telephone, e-mail, security and shipping systems. In 1998, The Heart Laser System was tested and is presently evaluatingbelieved to be Year 2000 compliant in all material respects. In addition, the Company has purchased and implemented new enterprise resource planning system software that the vendor has represented is Year 2000 compliant. This new software system has replaced substantially all of the Company's previous financial software systems. Current estimates of the impact of the Year 2000 Issueproblem on the Company's operations and financial results do not include costs and time that may be incurred as it affects business operations, interfaces with customers and vendors, and contingencies relateda result of vendor or customer failures to products thatbecome Year 2000 compliant, but no significant costs have been soldidentified to date. 22 Despite investigation and testing by the Company and its business partners, the Company's products and systems may contain errors or defects associated with Year 2000 date functions. The Company believes that may need to be modified. To date,its new enterprise resource planning software substantially addresses its material Year 2000 risks; however, the Company is unawarecontinuing to test its secondary systems and investigate third party compliance efforts. In a worst case scenario, known and unknown errors and defects that could affect the operation of our products or systems could result in: - delay or loss of revenue; - cancellation of customer contracts; - increased service and/or warranty costs; - increased litigation costs; - diversion of product development and personnel resources; and - damage to our reputation. Furthermore, the Company has not developed a Year 2000 contingency plan to address any situationsfailure of noncomplianceour Year 2000 compliance review to identify and correct significant Year 2000 risks. Development of contingency plans is in progress and will continue during calendar year 1999. Such plans could include stockpiling inventory parts and raw materials, accelerating replacement of affected equipment or software, using back-up equipment and software, developing temporary manual procedures to compensate for system deficiencies, and identifying alternative Year 2000 capable suppliers. The Company cannot be sure that would materially adversely effect its operations or financial condition. There can be no assurance, however, that instancessuch contingency plans will adequately address the year 2000 problem. Any of noncompliance whichthese occurrences could have a material adverse effect on the Company's operations orour business, financial condition and results of operations. RISK FACTORS OUR COMPANY HAS A LIMITED OPERATING HISTORY AND A HISTORY OF LOSSES PLC Systems Inc. was founded in 1987. We have incurred operating losses in every year of our existence except 1995. We have incurred net losses of $16,603,000 for the year ended December 31, 1998, $14,404,000 for the year ended December 31, 1997, and $1,540,000 for the year ended December 31, 1996. As of December 31, 1998, we have an accumulated deficit of $68,136,000. We have not achieved profitability and expect to continue to incur net losses for at least the next fiscal year. Moreover, although our business is not seasonal in nature, our revenues tend to vary significantly from fiscal quarter to fiscal quarter. OUR COMPANY IS DEPENDENT ON ONE PRINCIPAL PRODUCT We develop and market one principal product: a patented high-powered carbon dioxide laser system known as The Heart Laser System. Approximately 93.2% of our revenue in the fiscal year ended December 31, 1997 and 89.5% in the fiscal year ended December 31, 1998 was derived from The Heart Laser System. OUR COMPANY MAY BE UNABLE TO RAISE NEEDED FUNDS As of December 31, 1998, we had cash and cash equivalents totaling $4,846,000, a decrease of $11,483,000 from the balance of $16,329,000 we had as of December 31, 1997. The lack of widespread reimbursement for use of The Heart Laser System by third party payers such as Medicare, Medicaid and private health insurance plans has limited demand for and use of The Heart Laser System in the United States. 23 Although Medicare reimbursement is expected to begin in 1999 and some private insurance plans have begun reimbursing health care providers for TMR procedures using The Heart Laser System, we believe that operating losses are likely to continue until such time as third party payers begin to provide widespread reimbursement to healthcare providers for use of The Heart Laser System. Although we announced an $8 million equity financing commitment on March 4, 1999, we have been unable to access that commitment in full (see "Liquidity and Capital Resources" above). We have developed an action plan to ensure that the Company has adequate sources of cash to meet its working capital needs for at least the next twelve months. (See "Liquidity and Capital Resources" above). We are currently exploring a number of alternatives to raise additional capital. We may not be able to raise additional capital upon satisfactory terms and our business, financial condition and results of operations could be materially and adversely affected. IN ORDER TO COMPETE EFFECTIVELY, WE NEED TO GAIN COMMERCIAL ACCEPTANCE The Heart Laser System is designed for use in the treatment of coronary artery disease in a surgical laser procedure we pioneered known as transmyocardial revascularization. Transmyocardial revascularization is commonly referred to in our industry as "TMR." TMR is a new technology that is only recently becoming known. We may never achieve widespread commercial acceptance. To be successful, we need to: - demonstrate to the medical community in general, and to heart surgeons and cardiologists in particular, that TMR procedures and The Heart Laser System are effective, relatively safe and cost effective; and - train heart surgeons to perform TMR procedures using The Heart Laser System. To date, we have trained only a limited number of heart surgeons and will need to expand our marketing and training capabilities. Over 4,000 patients have been treated with TMR procedures using The Heart Laser System in the United States and overseas. As of December 31, 1998, we had shipped over 100 Heart Laser Systems worldwide. Although The Heart Laser System has received FDA approval and the CE Mark, and a number of research studies have reported favorably on The Heart Laser System, we have not yet received widespread commercial acceptance. If we are unable to maintain regulatory approvals or to achieve widespread commercial acceptance of The Heart Laser System, our business, financial condition and results of operations will be materially and adversely affected. RESULTS OF LONG-TERM CLINICAL STUDIES MAY ADVERSELY AFFECT OUR BUSINESS Patients have only been treated with The Heart Laser System since January 1990, and, as a result, there have been few long-term follow-up studies. If patients suffer harmful, long-term consequences from The Heart Laser System, our business, financial condition and results of operations will be materially and adversely affected. RAPID TECHNOLOGICAL CHANGES IN OUR INDUSTRY COULD MAKE THE HEART LASER SYSTEM OBSOLETE Our industry is characterized by rapid technological change and intense competition. New technologies and products and new industry standards will develop at a rapid pace. They could make The Heart Laser System obsolete. The advent of new devices and procedures and advances in new drugs and genetic engineering are especially threatening. Our future success will depend upon our ability to develop and introduce a variety of product enhancements to address the increasingly sophisticated needs of our 24 customers. Material delays in introducing product enhancements may cause customers to forego purchases of our product and purchase those of our competitors. Many of our competitors have substantially greater financial resources and are in a better financial position to exploit marketing and research and development opportunities. Most of our direct competitors are using a different type of laser than ours, including holmium and excimer lasers. Several of the companies that have entered the market are developing less invasive methods of performing TMR procedures. These new methods may eliminate the need to make an incision in the patient's chest, reducing costs and speeding recovery. These new methods may erode the potential TMR market. WE MUST RECEIVE AND MAINTAIN GOVERNMENT APPROVAL IN ORDER TO MARKET OUR PRODUCT GENERAL The Heart Laser System and our manufacturing activities are subject to extensive, rigorous and changing federal and state regulation in the United States and to similar regulatory requirements in other major markets, including the European Community and Japan. To date, we have received regulatory approval in the United States and the European Community, but not in Japan. Without regulatory approval, we cannot market The Heart Laser System in Japan. Even if granted, regulations may significantly restrict the use of The Heart Laser System. The process of obtaining and maintaining required regulatory approval is lengthy, expensive and uncertain. UNITED STATES -- ALTHOUGH WE HAVE RECEIVED FDA APPROVAL, THE FDA HAS RESTRICTED THE USE OF THE HEART LASER SYSTEM AND COULD REVERSE ITS APPROVAL AT ANY TIME In August 1998, we became the first company to receive FDA approval to market a laser system for TMR procedures. However, the FDA: - has not allowed us to market the Heart Laser System to treat patients whose condition is amenable to conventional treatments, such as heart bypass surgery and angioplasty; and - could reverse its ruling and prohibit use of The Heart Laser System at any time. EUROPE -- ALTHOUGH WE HAVE RECEIVED REGULATORY APPROVAL FROM THE EUROPEAN COMMUNITY, THE EUROPEAN COMMUNITY COULD REVERSE ITS APPROVAL AT ANY TIME AND FRANCE HAS PROHIBITED COMMERCIAL USE OF THE HEART LASER SYSTEM The Heart Laser System received the CE Mark, which is similar to FDA approval, from the European Community in 1995. The CE Mark allows us to market The Heart Laser System in all European Community countries. However: - The European Community could reverse its ruling and prohibit use of The Heart Laser System at any time; - We cannot market The Heart Laser System in France; and - Other European Community countries could prohibit or restrict use of The Heart Laser System. Despite receiving the CE Mark, The French Ministry of Health instituted a commercial moratorium on TMR procedures in October 1997. In its opinion, the procedure is considered to be experimental and should only be performed within the context of a clinical study. An evaluation of the safety of The Heart Laser System 25 is currently under review by a panel of French experts. We have provided our clinical results to the panel and are actively working to have this moratorium lifted. There is no assurance when or if we will be successful. ASIA -- WE CANNOT MARKET OUR PRODUCT IN MAJOR ASIAN MARKETS UNTIL WE RECEIVE GOVERNMENT APPROVAL We believe that Japan represents the largest potential market for The Heart Laser System in Asia. Prior to marketing The Heart Laser System in Japan, we must receive approval from the Japanese Government. This approval requires a clinical study in Japan with at least 60 patients. This study was completed in 1998. We submitted the results of this study to the Japanese Government in December 1998. We do not know whether the clinical study will be sufficient or when, if ever, we will receive approval to sell The Heart Laser System in Japan. Additional regulatory applications are pending in Taiwan and South Korea. We cannot be sure when, if at all, we will obtain regulatory approval in any particular country. ASSERTING AND DEFENDING INTELLECTUAL PROPERTY RIGHTS MAY IMPACT RESULTS OF OPERATION REGARDLESS OF SUCCESS In our industry, competitors often assert intellectual property infringement claims against one another. The success of our business depends on our ability to successfully defend our intellectual property. Future litigation may have a material impact on our financial condition even if we are successful in marketing The Heart Laser System. We may not be successful in defending or asserting our intellectual property rights. WE MAY BE SUBJECT TO PRODUCT LIABILITY LAWSUITS; OUR INSURANCE MAY NOT BE SUFFICIENT TO COVER DAMAGES We may be subject to product liability claims. A recent United States Supreme Court decision held that compliance with FDA regulations will not shield a company from common-law negligent design claims or manufacturing and labeling claims based on state rules. Although we have product liability insurance with a yearly aggregate maximum of $10 million, we cannot be identified,sure that our insurance is adequate to cover any product liability law suits. Our insurance is expensive and in the systemsfuture may not be available on acceptable terms, if at all. If a successful product liability claim or series of other companies with whichclaims exceeded our insurance coverage, it would divert the Company transacts business will be corrected on a timely basis; or that failure by such entities to correct a Year 2000 problem or a correction which is incompatible withattention of our key personnel, degrade the Company's information systems would notreputation and marketability of our technology and products, and could have a material adverse effect on our business, financial condition and results of operations. 26 WE HAVE BEEN SUED FOR ALLEGED VIOLATIONS OF SECURITIES LAW In July 1997, an FDA advisory panel recommended against approval of our application to market The Heart Laser System. Following this recommendation, we were named as defendant in 21 purported class action lawsuits filed between August 1997 and November 1997 in the United States District Court for the District of Massachusetts. The lawsuits seek an unspecified amount of damages in connection with alleged violations of the federal securities laws based on our failure to obtain a favorable FDA panel recommendation in 1997. Nineteen of these complaints have been consolidated by the court into a single action for pretrial purposes and two suits have been dismissed. The Company moved to dismiss all of the remaining claims. On March 26, 1999, the court issued an order dismissing some, but not all of the remaining claims. We have also been named as a defendant in a lawsuit filed in Massachusetts Superior Court in September 1998. This suit seeks over $2 million in damages for alleged negligent misrepresentations and fraud arising from our failure to obtain a favorable FDA recommendation in 1997. We cannot make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of these lawsuits, but an unfavorable outcome could have a material adverse affect on our business, financial position and results of operations. We may not be able to pay the amount of any judgment against us. We believe that we have valid defenses to these litigation matters and are conducting a vigorous defense. BECAUSE WE ARE INCORPORATED IN CANADA, YOU MAY NOT BE ABLE TO ENFORCE JUDGMENTS AGAINST US AND OUR CANADIAN DIRECTORS Under Canadian law, you may not be able to enforce a judgment issued by courts in the United States against us or our Canadian directors. The status of the law in Canada is unclear as to whether a U.S. citizen can enforce a judgment from a U.S. court in Canada for violations of U.S. securities laws. A separate suit may need to be brought directly in Canada. ANTITAKEOVER PROVISIONS MAY PREVENT YOU FROM REALIZING A PREMIUM RETURN Provisions of Canadian law could make it more difficult for a third party to acquire us, even if the acquisition would be beneficial to you. Specifically, Canadian law requires any person who makes a tender offer that would increase the person's stock ownership to more than 20% of our outstanding common stock to make a tender offer for all of our common stock. These provisions could prevent you from realizing the premium return that stockholders may realize in conjunction with corporate takeovers. In addition, our Articles provide for three classes of directors, with one-third elected each year for a three year term. These provisions may have the effect of delaying or preventing a corporate takeover or a change in our management. This could adversely affect the market price of your common stock. MARKET PRICE OF OUR STOCK MAY FALL IF OTHER STOCKHOLDERS SELL THEIR STOCK If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could fall. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a price we deem appropriate. THE VALUE OF YOUR COMMON STOCK MAY DECREASE IF OTHER SECURITY HOLDERS EXERCISE THEIR OPTIONS AND WARRANTS OR CONVERT THEIR DEBT INTO COMMON STOCK As shown in the table below, we have reserved an additional 3,186,290 shares of common stock for future issuance upon exercise or conversion of outstanding options, redeemable warrants and convertible debt. 27
Range of Weighted Average Shares Reserved Exercise/ Exercise/ for Future Conversion Prices Conversion Price Issuance Options $3.69 - $8.88 $5.16 2,868,161 Redeemable $15.78 - $27.81 $21.33 154,864 Warrants Convertible Debt $6.125 $6.125 163,265 ---------- Total 3,186,290 ---------- ----------
We plan to issue additional options and warrants in the future. If any of these securities are exercised or converted, you may experience significant dilution in the market value and earnings per share of your common stock. WE HAVE NO INTENTION TO PAY DIVIDENDS We have never paid any cash dividends on our common stock. We currently intend to retain all future earnings, if any, for use in our business and do not expect to pay any dividends in the foreseeable future. THE YEAR 2000 PROBLEM COULD CAUSE US TO EXPERIENCE MANUFACTURING DELAYS The Year 2000 problem is the result of computer programs that use two digits rather than four to define the applicable year. On January 1, 2000, computer equipment and programs that have time-sensitive software may not be able to distinguish whether "00" means 1900 or 2000. This could cause a major system failure or could create erroneous results. We could be unable to process transactions, send invoices, or engage in similar business activities. We may also be vulnerable to other companies' Year 2000 issues. Despite investigation and testing by us and our business partners, our products may contain errors or defects associated with Year 2000 date functions. We believe that our new enterprise resource planning software substantially addresses our material Year 2000 risks; however, we are continuing to test our secondary systems and continuing to investigate third party compliance efforts. In a worst case scenario, known and unknown errors and defects that affect the operation of our products or software could result in: - delay or loss of revenue; - cancellation of customer contracts; - diversion of product development resources; - damage to our reputation; and - increased service, warranty and litigation costs. Furthermore, we have not developed a Year 2000 contingency plan to address any failure of our Year 2000 compliance review to identify and correct significant Year 2000 risks. Development of contingency plans is in progress and will continue during calendar year 1999. Such plans could include 28 stockpiling inventory parts and raw materials, accelerating replacement of affected equipment or software, using back-up equipment and software, developing temporary manual procedures to compensate for system deficiencies, and identifying alternative Year 2000 capable suppliers. We cannot be sure that our contingency plans will adequately address the year 2000 problem. Any of these occurrences could have a material adverse effect on our business, financial condition and results of operations. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN FORWARD-LOOKING STATEMENTS This annual report and information incorporated by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements deal with our current plans and expectations and involve known and unknown risks and uncertainties. Statements containing terms such as: - believes - does not believe - plans - expects - intends - estimates - anticipates and other phrases of similar meaning are considered to contain uncertainty and are forward-looking statements. No forward-looking statement is a guarantee of future performance. Our actual results could differ materially from those anticipated in these forward-looking statements. We make cautionary statements in certain sections of this annual report, including in the risk factors identified above, and in materials incorporated by reference. You should read these cautionary statements as being applicable to all related forward-looking statements, wherever they appear in this annual report, in the materials referred to in this annual report, in the materials incorporated by reference into this annual report, or in our press releases. You should not place undue reliance on any forward-looking statement. 29 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK A portion of the Company's operations consists of sales activities in foreign jurisdictions. The Company manufactures its products in the United States and sells the products. As a result, the Company's financial condition. 23 25 NEW ACCOUNTING PRONOUNCEMENT Financial Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income" ("Statement 130"). Financial Accounting Standards Board Statement No. 131, "Disclosures About Segmentsresults could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. The Company's operating results are exposed to changes in exchanges rates between the U.S. dollar and Swiss Franc and the German Mark. When the U.S. dollar strengthens against the Franc or Mark, the value of an Enterprisenonfunctional currency sales decreases. When the U.S. dollar weakens, the functional currency amount of sales increases. Overall, the Company is a net receiver of currencies other than the U.S. dollar and, Related Information" ("Statement 131").as such, benefits from a weaker dollar, but is adversely affected by a stronger dollar relative to major currencies worldwide. The Company's exposures are not significant. The Company's interest income and expense are most sensitive to changes in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on the Company's cash equivalents as well as interest paid on its debt. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See Item 14 below and the Index therein for a listing of the financial statements and supplementary data filed as part of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. 2430 26 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth the ages of and positions and offices presently heldThis information is incorporated by each director and each executive officer of the Company as of March 23, 1998.
CLASS TO WHICH THE DIRECTOR NAME AGE POSITION BELONGS - ---- --- -------- --------- Robert I. Rudko, Ph.D..... 55 Chairman of the Board of Directors and Chief I Scientist William C. Dow............ 51 President, Chief Executive Officer and Director II Edward H. Pendergast...... 64 Lead Outside Director I Harold P. Capozzi......... 73 Director III H.B. Brent Norton, M.D. ................... 37 Director III Kenneth J. Pulkonik....... 57 Director II Roberts A. Smith, Ph.D. .................. 69 Director III Patricia L. Murphy........ 47 Chief Financial Officer and Treasurer N/A
The Company's Articles, as amended, provide that the members of the Board of Directors shall be classified and elected as nearby as possible into three classes, each with approximately one-third of the members of the Board of Directors. The classified board is designed to assure continuity and stability in the Board of Directors' leadership and policies. Dr. Rudko and Mr. Pendergast are classified as Class I directors and serve a three year term, expiring at the 1998 Annual Meeting, Messrs. Dow and Pulkonik are classified as Class II directors and serve until the 2000 Annual Meeting, and Drs. Norton and Smith and Mr. Capozzi are classified as Class III directors and serve until the 1999 Annual Meeting. The successors to the class of directors whose terms expire at that meeting would be elected for a term of office to expire at the third succeeding annual meeting after their election and until their successors have been duly elected by the stockholders. Directors chosen to fill vacancies on a classified board shall hold office until the next election of the class for which directors shall have been chosen, and until their successors are duly elected by the stockholders. Officers are elected by and serve at the discretion of the Board of Directors, subject to their employment contracts. The Company Act (British Columbia) requires that the Corporation's President serve on the Board of Directors. With the resignation of Mr. M. Lee Hibbs as President and Director of the Corporation effective June 30, 1997, Dr. Rudko agreed to become the Interim Acting President of the Corporation until a successor was hired which satisfied this requirement. However, there was a vacancy on the Board. Ms. Patricia L. Murphy was nominated and elected to serve as a member of the Board of Directors to fill this vacancy. In order to continue to satisfy the Company Act requirement, Ms. Murphy agreed with the Corporation to resign as a director effective immediately upon the Corporation hiring a new President and Chief Executive Officer. On August 15, 1997, Mr. Dow was elected as President, Chief Executive Officer and Director of the Corporation, at which point Ms. Murphy and Dr. Rudko resignedreference from their respective interim positions. Under British Columbia corporate law, a majority of the Company's directors mustProxy Statement to be residents of Canada and one director must be a resident of British Columbia. As a result, stockholders may be limited in the persons they can nominate and elect as directors. No director or executive officer is related to any other director or executive officer by blood or marriage. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, requires executive officers and directors, and persons who beneficially own more than ten percent (10%) of the Company's stock to file initial reports of ownership on Form 3, reports of changes in ownership on Form 4 and annual statements of changes 25 27 in beneficial ownership on Form 5filed with the Securities and Exchange Commission ("SEC") and any national securities exchange on whichin connection with the Company's securities are registered. Executive officers, directors and greater than ten percent (10%) beneficial owners are required1999 Annual Meeting of Stockholders. ITEM 11. COMPENSATION OF OFFICERS AND DIRECTORS This information is incorporated by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on a review of the copies of such forms furnished to the Company and written representationsreference from the executive officers and directors, the Company believes that all Section 16(a) filing requirements applicable to its executive officers, directors and greater than ten percent (10%) beneficial owners were complied with for Fiscal 1997, except for the following filed by Harold P. Capozzi: (i) one late Form 4 reporting one sale transaction, which Form 4 inadvertently under reported the number of shares beneficially owned; and (ii) Mr. Capozzi inadvertently over reported the number of options he beneficially owned in a timely filed Form 4. BACKGROUND The following is a brief account of the business experience of each director and executive officer: ROBERT I. RUDKO, PH.D. Dr. Rudko has served as Chairman of the Company since April 1992, President of the Company from April 1992 until October 1993, Chief Scientist of the Company since October 1993 and President of Laser Engineering, Inc. (now known as PLC Medical Systems, Inc. "PLC Medical"), a wholly owned subsidiary of the Company, since 1981. Dr. Rudko has 26 years of experience in the analysis, design, development, and manufacture of lasers and surgical laser systems. Prior to founding PLC Medical in 1981, Dr. Rudko was employed by the Research Division of Raytheon Company, a publicly traded defense contractor, from 1967 to 1981, first as a Senior Research Scientist and then as Principal Research Scientist. Dr. Rudko received his Ph.D. degree in electrical engineering from Cornell University. WILLIAM C. DOW. Mr. Dow has served as the President, Chief Executive Officer and director of the Company since August 1997. Prior to joining the Company, from 1993 to 1997, Mr. Dow served as President and Chief Executive Officer of Deknatel Snowden Pencer Worldwide, Inc., a $100 million medical device manufacturer. Deknatel Snowden Pencer Worldwide, Inc., became a manufacturing and marketing subsidiary of Genzyme Corporation in 1996. Mr. Dow has over 25 years of broad based experience in the medical device and service industry having held various positions in sales, marketing, distribution and general management with Griffith Micro Science, Kendall, Terumo and American Hospital Supply. Mr. Dow is a graduate of the United States Navel Academy with a Bachelor of Science in Engineering and served as both a pilot and a Supply Corps officer in the U.S. Navy. EDWARD H. PENDERGAST. Mr. Pendergast was a director of PLC Medical from its incorporation in 1981 until 1992. Mr. Pendergast has served as a director of PLC Systems Inc. since September 1992 and as its Lead Outside Director since March 1995. Mr. Pendergast is the President of Pendergast & Company, a privately held management consulting firm. Mr. Pendergast also serves as Chairman of the Board of Formware Corporation, a privately held software company. From 1984 to 1989, Mr. Pendergast served as the Chairman of Kennedy & Lehan, a public accounting firm. Mr. Pendergast also serves as a member of the Board of Directors of several other private companies. Mr. Pendergast is a Certified Public Accountant and the former President of the Massachusetts Society of Certified Public Accountants. HAROLD P. CAPOZZI. Mr. Capozzi has served as a director of the Company since 1991. For approximately the last 25 years through the present, Mr. Capozzi has acted in various managerial and operational capacities for several family-owned businesses. These businesses, Capozzi Enterprises, Ltd., Pasadena Investments, Ltd. and Catalina Properties Ltd., operate primarily in the real estate and real estate leasing markets and are privately held. He served seven years as a member of the Legislative Assembly for the Province of British Columbia and was a founding director of McDonald's Canada Ltd. and Expo '86. From 1987 to 1991, Mr. Capozzi was a director for Pineridge Capital Group Inc., a publicly traded venture capital company. Mr. Capozzi is currently a director of Richland Mines Inc. and Knightsbridge Corporation, both publicly traded companies. 26 28 Resources Ltd., a publicly traded mining company. He has also served as a director for Comac Food Group Inc., from 1991 to 1993. He has been a director of Richland Mines Inc., a publicly traded company, since 1993. KENNETH J. PULKONIK. Mr. Pulkonik has served as a director of the Company since 1992. Mr. Pulkonik has served as President and Chairman of the Board of Rush Electronics Ltd. of Ontario, Canada, a privately held business, since 1983. Mr. Pulkonik has also served as the Chairman of the Board for Rush Corporation, the United States subsidiary of Rush Electronics Ltd., a privately held company, since 1987. In 1971, Mr. Pulkonik co-founded Rush Industries, Inc., a privately held industrial distributor to the electronics industry in the New England area. ROBERTS A. SMITH, PH.D. Dr. Smith has served as a director of the Company since January 1993. From 1980 to 1986 and from 1988 to 1994, Dr. Smith has been the President of Viratek, Inc., a pharmaceutical development company. He was the Vice President of SPI Pharmaceuticals, a pharmaceutical marketing company from 1990 to 1992, and from 1985 to 1988, Dr. Smith was the Vice President and a director of the Nucleic Acid Research Institute. Dr. Smith has been the Vice Chairman since 1992 and a founding director since 1959 of ICN Pharmaceuticals, Inc. From 1958 to 1987, Dr. Smith was a full Professor and from 1987 to the present, Dr. Smith has been a Professor Emeritus, at the University of California, Los Angeles where he instructs in biochemistry. H. B. BRENT NORTON, M.D. Dr. Norton has served as a director of the Company since June 1994. He has served since 1991 as the President of IMI International Medical Innovations Inc. formerly IMI Diagnatech Inc., a publicly held biotechnology commercialization company. Additionally, since 1990, he has owned and been the President of the Ontario Workers Health Clinic, a privately held health assessment company. From 1990 to 1993, Dr. Norton was an associate at the Institute for Sport Medicine and Human Performance, a privately held provider of medical care to athletes. From 1989 to 1990, Dr. Norton served as the consultant Medical Director of Mueller Medical International Inc., a publicly traded medical technology company. Dr. Norton received his degree as a Doctor of Medicine from McGill University and a Master of Business Administration degree from the University of Western Ontario. PATRICIA L. MURPHY. Ms. Murphy has served as the Company's Chief Financial Officer and Treasurer since May 1992 and as PLC Medical's Corporate Controller since December 1991. Prior to joining the Company, she was Assistant Corporate Controller of Town & Country Corporation from 1989 to December 1991, a publicly traded jewelry manufacturer, and Corporate Controller at Bytex Corporation, a publicly traded manufacturer of computer network switching devices, from 1983 to 1989. Ms. Murphy has also worked in public accounting at Coopers & Lybrand LLP and is a Certified Public Accountant. KEY EMPLOYEES The significant employees of the Company, their ages and positions in the Company are as follows as of March 23, 1998:
NAME AGE POSITION - ---- --- -------- Stephen J. Linhares................ 41 Vice President of Research and Development and Clinical Trials -- PLC Medical John R. Serino..................... 50 Vice President of Sales and Marketing -- PLC Medical Jennifer T. Miller................. 31 General Counsel Vincent C. Puglisi................. 49 Vice President of Corporate Sales -- PLC Medical Paul A. Levesque................... 50 Vice President of Marketing and New Business Development -- PLC Medical
The following is a brief account of the business experience of each officer and key employee of the Company: STEPHEN J. LINHARES. Mr. Linhares has served as PLC Medical's Vice President of Research and Development and Clinical Trials since January 1996. Mr. Linhares was PLC Medical's Director of Engineering from 1987 to 1995. He joined PLC Medical in 1983 as an engineer and was subsequently 27 29 appointed Operations Manager in 1985 and Director of Engineering in 1987. His responsibilities currently include managing all aspects of PLC Medical's product research and development as well as clinical affairs. Prior to joining PLC Medical, he was employed in the Research Division of Raytheon Company, a publicly traded defense contractor, as an Associate Scientist from 1979 to 1983. JOHN R. SERINO. Mr. Serino has served as PLC Medical's Vice President of Global Sales since December 1997 and as PLC Medical's Vice President of Sales and Marketing since December 1995. From 1994 to 1995, Mr. Serino was the President of Paradigm Medical, Inc., a medical consulting company. From 1989 to 1994, Mr. Serino served as Vice President of Marketing at Medtronic Cardiopulmonary, a manufacturer of instruments used in open heart surgery. From 1976 to 1989, Mr. Serino held various positions at Shiley, Inc., a division of Pfizer Hospital, which manufactured and marketed specialty medical products for use in cardiovascular and respiratory care. JENNIFER T. MILLER. Ms. Miller has served as General Counsel since September 1997. From 1991 to 1997, Ms. Miller was an attorney with the firm of Fish & Richardson P.C. Ms. Miller is a magna cum laude graduate of Tufts University, where she was awarded a Fulbright Scholarship. Ms. Miller received her law degree from Harvard Law School. VINCENT C. PUGLISI. Mr. Puglisi has served as PLC Medical's Vice President of Corporate Sales since December 1997. His responsibilities include managing PLC Medical's reimbursement, national account and managed care initiatives. From 1984 to 1997, he was President of Medrep, an independent manufacturers' representative for several medical supply and equipment companies. Prior to founding Medrep in 1984, Mr. Puglisi served as Vice President, Marketing and Sales for Professional Disposables, Inc. beginning in 1980. He began his career in healthcare with American Hospital Supply in 1975 and held several positions there until 1980. Mr. Puglisi attended the U.S. Air Force Academy and served as a Captain in the USAF until 1975. PAUL A. LEVESQUE. Mr. Levesque has served as PLC Medical's Vice President of Marketing and Business Development since February 1998. Prior to joining PLC Medical, Mr. Levesque was Vice President of Marketing and Sales for Corometrics Medical System, a division of American Home Products. From 1984 to 1991, Mr. Levesque held senior marketing positions at General Electric Medical Systems and Zoll Medical. In addition, Mr. Levesque has over 11 years experience at Hewlett Packard, medical products group, where he served in various professional sales and marketing positions. ITEM 11. EXECUTIVE COMPENSATION During Fiscal 1997, the aggregate cash compensation paid or payable to the Company's executive officers was approximately $1,285,442 which includes severance payments to Mr. Hibbs of $161,404. 28 30 The following table sets forth the compensation paid to the Company's President and Chief Executive Officer and each of the four other most highly compensated persons who were serving as executive officers of the Company as of December 31, 1997 (collectively the "named executive officers") with respect to services rendered to the Company during Fiscal 1997, Fiscal 1996 and Fiscal 1995. SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ANNUAL COMPENSATION AWARDS ----------------------------------------------- ------------ (A) (B) (C) (D) (E) (G) (I) SECURITIES UNDERLYING OTHER ANNUAL OPTIONS ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(3) (#) COMPENSATION - --------------------------- ---- -------- ------- --------------- ------------ ------------ Robert I. Rudko, Ph.D.... 1997 $192,500(1) $48,000(1) $28,875 0 $ 0 Chairman of the 1996 $192,500(1) $38,500(1) $28,875 0 $ 0 Board and 1995 $175,000(1) $84,000(1) $26,250 100,000 $ 0 Chief Scientist William C. Dow........... 1997(5) $116,538(2) $50,000(2) $17,481 660,000 $ 0 President, Chief Executive Officer and Director M. Lee Hibbs............. 1997 $215,000(4) $ 0 $35,794(4) 0 $161,404(4) Former President, 1996 $215,000 $43,000 $32,250 25,000 $ 23,540 Chief Executive........ 1995 $195,000 $113,600 $29,250 100,000 $ 13,170 Officer and Director Patricia L. Murphy....... 1997 $127,000 $12,700 $19,050 0 $ 0 Chief Financial 1996 $115,000 $23,000 $17,250 10,000 $ 0 Officer and Treasurer 1995 $100,000 $15,000 $15,000 55,000 $ 0 Stephen J. Linhares...... 1997 $100,000 $ 6,000 $ 6,000 0 $ 0 PLC Medical's 1996(5) $ 77,012 $11,500 $ 6,000 5,000 $ 0 Vice President of R&D and Clinical Affairs John R. Serino........... 1997 $135,000 $ 8,100 $ 6,000 0 $ 0 PLC Medical's 1996 $125,000 $31,250 $ 6,000 50,000 $ 10,390 Vice President of 1995(5) $ 4,800 $ 0 $ 0 0 $ 0 Global Sales
- --------------- (1) Amounts shown indicate annual cash compensation earned and received by Dr. Rudko, Mr. Dow, Mr. Hibbs, Ms. Murphy, Mr. Linhares and Mr. Serino. Executive officers, including Dr. Rudko, Mr. Dow, Ms. Murphy, Mr. Linhares and Mr. Serino participate in the Company's group life, health and long-term disability insurance, at generally the same benefit levels as are available to all of the Company's full time employees. Effective in September 1994, the Compensation Committee recommended and the Board of Directors approved an employment agreement which provided for a base salary of $175,000 for Dr. Rudko and benefits,Proxy Statement to be selected by him equal to 15% of his base salary. This agreement was automatically renewed for one year on January 1, 1998, provides for annual reviews of salary increases and bonus plans by the Board of Directors for each fiscal year beginning January 1, 1996. Effective January 1, 1996, the base salary of Dr. Rudko increased from $175,000 to $192,500. No salary increase was provided for Dr. Rudko for fiscal 1997. This agreement also provides that Dr. Rudko may receive a bonus, commencingfiled with Fiscal 1995, of a sliding scale based upon the Company achieving a certain percentage of its annual plan for sales and placements of the Heart Laser, provided that the Company must achieve at least 70% of plan for the bonus to be paid. If the Company achieves at least 70% of its plan, the executive will receive 28% of his base salary as a bonus. If the Company achieves 100% of its plan the officer will receive 40% of his base salary. The bonus available provides for linear increases such that the maximum bonus the officer may receive is 120% of base salary if the Company achieves 190% of 29 31 its plan. Pursuant to the terms of this agreement bonuses in the amounts of $38,500 and $84,000 were paid to Dr. Rudko for Fiscal 1996 and 1995, respectively. In Fiscal 1997, the Compensation Committee approved a $23,000 bonus for Dr. Rudko for acting as Interim President of the Company as well as a $25,000 annual bonus. (2) Effective August 15, 1997, the Compensation Committee recommended and the Board of Directors approved an employment agreement through August 31, 2000, for Mr. Dow which provided for a base salary of $300,000 per annum through December 31, 1998. Increases for future years shall be established by the Board of Directors. This agreement also provided that Mr. Dow may receive a yearly incentive bonus, commencing with a guaranteed bonus of $50,000 for Fiscal 1997, followed by an incentive bonus commencing in Fiscal 1998, of a sliding scale based upon the Company achieving a certain percentage of its annual plan for sales and placements of the Heart Laser, revenue, operating results and other strategic goals equal to or at least 70% of the performance plan as approved by the Board of Directors. The incentive bonus will range from 70% to 120% of 50% of Mr. Dow's then base salary for the fiscal year. Pursuant to this agreement, a bonus of $50,000 was paid for Fiscal 1997. (3) In Fiscal 1995, the Compensation Committee approved a benefit allowance of up to 15% of base salary for Dr. Rudko and Mr. Hibbs. Ms. Murphy was also given the same benefit allowance starting in Fiscal 1995. In August 1997, a 15% benefit allowance was approved as part of Mr. Dow's employment agreement. The determination of such benefits is up to the individual. In Fiscal 1997 and 1996 Mr. Serino received a $500 per month compensatory car allowance. Mr. Linhares received the same allowance in 1997. (4) On April 18, 1997, Mr. Hibbs and the Company entered into a severance agreement and release (the "Agreement"). Pursuant to the terms of the Agreement, Mr. Hibbs agreed to resign as Chief Executive Officer of the Corporation on July 31, 1997. Mr. Hibbs continued to receive his annual base salary of $215,000 through December 31, 1997 as an employee of the Corporation. Mr. Hibbs received his accrued and unpaid 15% benefit allowance of $11,151 and accrued and unpaid vacation of $24,643 which is reflected in the "Other Annual Compensation" column. He also received an additional 15% annual benefit allowance of $32,250 and $20,000 in professional expenses as part of his severance. From January 1, 1998 through April 18, 1998, he will receive severance pay at the rate of $215,000 per annum which will total $66,154. In addition, pursuant to the terms of his employment agreement, he is entitled to receive $43,000 payable in twelve (12) equal monthly installments which commenced on August 1, 1997. (5) Mr. Dow joined the Company in August 1997 and Mr. Serino joined PLC Medical in December 1995. Mr. Linhares became PLC Medical's Vice President of Research and Development and Clinical Trials in January 1996. Except for the Agreement with Mr. Hibbs, the Company has no plans other than as set out herein pursuant to which cash or non-cash compensation was paid or distributed to the executive officers during Fiscal 1997 or is proposed to be paid or distributed in a subsequent year. No other compensation was paid by the Company to the executive officers during Fiscal 1997, including personal benefits and securities or property paid or distributed other than pursuant to a formal plan which compensation is not offered on the same terms to all full time employees, except as noted above. 30 32 The following table sets forth the options granted to the named executive officers in Fiscal 1997. OPTION GRANTS IN FISCAL YEAR 1997
POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF STOCK PRICE APPRECIATION INDIVIDUAL GRANTS FOR OPTION TERM(5) -------------------------------------------------------- ------------------------- (A) (B) (D) (E) (F) (G) NUMBER OF (C) SECURITIES % OF TOTAL UNDERLYING OPTIONS GRANTED EXERCISE OR OPTIONS TO EMPLOYEES IN BASE PRICE EXPIRATION NAME GRANTED(#) FISCAL YEAR(3) ($/SH) DATE(4) 5% 10% ---- ----------- --------------- ----------- ---------- ---------- ----------- William C. Dow....... 644,466(1) 74% $12.88 08/15/2007 $5,218,253 $13,224,078 William C. Dow....... 15,534(2) 2% $12.88 08/15/2007 $ 125,828 $ 318,873
- --------------- (1) These non-qualified options were granted on August 15, 1997 with 99,466 of the options vesting over time as follows: 20,983 on August 15, 1997, 20,983 on December 1, 1997, 28,750 on March 1, 1998 and 28,750 on June 1, 1998. The remaining 545,000 vest on performance criteria as follows: (i) 115,000 vest on the earlier of August 15, 2000 or receipt of PMA from the FDA, (ii)115,000 vest on the earlier of August 15, 2000 or release of audited financial statements reporting positive earnings after taxes, (iii) 115,000 vest on the earlier of August 15, 2000 or the 30th consecutive day when the Company's closing price for its Common Stock exceeds $15.00 per share, (iv) 50,000 vest on the earlier of August 15, 2002 or the 30th consecutive day when the Company's closing price for its Common Stock exceeds $18.00 per share, (v) 50,000 vest on the earlier of August 15, 2002 or the 30th consecutive day when the Company's closing price for its Common Stock exceeds $21.50 per share, (vi) 50,000 vest on the earlier of August 15, 2002 or the 30th consecutive day when the Company's closing price for its Common Stock exceeds $35.00 per share, and (vii) 50,000 vest on the earlier of August 15, 2002 or the 30th consecutive day when the Company's closing price for its Common Stock exceeds $40.00 per share. All options vest upon a sale or acquisition of substantially all of the stock or assets of the Company. (2) These incentive stock options were granted on August 15, 1997 and vest as follows; 7,767 vested on August 15, 1997 and 7,767 vest on January 1, 1998. (3) In Fiscal 1997, options to purchase 872,500 shares of Common Stock were granted to Company employees, including executive officers. (4) The options are subject to earlier termination upon certain events related to termination of employment. (5) Amounts for the named executives shown in these columns have been derived by multiplying (i) the difference between (a) the product of the per share market price at the time of the grant and the sum of 1 plus the adjusted stock price appreciation rate (the assumed rate of appreciation compounded annually over the term of the option) and (b) the per share exercise price of the option; and (ii) the number of securities underlying the option. The dollar gains under these columns result from calculations assuming hypothetical growth rates as set by the Securities and Exchange Commission and are not intended to forecast possible future price appreciation, if any, ofin connection with the Company's Common Stock. 31 33 The following table indicates the options that were exercised in Fiscal 1997 and sets forth the value1999 Annual Meeting of outstanding options held by the named executive officers of the Company during the year ended December 31, 1997. AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1997 AND FY-END OPTION VALUES
(A) (B) (C) (D) (E) NUMBER OF SECURITIES VALUE OF UNDERLYING UNEXERCISED UNEXERCISED IN-THE-MONEY SHARES OPTIONS AT FY-END OPTIONS AT FY-END ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/ NAME ON EXERCISE REALIZED($) UNEXERCISABLE UNEXERCISABLE(1)(2) - -------------------------------- ------- ---------- --------------- ---------------- Robert I. Rudko, Ph.D. ......... 0 0 172,900/200,000 $643,960/$718,750 William C. Dow.................. 0 0 49,733/610,267 $0/$0 M. Lee Hibbs.................... 375,000 $3,130,461(3) 0/0 $0/$0 Patricia L. Murphy.............. 0 0 83,755/6,666 $306,410/$0 John R. Serino.................. 0 0 16,667/33,333 $0/$0 Stephen J. Linhares............. 0 0 14,960/7,500 $8,910/$0
- --------------- (1) In-the-Money options are those options for which the fair market value of the underlying Common Stock is greater than the exercise prices of the option. (2) The value of unexercised options is determined by multiplying the number of options held by the difference between the fair market value of the Common Stock underlying the options at the end of Fiscal 1997 ($7.59 per share as determined by the average of the high and low sale prices of the Common Stock as reported by the American Stock Exchange on December 31, 1997) and the exercise price of the options granted. Since the fair market value at the end of Fiscal 1997 was less than the exercise price of certain options held, the following options were not included in the In the Money table; Mr. Dow: 660,000 options, Ms. Murphy: 10,000 options (3,334 exercisable and 6,666 unexercisable), Mr. Serino: 50,000 options and Mr. Linhares: 20,000 options (12,500 exercisable and 7,500 unexercisable). (3) The value realized is calculated by determining the difference between the fair market value of the Common Stock acquired at exercise and the exercise price. COMPENSATION OF DIRECTORS Each of the non-employee directors receives a fee of $650 for each meeting of the Board of Directors plus reimbursement for related travel expenses. Each of the non-employee directors receives an additional $2,000 per quarter. Eligible directors also received an aggregate of 240,000 stock options through 1996 pursuant to the Company's 1993 Formula Stock Option Plan. In June 1997, an aggregate of 70,000 stock options were granted to the non-employee directors pursuant to the 1995 Stock Option Plan, except Mr. Capozzi. Mr. Capozzi's option to purchase 10,000 shares was granted pursuant to the 1993 Formula Plan which plan was extinguished with the grant of this option. See "Beneficial Ownership of Common Stock." In March 1995, Mr. Pendergast agreed to serve as the Lead Outside Director of the Company and effective January 17, 1997, he receives an additional $4,000 per quarter for his services as lead outside director in addition to the fees and expenses referenced above. Mr. Pendergast may also receive $200 per hour for other consulting activities provided to the Company in excess of eight hours each month on a pre-approved basis by the Board of Directors. Mr. Pendergast was also granted an option on August 4, 1995 to purchase up to 10,000 shares of Common Stock at an exercise price of $12.56 per share through August 3, 2005, subject to certain requirements and his continued service as Lead Outside Director for the Company. See "Beneficial Ownership of Common Stock." The Company has no arrangements, pursuant to which directors were compensated for their services in their capacity as directors during Fiscal 1997 or thereafter, except as described above. 32 34 EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS The Company has arrangements with respect to compensation received or that may be received by the named executive officers to compensate such officers in the event of termination of employment (resignation, retirement, change in control) or in the event of a change in responsibilities following a change in control. An employment agreement was entered into in May 1992 between Dr. Rudko and the Company providing for payment of 24 months' base salary and prior bonus to Dr. Rudko. The agreement was amended in September 1994 to provide that in addition to the severance benefits discussed above, in the event of a sale or change of control in the Company, and if Dr. Rudko's employment is terminated without cause, or if Dr. Rudko is transferred outside of Eastern Massachusetts or if he has a significant reduction in responsibility with the Company, then he shall be entitled to receive 299% of his prior year's compensation (as determined by Section 280G of the Internal Revenue Code of 1986, as amended). In addition, this employment agreement, as modified, provides that if Dr. Rudko remains with the Company for one year after a sale or change of control in the Company, then he shall receive as a bonus an amount equal to 18 months of his then current base salary. An employment agreement was entered into in August 1997 between Mr. Dow and the Company providing for payment of Severance Benefits of 150% of his then current base salary, 150% of his incentive bonus earned in the Company's most recent fiscal year and any other benefits allowed under his benefit allowance. The agreement further provides, in the event of a sale or change of control in the Company, and if Mr. Dow's employment is terminated without cause, then he shall be entitled to receive 299% of his Severance Benefits. In addition, this employment agreement provides that if Mr. Dow remains with the Company for one year after a sale or change of control in the Company, then he shall receive as a bonus an amount equal to 100% of his then current base salary and incentive bonus paid during the preceding fiscal year and the fair market value of all other benefits then payable, irrespective of whether he thereafter actually terminates employment with the Company. In addition, the Company entered into an agreement with each of Ms. Murphy and Mr. Linhares in April 1996 that provide for a severance payment equal to 12 months' base salary if either Ms. Murphy or Mr. Linhares is terminated without cause. These agreements also provide that in the event of a sale or change of control in the Company, and if Ms. Murphy's or Mr. Linhares' employment is terminated without cause, or their base salary or Company-paid benefits are reduced, or if they are transferred outside of Eastern Massachusetts or if they have a significant reduction in responsibility with the Company, then they shall be entitled to receive 100% of their prior year's compensation. 33 35Stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of March 23, 1998, certainThis information concerning stock ownership of the Companyis incorporated by (i) each person who is known by the Company to own of record or beneficially more than five percent (5%) ofreference from the Company's Common Stock, (ii) each of the Company's directors and named executive officers and (iii) all current directors and executive officers as a group. Except as otherwise indicated, the stockholders listed in the table have sole voting and investment powersProxy Statement to be filed with respect to the shares indicated.
NUMBER OF SHARES PERCENTAGE NAME OF BENEFICIAL OWNER(1) BENEFICIALLY OWNED(2) OF CLASS --------------------------- --------------------- ---------- Robert I. Rudko, Ph.D.(3)................................... 1,294,762 6.8% William C. Dow(4)........................................... 115,000 * M. Lee Hibbs................................................ 339,000 * Edward H. Pendergast(5)(6)(7)(8)(9)......................... 123,092 * Harold P. Capozzi(6)(8)(10)(11)............................. 53,000 * Kenneth J. Pulkonik(5)(6)(8)(11)............................ 75,000 * Roberts A. Smith, Ph.D.(6)(8)(11)(12)....................... 55,000 * Brent H. B. Norton, M.D.(8)(11)(13)......................... 47,000 * Patricia L. Murphy(14)...................................... 122,381 * Stephen J. Linhares(15)..................................... 80,667 * John R. Serino(16).......................................... 21,667 * Scudder Kemper Investments, Inc.(17)........................ 961,000 5.1% All current directors and executive officers as a group (8 persons) (3)(4)(5)(6)(7)(8)(9)(10)(11)(12)(13)(14)........ 1,885,235 9.6%
- --------------- * Less than 1%. (1) Each of such persons, with the exception of Scudder Kemper Investments, Inc., may be reached through the Company at 10 Forge Park, Franklin, Massachusetts 02038. The address for Scudder Kemper Investments, Inc. is Two International Place, Boston, Massachusetts 02110. (2) Pursuant to the rules of the Securities and Exchange Commission shares of Common Stock which an individual or group has a right to acquire within 60 days pursuant to the exercise of options or warrants are deemed to be outstanding for the purpose of computing the percentage ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table. (3) The figures presented in the table include 100,000 shares of an option to purchase up to 300,000 shares of Common Stock through December 31, 1999 at a price of $4.00 per share, which option fully vests at December 31, 1999 or earlier upon receipt of PMA of the Heart Laser System from the FDA, except that all such options shall vest immediately in the event of a sale or acquisition of all or substantially all of the assets of the Company or the sale of all or substantially all ofconnection with the Company's stock to an acquiring party. The figures in this table also include an option granted on March 3, 1995 to purchase up to 72,900 shares1999 Annual Meeting of Common Stock at an exercise price of $3.69 per share which vested on December 2, 1997 and terminates on March 2, 2005. Also includes 94,762 shares of Common Stock held by Dr. Rudko's wife, but as to which Dr. Rudko disclaims any beneficial interest. Excludes 13,750 shares of Common Stock held by Dr. Rudko's adult children, as to which he disclaims any beneficial interest. (4) Includes (i) 15,534 shares of an option granted on August 15, 1997 at an exercise price of $12.88 per share which is fully vested and terminates on August 15, 2007 and (ii) 99,466 shares of an option to purchase up to 644,466 shares of Common Stock granted on August 15, 1997 at an exercise price of $12.88 per share which terminates on August 15, 2007. See "Option Grants in Fiscal Year 1997" for vesting details. (5) Includes an option granted on September 16, 1993 to purchase up to 30,000 shares of Common Stock at an exercise price of $4.00 per share through September 15, 2003 which is fully vested. 34 36 (6) Includes an option granted on June 19, 1995 to purchase up to 10,000 shares of Common Stock at an exercise price of $10.44 per share through June 18, 2005, which is fully vested. (7) Includes an option granted on August 4, 1995 to purchase up to 10,000 shares of Common Stock at an exercise price of $12.56 per share through August 3, 2005, which is fully vested. Excludes 1,000 shares of Common Stock owned by a trust established for the benefit of a child of Mr. Pendergast over which Mr. Pendergast has no control, and of which he disclaims any beneficial ownership. (8) Includes an option granted on June 17, 1996 to purchase up to 10,000 shares of Common Stock at an exercise price of $24.50 per share through June 16, 2006, which is fully vested. (9) Includes an option granted on June 30, 1997 to purchase up to 30,000 shares of Common Stock at an exercise price of $20.75 per share through June 30, 2007, which fully vests on April 1, 1998. (10) Includes 17,438 shares of Common Stock owned by Mr. Capozzi as well as an option granted on September 16, 1993 to purchase up to 5,562 shares of Common Stock at an exercise price of $4.00 per share through September 15, 2003, which is fully vested. (11) Includes an option granted on June 30, 1997 to purchase up to 10,000 shares of Common Stock at an exercise price of $20.75 per share through June 30, 2007, which fully vests on April 1, 1998. (12) Includes an option granted on September 16, 1993 to purchase up to 25,000 shares of Common Stock at an exercise price of $4.00 per share through September 15, 2003, which is fully vested. (13) Includes an option granted on June 9, 1994 to purchase up to 27,000 shares of Common Stock at an exercise price of $4.63 per share through June 9, 2004, which is fully vested. (14) Includes (i) 35,293 shares of Common Stock; (ii) 13,571 shares of an option granted on July 28, 1994 at an exercise price of $3.97, which is fully vested and terminates on January 5, 2004; (iii) 13,333 shares of an option granted on July 28, 1994 at an exercise price of $3.97 per share, which is fully vested and terminates on July 27, 2004; (iv) 53,517 shares of an option granted on March 3, 1995 at an exercise price of $3.69 per share, which is fully vested and terminates on March 2, 2005 and (v) 6,667 shares of an option to purchase up to 10,000 shares of Common Stock granted on January 2, 1996 at an exercise price of $16.31 per share, which vests on January 2, 1999 and terminates on January 1, 2006. (15) Includes (i) 59,040 shares of Common Stock, (ii) 2,460 shares of an option granted on July 28, 1994 at an exercise of $3.97 per share, which is fully vested and terminates on December 31, 2003; (iii) 10,000 shares of an option to purchase up to 15,000 shares of Common Stock granted on August 4, 1995 at an exercise price of $12.56 per share, which vests on August 4, 1998 and terminates on August 3, 2005; (iv) 2,500 shares of an option to purchase up to 5,000 shares of Common Stock granted on July 17, 1996 at an exercise price of $14.88, which vests on the earlier of August 1, 2001 or upon receipt of the PMA from the FDA and terminates on July 16, 2006 and (v) 6,667 shares of an option to purchase up to 20,000 shares of Common Stock granted on January 16, 1998 at an exercise price of $8.88 per share, such option vests in equal installments over three years beginning April 23, 1998 and terminates on April 22, 2008. (16) Includes (i) 16,667 shares of an option to purchase up to 50,000 shares of Common Stock granted on January 2, 1996 at an exercise price of $16.31 per share, such option vests in equal installments over three years beginning on January 2, 1997 and terminates on January 1, 2006; and (ii) 5,000 shares of an option to purchase up to 25,000 shares of Common Stock granted on January 16, 1998 at an exercise price of $8.88 per share, such option vests 15,000 shares in equal installments over three years beginning April 23, 1998 with the remaining 10,000 vesting on the earlier of April 23, 2000 or on the following performance criteria: 1,000 shares for each Heart Laser sold in Fiscal 1998. Such option terminates on April 22, 2008. (17) Based solely on a Schedule 13G filed in February 1998 by Scudder Kemper Investments, Inc. ("Scudder"). Scudder has sole voting power as to 358,700 shares and shared voting power as to 374,600 shares. Scudder has sole dispositive power as to all 961,000 shares. 35 37Stockholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS During Fiscal 1991,This information is incorporated by reference from the Corporation loaned Corhart Management Group, Inc. ("Corhart")Company's Proxy Statement to be filed with the sumSecurities and Exchange Commission in connection with the Company's 1999 Annual Meeting of $126,061 on a demand basis. Corhart provided office and administrative services for the Corporation's Vancouver office. Corhart then loaned a portion of the $126,061 to Dr. Rudko, the Corporation's Chairman of the Board and Chief Scientist. The balance of the loan to Dr. Rudko plus accrued interest is approximately $85,000. The loan currently bears interest at 8.65%. No insider of the Company and no associate or affiliate of the foregoing persons has or has had any material interest, direct or indirect, in any transaction since the commencement of Fiscal 1997 or in any proposed transaction which in either such case has materially affected or will materially affect the Company, except as described above. The Company believes that the aforementioned transactions were on terms as favorable as could have been obtained from independent third parties, and that any future transaction by the Company with its officers, directors or principal stockholders will be on terms no less favorable than could be obtained from independent third parties and will be subject to approval by a majority of the independent directors.Stockholders. 31 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a)(1) Financial Statements.FINANCIAL STATEMENTS. The financial statements required to be filed by Item 8 herewith are as follows:
PLC SYSTEMS INC. PAGE ----------------Page ---- Report of Independent Auditors..............................Auditors. . . . . . . . . . . . . . . . . . . F-2 Consolidated Balance Sheets as of December 31, 1998 and 1997 and 1996....................................................... . . F-3 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 1996 and 1995..........................1996. . . . . . . . . . . . . . . . . F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 1996 and 1995..............1996. . . . . . . . . . . . . . . . . F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 1996 and 1995..........................1996. . . . . . . . . . . . . . . . . F-6 Notes to Consolidated Financial Statements..................Statements. . . . . . . . . . . . . F-7
(a)(2) Financial Statement Schedules.FINANCIAL STATEMENT SCHEDULES. The following financial statement schedules are filed herewith: Schedule II Valuation and Qualifying Accounts..............Schedule II Valuation and Qualifying Accounts S-1
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. (a)(3) Exhibits. 36 38 (i) The following exhibits, required by Item 601 of Regulation S-K, are filed herewith:EXHIBITS. EXHIBIT INDEX
EXHIBIT NO. TITLE ------- ------------------------------------------------------------NUMBER DESCRIPTION OF DOCUMENT - ------ ----------------------- 21 Subsidiaries3.1 Certificate of Incorporation, incorporated by reference to the Registrant,Registrant's registration statement on Form S-1 (SEC File No. 33-48340) and amendments thereto, as amended. 23 Consentpreviously filed with the Securities and Exchange Commission. 3.2 Articles of Ernst & Young LLP. 27a Financial DataContinuance, pursuant to the Yukon Business Corporations Act, incorporated by reference to the Registrant's Definitive Proxy Statement on Schedule for fiscal year ended December 31, 1997. 27b Restated Financial Data Schedule for14A dated May 26, 1998, as previously filed with the quarter ended September 30, 1997. 27c Restated Financial Data Schedule forSecurities and Exchange Commission. 3.3 Memorandum and Articles (Bylaws), incorporated by reference to the quarter ended June 30, 1997. 27d Restated Financial Data Schedule forRegistrant's registration statement on Form S-1 (SEC File No. 33-48340) and amendments thereto, as previously filed with the quarter ended March 31, 1997. 27e Restated Financial Data Schedule forSecurities and Exchange Commission. 3.4 Amendment to Memorandum and Articles (Bylaws), incorporated by reference to the quarter ended December 31, 1996. 27f Restated Financial Data Schedule forRegistrant's registration statement on Form S-1 (SEC File No. 33-48340) and amendments thereto, as previously filed with the quarter ended September 30, 1996. 27g Restated Financial Data Schedule for the quarter ended June 30, 1996. 27h Restated Financial Data Schedule for the quarter ended March 31, 1996.
(ii) The following exhibits were filed as part of the Company's Report on Form 10-Q for the quarter ended September 30, 1997, filed with the Commission on November 14, 1997 and are herein incorporated by reference:
EXHIBIT NO. TITLE ------- ------------------------------------------------------------ 10a**Securities and Exchange Commission. 4.1 Form of Key Employment Agreement of William C. Dow. 10b** 1997 ExecutiveCommon Stock Certificate, incorporated by reference to the Registrant's registration statement on Form S-1 (SEC File No. 33-48340) and amendments thereto, as previously filed with the Securities and Exchange Commission. 10.1 1992 Stock Option Plan.
(iii) The following exhibits were filed as part of the Company's Report on Form 10-Q for the quarter ended June 30, 1997, filed with the Commission on August 14, 1997 and are herein incorporated by reference:
EXHIBIT NO. TITLE ------- ------------------------------------------------------------ 10a Convertible Debenture Agreement. 10b First AmendmentPlan, incorporated by reference to Convertible Debenture Agreement. 10c Second Amendmentthe Registrant's registration statement on Form S-1 (SEC File No. 33-48340) and amendments thereto, as previously filed with the Securities and Exchange Commission. 10.2 1993 Stock Option Plan, incorporated by reference to Convertible Debenture Agreement. 10dthe Registrant's registration statement on Form of Convertible Denbenture. 10eS-1 (SEC File No. 33-58258) and amendments thereto, as previously filed with the 32 Securities and Exchange Commission. 10.3 1993 Formula Stock Option Plan, incorporated by reference to the Registrant's registration statement on Form of Redeemable Warrant. 10f Registration Rights Agreement.
(iv) The following exhibits were filed as part of the Company's Annual Report on Form 10-K for the year ended December 31, 1994 as filed with the Commission on March 31, 1995 and are herein incorporated by reference:
EXHIBIT NO. TITLE ------- ------------------------------------------------------------ 10a**S-1 (SEC File No. 33-58258) and amendments thereto, as previously filed with the Securities and Exchange Commission. 10.4 Revised Form of Key Employee Agreement for Dr. Robert I. Rudko. 10b**Rudko, incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.5 1995 Stock Option Plan.
37 39 (v) The following exhibits were filed as part of the Company's Form S-1 Registration Statement (33-58258) declared effective by the Commission on November 5, 1993 and are herein incorporated by reference:
EXHIBIT NO. TITLE ------- ------------------------------------------------------------ 10a** 1993Plan, incorporated by reference to the Registrant's Registration Statement on Form S-8 (SEC File No. 33-95168), as previously filed with the Securities and Exchange Commission. 10.6 Convertible Debenture Agreement, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.7 First Amendment to Convertible Debenture Agreement, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.8 Second Amendment to Convertible Debenture Agreement, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.9 Form of Convertible Debenture, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.10 Form of Redeemable Warrant, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.11 Registration Rights Agreement, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.12 Form of Key Employment Agreement for William C. Dow, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.13 1997 Executive Stock Option Plan. 10b 1993 FormulaPlan, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (SEC File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.14 Convertible Debenture Purchase Agreement dated as of April 23, 1998 between Southbrook International Investment, Ltd., Brown Simpson Strategic Growth Fund, L.P. and Brown Simpson Strategic Growth Fund, Ltd. and the Registrant, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the Quarter ended March 31, 1998 (File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.15 Form of Convertible Debenture, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the Quarter ended March 31, 1998 (File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.16 Form of Redeemable Warrant, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the Quarter ended March 31, 1998 (File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.17 Registration Rights Agreement dated as of April 23, 1998 between Southbrook International Investment, Ltd., Brown Simpson Strategic Growth Fund, L.P. and Brown Simpson Strategic Growth Fund, Ltd. and the Registrant, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the Quarter ended March 31, 1998 (File 33 No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.18 Key Employee Agreement of Robert Svikhart, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the Quarter ended June 30, 1998 (File No. 1-11388), as previously filed with the Securities and Exchange Commission. 10.19 Form of Common Stock Option Plan.Purchase Agreement, incorporated by reference to the Registrant's Current Report on Form 8-K dated March 12, 1999 (File No. 1-11388), as previously filed with the Securities and Exchange Commission. 21.1 * Subsidiaries of the Registrant. 23.1 * Consent of Ernst & Young LLP. 27.1 * Financial Data Schedule. * Filed with this Annual Report on Form 10-K for the fiscal year ended December 31, 1998.
(vi) The following exhibits were filed as part of the Company's Form S-1 Registration Statement (33-48340) declared effective by the Commission on September 17, 1992 and are incorporated herein by reference:
EXHIBIT NO. TITLE ------- ------------------------------------------------------------ 3a Certificate of Incorporation. 3b Articles. 4a Rights of security holders (included in Exhibits 3a and 3b). 4c Specimen Stock Certificate. 10g** 1992 Stock Option Plan.
- --------------- ** Management contracts or compensatory plan or arrangements required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of this report. (b) Reports on FormREPORTS ON FORM 8-K. No reports on Form 8-K were filed during the last quarter of the period covered by this report. (c) Exhibits.EXHIBITS. The Company hereby files as part of this Form 10-K the exhibits listed in Item 14(a)(3) as set forth above. (d) Financial Statement Schedules.FINANCIAL STATEMENT SCHEDULES. See Item 14(a)(2) above. 3834 40 SIGNATURES Pursuant to the requirements of SectionPURSUANT TO THE REQUIREMENTS OF SECTION 13 or 15(d) of the Securities Exchange Act ofOR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. PLC SYSTEMS INC. Date: March 31, 19981999 By: /s/ WILLIAMWilliam C. DOW ------------------------------------Dow --------------------------------------- William C. Dow President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act ofPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, this Report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated.THIS REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED.
NAME CAPACITY DATEName Capacity Date ---- -------- ---- /s/ WILLIAM C. DOW President and Chief ExecutiveEdward H. Pendergast Chairman of the Board of Directors March 31, 19981999 - --------------------------------------------------- Officer------------------------------- (Principal Executive William C. Dow Officer) Edward H. Pendergast /s/ PATRICIA L. MURPHYRobert Svikhart Chief Financial Officer March 31, 19981999 - ---------------------------------------------------------------------------------- (Principal Financial and Patricia L. Murphy Accounting Robert Svikhart Officer) /s/ ROBERT I. RUDKO, PH.D. Chairman of the Board ofWilliam C. Dow President and Chief Executive Officer March 31, 19981999 - --------------------------------------------------- Directors------------------------------- William C. Dow /s/ Harold P. Capozzi Director March 31, 1999 - ------------------------------- Harold P. Capozzi /s/ H.B. Brent Norton, M.D. Director March 31, 1999 - ------------------------------- H.B. Brent Norton, M.D. /s/ Kenneth J. Pulkonik Director March 31, 1999 - ------------------------------- Kenneth J. Pulkonik /s/ Robert I. Rudko, Ph.D. Director March 31, 1999 - ------------------------------- Robert I. Rudko, Ph.D. /s/ HAROLD P. CAPOZZIRoberts A. Smith, Ph.D. Director March 31, 19981999 - --------------------------------------------------- Harold P. Capozzi /s/ H.B. BRENT NORTON, M.D. Director March 31, 1998 - --------------------------------------------------- H.B. Brent Norton, M.D. /s/ EDWARD H. PENDERGAST Director March 31, 1998 - --------------------------------------------------- Edward H. Pendergast /s/ KENNETH J. PULKONIK Director March 31, 1998 - --------------------------------------------------- Kenneth J. Pulkonik /s/ ROBERTS A. SMITH, PH.D. Director March 31, 1998 - ---------------------------------------------------------------------------------- Roberts A. Smith, Ph.D.
3935 41 PLC SYSTEMS INC. CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 1998, 1997, 1996 1995 40 42 PLC SYSTEMS INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGEPage ---- Report of Independent Auditors..............................Auditors . . . . . . . . . . . . . . . . . . . . . F-2 Consolidated Balance Sheets as of December 31, 1998 and 1997 and 1996....................................................... . . . . . F-3 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 and 1995........................... . . . . . . . . . . . . . . . . . . . F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996 and 1995............... . . . . . . . . . . . . . . . . . . . F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 and 1995........................... . . . . . . . . . . . . . . . . . . . F-6 Notes to Consolidated Financial Statements..................Statements . . . . . . . . . . . . . . . F-7 Financial Statement Schedule: Schedule II --- Valuation and Qualifying Accounts..........Accounts. . . . . . . . . . . . S-1
F-1 43 REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders PLC Systems Inc. We have audited the accompanying consolidated balance sheets of PLC Systems Inc. as of December 31, 19971998 and 1996,1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the index at Item 14(a).1998. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. 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 consolidated financial position of PLC Systems Inc. at December 31, 19971998 and 1996,1997, and the consolidated results of its operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 19971998 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Ernst & Young LLP Boston, Massachusetts February 20, 199819, 1999 except for Note 11, as to which the date is March 4, 1999 F-2 44 PLC SYSTEMS INC. CONSOLIDATED BALANCE SHEETS DECEMBERDecember 31, 1998 and 1997 AND 1996
1998 1997 1996 -------- -------- (IN THOUSANDS)---- ---- (In thousands) ASSETS ASSETS Current assets: Cash and cash equivalents.................................equivalents $ 4,846 $ 3,484 $ 3,039 Marketable securities.....................................securities - 12,845 5,470 Accounts receivable, net..................................net 2,262 1,337 2,635 Inventories, net..........................................net 2,953 2,512 2,345 Prepaid expenses and other current assets.................assets 547 502 679 -------- --------------- ------- Total current assets..............................assets 10,608 20,680 14,168 Equipment, furniture and leasehold improvements, net........net 5,091 5,636 4,712 Other assets................................................assets 558 701 537 -------- --------------- ------- Total assets...................................... $ 27,017 $ 19,417 ======== ========assets $16,257 $27,017 ------- ------- ------- ------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable..........................................payable $ 986 $ 917 $ 867 Accrued clinical costs....................................costs 1,016 1,292 935 Accrued compensation......................................compensation 989 570 467 Accrued expenses..........................................expenses 1,127 923 304 Deferred revenue..........................................revenue 195 70 339 5% Convertible Debentures.................................Debentures due 2002 - 3,819 --Convertible Debentures due 2003 934 - Secured borrowings 240 - Other accrued liabilities.................................liabilities 72 296 11 -------- -------------- ------ Total current liabilities.........................liabilities 5,559 7,887 2,923 Capital lease obligations...................................obligations 37 121 27 Commitments and contingencies Stockholders' equity: Preferred stock, no par value, 5,000 shares authorized Common stock, no par value, 25,00050,000 shares authorized, 18,36819,740 and 16,51318,368 shares issued and outstanding in 1998 and 1997, and 1996, respectively.................................respectively 79,521 71,115 54,030 Accumulated deficit.........................................deficit (68,136) (51,533) (37,129) Foreign currency translation................................Accumulated other comprehensive loss (724) (573) (434) -------- --------------- ------- 10,661 19,009 16,467 -------- --------------- ------- Total liabilities and stockholders' equity........ $ 27,017 $ 19,417 ======== ========equity $16,257 $27,017 ------- ------- ------- -------
The accompanying notes are an intergalintegral part of the consolidated financial statements. F-3 45 PLC SYSTEMS INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBERFor The Years Ended December 31, 1998, 1997 and 1996 AND 1995
1998 1997 1996 1995 -------- ------- ------- (IN THOUSANDS)---- ---- ---- (In thousands, except per share data) Revenue: Product sales.............................................sales $ 3,088 $ 5,687 $ 9,082 $11,938 Placement and service fees................................fees 2,605 3,254 2,790 1,407 -------- ------- --------------- -------- Total revenues....................................revenues 5,693 8,941 11,872 13,345 Cost of revenues: Product sales.............................................sales 1,945 2,721 2,911 4,177 Placement and service fees................................fees 2,622 2,595 1,155 386 -------- ------- --------------- -------- Total cost of revenues............................revenues 4,567 5,316 4,066 4,563 -------- ------- --------------- -------- Gross Profit................................................Profit 1,126 3,625 7,806 8,782 Operating expenses: Selling, general and administrative.......................administrative 13,718 13,049 7,023 5,035 Research and development..................................development 4,468 5,158 2,835 2,246 -------- ------- --------------- -------- Total operating expenses..........................expenses 18,186 18,207 9,858 7,281 -------- ------- ------- Income (loss)-------- -------- Loss from operations...............................operations (17,060) (14,582) (2,052) 1,501 Other income, (expense), net.................................net 457 178 512 588 -------- ------- ------- Income (loss) before provision for income taxes............. (14,404)-------- -------- Net loss $(16,603) $(14,404) $ (1,540) 2,089 Provision for income taxes.................................. -- -- 85 -------- ------- --------------- -------- -------- -------- -------- Net income (loss)........................................... $(14,404) $(1,540) $ 2,004 Net income (loss)loss per share -- Basic........................- Basic $ (.86) $ (.84) $ (.09) $ .13 Net income (loss)loss per share -- Diluted......................- Diluted $ (.86) $ (.84) $ (.09) $ .12 Shares used to compute net income (loss)loss per share -- Basic..................................................- Basic 19,218 17,050 16,376 15,868 -- Diluted................................................- Diluted 19,218 17,050 16,376 16,590
The accompanying notes are an intergalintegral part of the consolidated financial statements. F-4 46 PLC SYSTEMS INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBERFor The Years Ended December 31, 1998, 1997 and 1996 AND 1995
COMMON STOCK FOREIGN ----------------- ACCUMULATED CURRENCY SHARES AMOUNT DEFICIT TRANSLATION TOTALAccumulated Common Stock Other ------------ Accumulated Comprehensive Shares Amount Deficit Loss Total ------ ------ ------- ----------- ----------- -------- (IN THOUSANDS)------ ----- (In Thousands) Balance, December 31, 1994........... 15,845 $50,943 $(37,593) $(291) $ 13,059 Exercise of stock options............ 99 399 399 Repayment of stockholder notes....... -- 69 69 Net income........................... 2,004 2,004 Currency translation adjustment...... (23) (23) ------ ------- -------- ----- -------- Balance, December 31, 1995...........1995 15,944 51,411 (35,589) (314) 15,508$51,411 $(35,589) $(314) $15,508 Exercise of stockholder warrants.....warrants 351 1,680 1,680 Exercise of stock options............options 218 820 820 Repayment of stockholder notes....... --notes - 119 119 Comprehensive loss: Net loss.............................loss (1,540) (1,540) CurrencyForeign currency translation adjustment...... (120) (120) ------Total comprehensive loss (1,660) -------- --------- ---------- ------- -------- ----- ------------------ Balance, December 31, 1996...........1996 16,513 54,030 (37,129) (434) 16,467 Exercise of stock options............options 435 1,909 1,909 Exercise of warrants.................warrants 17 94 94 Conversion of debentures.............debentures 1,403 14,465 14,465 Issuance of warrants................. --warrants - 617 617 Comprehensive loss: Net loss.............................loss (14,404) (14,404) CurrencyForeign currency translation adjustment...... (139) (139) ------Total comprehensive loss (14,543) -------- --------- ---------- ------- -------- ----- ------------------ Balance, December 31, 1997...........1997 18,368 $71,115 $(51,533) $(573) $71,115 (51,533) (573) 19,009 ====== ======= ======== ===== ========Exercise of stock options 142 623 623 Conversion of 5% debentures due 2002 577 3,923 3,923 Conversion of debentures due 2003 653 3,810 3,810 Issuance of warrants - 50 50 Comprehensive loss: Net loss (16,603) Foreign currency translation (151) Total comprehensive loss (16,754) -------- --------- ---------- ------- ---------- Balance, December 31, 1998 19,740 $79,521 $(68,136) $(724) $10,661 -------- --------- ---------- ------- ---------- -------- --------- ---------- ------- ----------
The accompanying notes are an integral part of the consolidated financial statements. F-5 47 PLC SYSTEMS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBERFor The Years Ended December 31, 1998, 1997 and 1996 AND 1995
1998 1997 1996 1995 -------- -------- ------- (IN THOUSANDS)---- ---- ---- (In thousands) Operating activities: Net income (loss).........................................loss $(16,603) $(14,404) $ (1,540) $ 2,004$(1,540) Adjustments to reconcile net income (loss)loss to net cash provided by (used for) operating activities: Depreciation and amortization.............................amortization 3,170 2,007 1,228 565 Change in assets and liabilities: Accounts receivable....................................receivable (973) 1,389 4,149 (6,387) Inventory..............................................Inventory (475) (136) (556) (435) Prepaid expenses and other assets......................assets 89 (20) (359) (399) Account payable........................................payable 82 24 303 220 Deferred revenue.......................................revenue 142 (77) 107 33 Accrued liabilities....................................liabilities 304 1,163 (252) 1,225 -------- --------------- ------- ------- Net cash provided by (used for) operating activities........activities (14,264) (10,054) 3,080 (3,174) Investing activities: Purchase of marketable securities.........................securities (1,986) (17,827) (19,419) (8,500) Maturities of marketable securities.......................securities 14,831 10,452 20,449 9,858 Purchase of fixed assets..................................assets (2,574) (2,642) (4,216) (1,584) -------- --------------- ------- ------- Net cash used forprovided by (used for) investing activities......................activities 10,271 (10,017) (3,186) (226) Financing activities: Issuance of 5% Convertible Debentures, net of issuance costs..................................................costs - 18,779 -- --- Secured borrowing 240 - - Net proceeds from sale of common stock....................stock 623 2,003 2,499 388 Tax benefit relating to stock option plans................ -- -- 11Issuance of Convertible Debentures, net of issuance costs 4,659 - - Repayment of stockholder notes............................ --notes - - 119 69 Principal payments on capital lease obligations...........obligations (79) (25) (13) (17) -------- --------------- ------- ------- Net cash provided by financing activities...................activities 5,443 20,757 2,605 451 Effect of exchange rate changes on cash and cash equivalents...............................................equivalents (88) (241) (164) (46) -------- --------------- ------- ------- Net increase (decrease) in cash and cash equivalents........equivalents 1,362 445 2,335 (2,995) Cash and cash equivalents at beginning of year..............year 3,484 3,039 704 3,699 -------- --------------- ------- ------- Cash and cash equivalents at end of year....................year $ 4,846 $ 3,484 $ 3,039 $ 704 ======== ======== =======------- ------- ------- ------- ------- ------- Non-Cash Financing Activities: Conversion of Convertible Debentures and accrued interest into Common Stock...................................... 14,464 -- -- Warrant value.............................................Stock 7,733 14,465 - Ascribed warrant value 50 617 -- --- Capital leases............................................leases - 150 -- --- Supplemental disclosure: Interest paid.............................................paid $ - $ 2 $ 1 $ 6 Income taxes paid (refunded).............................. $ - $ (29) $ 91 $ --
The accompanying notes are an integral part of the consolidated financial statements. F-6 48 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBERDecember 31, 19971998 1. NATURE OF BUSINESS The accompanying financial statements have been presented on the assumption that the Company is a multinational manufacturergoing concern, which contemplates the realization of medical lasersassets and related products operating primarilythe satisfaction of liabilities in the United States with sales offices in Europenormal course of business. During 1997 and 1998 the Pacific Rim. The Company's primary product is The Heart Laser(TM)(1) TMR System ("Heart Laser System") which is a patented CO(2) laser used for a surgical technique known as Transmyocardial Revascularization.Company incurred significant operating losses and utilized significant amounts of cash to fund operations. The Company is currently conducting clinical testsreaching a critical stage in its growth as it transitions from a research and development company to a commercial company with complete sales, marketing and production capabilities. During this time the Company increased its overall operating expenses and overhead to be positioned to further increase its sales and production capabilities in anticipation of possible FDA approval. In order to be adequately positioned to meet these demands, the Company obtained equity financing. The Company continues to seek equity financing as its primary means of funding operations during this transition. On March 4, 1999, the Company announced that it had obtained a provisional equity financing commitment of $8 million from a major institutional investor. The Company is unable to utilize this commitment at this time due to its stock price. During the second half of 1998, the Company implemented a number of programs to reduce its consumption of cash, including operating expense reductions and the financing agreement with GE Capital, which enables the Company to obtain an upfront cash payment on certain domestic placement agreements. While the Company is encouraged by the recent developments with respect to FDA approval and the HCFA announcement that Medicare will provide coverage for TMR procedures performed with devices approved by the FDA, the historical absence of widespread reimbursement for the TMR procedure by third party payers, principally Medicare, Medicaid, and private health insurance plans, has limited demand for and use of The Heart Laser System in the United States under the regulation of the FoodStates. Although Medicare reimbursement is expected to begin in 1999 and Drug Administration.some private insurance plans have begun reimbursing health care providers for TMR procedures using The Heart Laser System, is being marketed internationallythe Company believes that operating losses are likely to continue until such time as third party payers begin to provide widespread reimbursement to healthcare providers for use of The Heart Laser System. Recognizing the deliberate nature that accompanies a highly regulated process such as the above, management of the Company has outlined a plan of appropriate action steps to attempt to ensure that the Company has adequate sources of cash to meet its working capital needs for at least the next twelve months. In March 1999, management of the Company received approval from the Board of Directors to implement this action plan. The key elements of the plan are as follows: - Further operating expense reductions to eliminate certain expenditures which are not essential to achieving critical business objectives at this time (e.g., discretionary spending, further development efforts) - Strategic realignment of the Company's international sales organization. - Pursuit of strategic alternatives related to the Company's domestic sales efforts that can help it further penetrate existing markets. - Pursuit of strategic financing alternatives including the sale of debt securities, bank financing, strategic alliances, joint ventures or by other means. As a result of implementing the above actions, management believes that its existing cash resources and cash from operations will meet working capital requirements over the next twelve months and improve operating results. Unanticipated decreases in countries where it has received regulatory approvalsoperating revenues, increases in expenses or further delays in the process of third F-7 party payers committing to provide reimbursement to healthcare providers, may adversely impact the Company's cash position and require further cost reductions or the need to obtain additional financing. Should additional financing not be available on terms and conditions acceptable to the Company, additional actions may be required that could adversely impact the Company's ability to continue to realize assets and satisfy liabilities in other countries where no approval is required.the normal course of business. The financial statements do not include any adjustments to reflect the possible future effects of these uncertainties. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of PresentationBASIS OF PRESENTATION The consolidated financial statements include the accounts of PLC Systems Inc. (PLC or the "Company") and its seven wholly-owned subsidiaries, PLC Medical Systems, Inc., PLC Sistemas Medicos Internacionais, Lda, PLC Sistemas Medicos GmbH, PLC Medical Systems AG, PLC Medical Systems Asia/Pacific Pte Ltd, PLC Medical Systems France and PLC Medical Systems Australia Pty Ltd. All intercompany accounts and transactions have been eliminated. These consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). Had the statements been prepared in accordance with Canadian GAAP, certain transactions would have been accounted for differently. Under Canadian GAAP, the 5% Convertible Debentures, net of issuance costs, would be classified as equity since the Company has the right to settle the principal and interest amounts due on the debentures by issuing common stock. Accordingly, if the accompanying financial statements had been prepared under Canadian GAAP at December 31, 1998 and 1997, common stock would be $934,000 and $3,697,000, respectively, greater due to the inclusion of the 5% Convertible Debentures and accrued expenses would be reduced by $33,000 in 1998 and $75,000 in 1997 due to the elimination of accrued interest on the debt. In addition, the accumulated deficit would be reduced by $252,000 in 1998 and $197,000 in 1997 as a result of the elimination of interest and other debt issuance expenses included in the accompanying statement of operations for the year ended December 31, 1998 and 1997, as required under U.S. GAAP. Cash and Marketable SecuritiesCASH AND MARKETABLE SECURITIES Investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents and those with maturities greater than three months are considered to be marketable securities. Marketable securities are stated at cost, which approximates fair value. Cash equivalents and marketable securities, which are classified as available-for-sale securities, consist primarily of time deposits, bankers acceptances and obligations of U.S. government and agencies. There were no unrealized gains or losses at December 31, 1997. Maturities of marketable securities at December 31, 1997 1996 or 1995. Inventorywere less than six months. F-8 INVENTORY Inventory is stated at the lower of average cost or market value. Equipment, Furniture and Leasehold ImprovementsEQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS Equipment, fixtures and leasehold improvements are stated on the basis of cost. Depreciation is computed principally on the straight-line method for financial reporting purposes and on accelerated methods for income tax purposes. - --------------- 1.Depreciation and amortization are based on the following useful lives: Equipment 3-5 years Equipment under placement contracts Life of contract Office furniture and fixtures 5 years Equipment under capital lease 5 years Leasehold improvements Life of lease
The Heart Laser isCompany reviews and evaluates long-lived assets for impairment on a trademarkregular basis. In management's opinion, long-lived assets are not impaired as of PLC Medical Systems, Inc. F-7 49 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Revenue Recognitionthe balance sheet dates presented. The amounts capitalized have future value to the Company. REVENUE RECOGNITION Revenues from product sales, except sales to certain distributors, are recognized at the time of shipment. Shipments made to distributors, where payment is dependent on the resale of the product, are recognized at the time of payment from the distributor. Revenues from placement contracts are recognized as earned based on the terms of each placement contract. Placement contracts currently in place have either a "minimum billings" clause or a "pay per actual usage" clause. Revenues from service contracts are recognized ratably over the life of the contract. Foreign Currency TranslationFOREIGN CURRENCY TRANSLATION Assets and liabilities are translated into U.S. dollars at current exchange rates, while income and expense items are translated at average rates of exchange prevailing during the year. Exchange gains and losses arising from translation are accumulated as a separate component of stockholders' equity. Gains and losses from foreign currency transactions are recorded in the accompanying statements of operations and are not material. Net Income (Loss) per ShareNET LOSS PER SHARE In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings Per Share" ("Statement 128") which replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earningsloss per share amounts for all periods have been presented, and have been restated, to conform to Statement 128. At December 31, 1995, the difference between basic and diluted shares used in the computation of earnings per share is approximately 722,000 weighted average common equivalent shares resulting from outstanding common stock options. Stock Based CompensationF-9 STOCK BASED COMPENSATION The Company grants stock options for a fixed number of shares to employees and certain other individuals with exercise prices equal to the fair value of the shares at the dates of grant. The Company has adopted the disclosure only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-based CompensationACCOUNTING FOR STOCK-BASED COMPENSATION ("FAS 123") and will continue to account for its stock option plans in accordance with the provisions of APB 25 Accounting for Stock Issued to Employees.ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Accordingly, no compensation cost has been recognized for the stock option plans. Use of EstimatesUSE OF ESTIMATES The preparation of financial statements in accordance 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 revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company has provided a valuation allowance for all deferred tax assets due to the inability to assume the realization of such tax benefits in the foreseeable future. ImpactCOMPREHENSIVE INCOME As of Recently Issued Accounting Standards During 1997,January 1, 1998, the Financial Accounting Standards Board issuedCompany adopted Statement No. 130, "ReportingReporting Comprehensive Income"Income ("Statement 130"). The Company will adopt the provisions of Statement 130 during fiscal 1998. At that time,establishes new rules for the Company will be required to disclosereporting and display of comprehensive income and comprehensive income per share. Comprehensive income is generally defined as all changesits components in the financial statements. The Company has changed the format of its consolidated statements of stockholders' equity exclusive of transactions with owners such as capital investments and dividends. In June 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("Statement 131") which is required to be adopted for F-8 50 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) years beginning after December 15, 1997. Management of the Company does not expect the adoption of Statement 131 to have a material impact on the Company's financial statement disclosures.present comprehensive income. 3. INVENTORIESINVENTORY Inventories consist of the following at December 31 (in thousands):
1998 1997 1996 ------ ---------- ---- Raw materials..............................................materials $1,035 $1,141 $1,043 Work in process............................................process 145 10 306 Finished goods.............................................goods 1,773 1,361 996 ------ ------ $2,953 $2,512 $2,345 ====== ======------ ------ ------ ------
F-10 4. EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS Equipment, furniture and leasehold improvements consist of the following at December 31 (in thousands):
1998 1997 1996 ------ ---------- ---- Equipment..................................................Equipment $2,461 $2,010 $1,995 Equipment under placement contracts........................contracts 6,617 5,760 3,387 Office furniture and fixtures..............................fixtures 929 1,082 834 Equipment under capital lease..............................lease 429 455 284 Leasehold improvements.....................................improvements 587 576587 ------ ------ 11,023 9,894 7,076 Less accumulated depreciation and amortization.............amortization 5,932 4,258 2,364 ------ ------ $5,091 $5,636 $4,712 ====== ======------ ------ ------ ------
Equipment under placement contracts represents Heart Lasers that the Company has provided to customers under contracts which require the customers to pay a fee for each use of the equipment, subject to guaranteed annual minimum fees. The Company maintains title to the equipment, which is depreciated over the term of the contract, and is responsible for maintenance. Depreciation expense was $3,116,000, $1,894,000, and $717,000 respectively for the years ended December 31,1998, 1997, and 1996. 5. LEGAL PROCEEDINGS In September 1996, CardioGenesis Corporation, ("CardioGenesis") filed a civil lawsuit in the United States District Court for the Northern District of California seekingasking the court to havedeclare the Company's synchronization patent declared(U.S. Patent No. 5,125,926) invalid and unenforceable, or, alternatively, asking the court to determine whether CardioGenesis infringes onfind that CardioGenesis' TMR and PMR lasers do not infringe this patent. In October 1996, theThe Company filed an answer anda counterclaim alleging that CardioGenesis infringes on this patent. The counterclaim seeks both injunctive reliefall of CardioGenesis' TMR and monetary damages against CardioGenesis.PMR lasers infringe U.S. Patent No. 5,125,926. In OctoberJanuary 1997, CardioGenesis filed an amended complaint seeking to have the Company's synchronization patent declared unenforceable. CardioGenesis is not seeking monetary damages from the Company. In January 1997, CardioGenesis Corporation, filed a challenge to the Company's European synchronization patentopposition in the European Patent Office and in March 1997to have the Company filed its response.Company's German synchronization patent declared invalid. In addition, in April 1997, the Company filed an infringement lawsuit against CardioGenesis in the Munich District Courts alleging infringementand one of its synchronization patent. An oral hearing has been scheduleddistributors in the Munich District Court alleging that CardioGenesis' TMR and PMR lasers infringe the Company's German synchronization patent. The PLC patents at issue in these lawsuits cover the Company's synchronization technology, a critical factor in ensuring the safety of TMR and PMR procedures. In January 1999, the Company settled its outstanding patent infringement litigation with CardioGenesis. Under the settlement, CardioGenesis acknowledged that U.S. Patent No. 5,125,926 and related international patents of the Company are valid and enforceable. PLC granted CardioGenesis a non-exclusive worldwide license to the patents in exchange for payment of a license fee and ongoing royalties over the life of the patents (at least 10 years unless the patents are all held invalid in future lawsuits). As part of the settlement, CardioGenesis must pay the Company: - a minimum of $2.5 million over the next 42 months; and - license fees and ongoing royalties on October 1, 1998. F-9 51 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)sales of all covered products for at least 10 years (unless the patents are all held invalid in future lawsuits). In July 1997, an FDA advisory panel recommended against approval of the Company's application to market The Heart Laser System in the United States. Following this recommendation, the Company and certain of its officers have beenwas named as defendantsdefendant F-11 in 21 purported class action lawsuits filed between August 1997 and November 1997 in the United States District Court for the District of Massachusetts. The suits allegelawsuits seek an unspecified amount of damages in connection with alleged violations of the federal securities laws. The plaintiffs are seeking damageslaws based on the Company's failure to obtain a favorable FDA panel recommendation in connection with such alleged violations.1997. Nineteen of these complaints have been consolidated by the court into a single action for pretrial purposes. A motion hasTwo of these suits have been filed to consolidate the other two suits with each other. These matters are in the earliest stages of litigation and thedismissed. The Company intends to seek motionsmoved to dismiss all of thesethe remaining claims. There can be no assurance thatOn March 26, 1999, the motionscourt issued an order dismissing some, but not all of the remaining claims. The Company has also been named as a defendant in a lawsuit filed in Massachusetts Superior Court in September 1998. This suit seeks over $2 million in damages for alleged negligent misrepresentations and fraud arising from the Company's failure to dismiss these claims will be successful. Management is unable toobtain a favorable FDA recommendation in 1997. The Company cannot make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of these pending litigation matters. It is possible that the Company's result of operations or cash flows inlawsuits, but an unfavorable outcome could have a particular quarter or annual period or itsmaterial adverse affect on our business, financial position could be materially affected by an ultimate unfavorable outcomeand results of this pending litigation.operations. The Company believes that it has valid defenses to these class action litigation matters and intendsit has and continues to vigorously defend itself in these matters. In August 1997, the Company received from the United States Securities and Exchange Commission (the "Commission") an informal request for information relating to the decision by the FDA Advisory Panel not to recommend approval of The Heart Laser System in July 1997. The Company has responded and has not received any further communication from the Commission regarding this matter since June 1998. In February 1996, PLC Medical Systems, Inc. filed suit against Eclipse Surgical Technologies, Inc. ("Eclipse") in the United States District Court for the District of Massachusetts alleging copyright infringement and unfair and deceptive trade practices based on Eclipse's misappropriation and copying of one of PLC's confidential clinical study protocols. The Company is seeking injunctive relief and damages, as well as any profits derived by Eclipse as a result of the misappropriation, attorney's fees, treble damages and other relief. In November 1998, a hospital in France, Centre Medico Chirurgical Foch ("Foch Hospital") sued the Company's Portuguese subsidiary, PLC Sistemas Medicos Internacionais Lda., and a third party, Johnson & Johnson Leasing GmbH in Paris, France alleging breach of contract. In October 1997, the French Ministry of Health suspended commercial use of TMR devices in France. Foch Hospital is seeking reimbursement of lease payments made for the Heart Laser System. The Company intends to vigorously defend itself in this matter. This matter is in the earliest stage of litigation and a meaningful estimate of the loss that could result from this matter has not been made. The Company is not involved in any other litigation of a material nature. 6. ISSUANCE OF CONVERTIBLE DEBENTURES a. 5% Convertible Debentures due July 17, 2002 and August 14, 2002 In July 1997, the Company entered into a $20 million financing commitment. Under the terms of the financing, the Company received $10,075,000 in July 1997 and $10,075,000 in August 1997 from the issuance of five-year convertible debentures to accredited investors through Smith Barney Inc. as placement agent. The convertible debentures accrue interest at 5% per annum, payable in cash or common stock at the Company's option, at the time of conversion. The debentures are convertible into common shares under a predetermined formula. The first tranche of the debentures are convertible into common shares at the lesser of (a) $25.98, or (b) the market price of the Company's Common Stock at the time of conversion, with no more than 1,007,500 shares of Common Stock issuable in full payment of all accrued interest and principal.investors. In September 1997, the entire first tranche of convertible debentures of $10,075,000 and related accrued interest converted into 890,394 shares of common stock. The second tranche of the debentures are convertible into common shares at the lesser of (a) $14.60, or (b) the market price of the Company's Common Stock at the time of conversion, with no more than 1,507,500 shares of Common Stock issuable in full payment of all accrued interest and principal. In September 1997, $5,825,000 of the second tranche of convertible debentures and related accrued interest converted into 512,572 shares of common stock. In January and February 1998, the remaining $4,250,000 of the second tranche of convertible debtdebentures and related accrued interest converted into 576,606 shares of common stock. In connection with the issuance of the first tranche of convertible debentures, the Company issued 69,875 redeemable warrants to purchase shares of its Common Stock at $27.81 per share. In connection with the issuance of the second tranche of convertible debentures, the Company issued 80,125 redeemable warrants to purchase shares of its Common Stock at $15.78 per share. If the average closing sale price of its Common Stock for any consecutive 30 trading day period commencing January 17, 1999 exceeds the exercise price by more than 50%, the Company has the right, exercisable at any time upon 30 days notice to the holder, to redeem the warrant at a price of $.10 per warrant share. The warrants issued in connection with the first tranche expire on July 17, 2002. The warrants issued in connection with the second tranche expire on August 14, 2002. The detachable warrants were valued at $617,000 (using the Black-Scholes formula), classified as a component of equity, and disclosed separately in the Consolidated Statement of Stockholders' Equity. F-12 b. Convertible Debentures due April 23, 2003 In April 1998, the Company obtained a $10 million financing commitment from three institutional investors. Pursuant to the terms of the financing, the Company received approximately $5 million in April 1998 from the issuance of non-interest bearing, five-year convertible debentures. As of December 31, 1998, $4,000,000 of the convertible debentures outstanding converted into 653,063 shares of the Company's Common Stock. In January 1999, the remaining $1,000,000 of the convertible debentures outstanding converted into 163,264 shares of the Company's Common Stock. The remaining $5 million of the commitment expired on December 31, 1998. In connection with the First Tranche, the Company issued 4,864 redeemable warrants to purchase shares of its Common Stock at $19.53 per share. If the average closing sale price of its Common Stock for any consecutive thirty trading day period commencing April 23, 1999 exceeds the exercise price by more than 50%, the Company has the right, exercisable at any time upon 30 days notice to the holder, to redeem the warrants at a price of $.10 per warrant. The warrants expire on April 23, 2003. The detachable warrants were valued at $50,000 (using the Black-Scholes formula), classified as a component of equity, and disclosed separately in the Consolidated Statement of Stockholders' Equity. 7. STOCKHOLDERS' EQUITY The Company has three stock option plans, theCompany's 1992 Stock Option Plan ("1992 Plan"), the 1993 Stock Option Plan ("1993 Plan") and the 1995 Stock Option Plan ("1995 Plan"), which provide for option grants to primarily employees, officers and consultants. The Plans allow for the granting of options aggregating 2,505,000 shares of common stock. All of the Plans consist of both incentive stock options and nonqualifiednon-qualified options. Incentive stock options are issuable only to employees of the Company, while nonqualifiednon-qualified options may be issued to nonemployeenon-employee directors, consultants, and others, as well as to employees. The options granted F-10 52 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) under all the Plans generally become exercisable ratably over one to three years from the date of grant, or based on the attainment of specific performance criteria, and expire ten years from the date of grant. The per share exercise price of the common stock subject to an incentive stock option may not be less than the fair market value of the common stock on the date the option is granted. The Company must grant nonqualified options at an exercise price of at least 85% of the fair market value of the common stock on the date the option is granted. The Company also has theCompany's 1993 Formula Stock Option Plan (the "Formula Plan") that provides for the grant of nonqualifiednon-qualified options to nonemployeenon-employee directors to purchase up to 250,000 shares of common stock. The Plan is administered by the Board of Directors. Annually, the Company grants 10,000 options to each of its nonemployeenon-employee directors. A director must attend at least 60% of all Board meetings, as well as committee meetings, to receive the grant. The options vest over one year on a quarterly basis and expire ten years from the date of grant. The exercise price is the fair market value of the Company's common stock on the last business day preceding the date of grant. In addition, in 1995, the Company granted 10,000 nonqualifiednon-qualified options at $12.88 per share to the Company's Lead Outside Director. As of December 31, 1997,1998, the options are fully exercisable and expire ten years from the date of grant. The Company has aCompany's 1997 Executive Stock Option Plan ("1997 Executive Plan") that provides for the grant of nonqualifiednon-qualified options to an executiveofficers and directors of the Company to purchase up to 650,000 shares of common stock. In 1998, the Board of Directors voted to increase the shares available in this plan to 1,000,000. The options vest over a combination of time and the attainment of specific performance criteria. The per share exercise price of the common stock subject to an incentive stock option may not be less than the fair market value of the common stock on the date the option is granted. The Company must grant non-qualified options at an exercise price of at least 85% of the fair market value of the common stock on the date the option is granted. During 1998, the Board of Directors (together with its Compensation and Executive Committees) adopted the following incentive compensation programs: a.) In January 1998, the outstanding options of all employees (except executive officers and directors) F-13 having a higher exercise price were repriced to $8.88 per share. As a result, the exercise price of options to purchase 526,784 shares of Common Stock was reduced to $8.88 per share. b.) In August, 1998, the outstanding options of all directors and executive employees having a higher exercise price were repriced to $7.75 per share. As a result, the exercise price of options to purchase 1,373,500 shares of Common Stock was reduced to $7.75 per share. c.) In September 1998, a new Senior Management Investment Program ("SMIP") was adopted to promote investment in the Company's stock by directors and members of our senior management team. Under the SMIP, individuals who purchased additional shares of the Company's stock between September 15, 1998 and December 15, 1998 (the "Participants") received options to purchase an additional 1.5 shares of Common Stock at an exercise price equal to the Participant's share purchase price (the "Share Purchase Price"). In addition, Participants received ten "option credits" for each share of Common Stock purchased between September 15, 1998 and December 15, 1998. Participants could use each "option credit" to: (i) reduce the exercise price of an outstanding option (vested or unvested) to purchase one share of Common Stock to the Participant's Share Purchase Price; or (ii) extend the expiration date of any outstanding option (vested or unvested) for an additional three years; or (iii) acquire new vested options with an exercise price equal to the Participant's Share Purchase Price (at a rate of 6.67 option credits for each new option to purchase one share of Common Stock). Under this program, the Company granted options to purchase an additional 331,575 shares of Common Stock at exercise prices ranging from $3.875 to $6.625 per share under the SMIP. Furthermore, the Company has reduced the exercise prices of options to purchase 1,243,500 shares of common Stock to new exercise prices ranging from $4.6875 to $5.5625. d.) In December 1998, the outstanding options held by employees not eligible to participate in the SMIP having a higher exercise price were repriced to $4.875 per share. As a result, the exercise price of options to purchase 332,316 shares of Common Stock was repriced to $4.875 per share. The following is a summary of option activity under all Plans (in thousands, except per option data):
1998 1997 1996 1995 ---- ---- ---- Outstanding at beginning of year....year 2,187 1,914 1,635 1,153 Granted...........................Granted 823 938 500 615 Exercised.........................Exercised (142) (435) (220) (99) Canceled..........................Canceled (80) (230) (1) (34) ----- ----- ------------ ------ ------- Outstanding at end of year..........year 2,788 2,187 1,914 1,635 ===== ===== =====------- ------ ------- ------- ------ ------- Exercisable at end of year..........year 1,711 878 874 693 Available for grant at end of year..............................year 71 463 521 321
F-14
1998 1997 1996 1995 ---- ---- ---- Weighted-averageWeighted - average exercise price: Outstanding at beginning of year...........................$8.75 $ 8.18 $ 4.67 $4.15 Granted...........................Granted $5.39 $13.56 $17.83 $5.49 Canceled..........................Canceled $9.09 $11.50 $ 3.97 $3.69 Exercised.........................Exercised $4.39 $ 4.39 $ 3.73 $4.09 Outstanding at end of year........$5.16 $10.84 $ 8.18 $4.67 Exercisable at end of year........$4.88 $ 8.75 $ 5.34 $4.22 Weighted-averageWeighted - average fair value of optionsOptions granted during the year...$3.33 $ 8.20 $ 5.56 -- Price range per share Range of outstanding options........................... $ 3.69 - $24.50 $ 3.69 - $24.50Exercise Prices ------------------------ $3.69 - $16.25 Price range per share of options granted........................... $10.03$5.00 $5.13 - $22.19 $14.88 - $24.50$8.88 $3.69 - $16.25 Price range per share of options exercised......................... $ 3.69 - $21.25 $3.69 - $16.25 $3.69 - $ 7.25
F-11 53 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Exercise prices for options outstanding as of December 31, 1997 ranged from $3.69 to $24.50. The weighted-average contractual life of those options is 7.6 years.
RANGE OF EXERCISE PRICES ------------------------------------------------------------ $3.69 - $5.38 $8.06 - $12.88 $14.13 - $22.19 $24.50$8.88 ------------- -------------- --------------- ------------------- ------------- OPTIONS OUTSTANDING:Options Outstanding: -------------------- Number (in thousands)............... 761 859 517 50 1,283 1,505 2,788 Weighted-Average Remaining Contractual Life.................. 4.6 9.4 8.8 8.5Life 6.6 8.6 7.7 Weighted-Average Exercise Price..... $3.97 $12.39 $17.06 $24.50 OPTIONS EXERCISABLE:Price $4.39 $5.81 $5.16 Options Exercisable: -------------------- Number (in thousands)............... 542 123 163 50 1,023 688 1,711 Weighted-Average Exercise Price..... $3.96 $11.70 $17.61 $24.50Price $4.28 $5.77 $4.88
In January 1998, the Board of Directors approved the repricing of all options priced greater than $8.88 other than to executive officers and Board Members. Pursuant to the requirements of FAS 123, the following are the pro forma net income (loss)loss and net income (loss)loss per share for 1998, 1997 1996 and 1995,1996, as if the compensation cost for the option plans had been determined based on the fair value at the grant date for grants in 1998, 1997 1996 and 1995,1996, consistent with the provisions of FAS 123.
1998 1997 1996 1995 -------- ------- ---------- ---- ---- Proforma net income (loss)(inloss (in thousands).............. $(22,438) $(16,523) $(2,404) $1,868 Proforma net income (loss)loss per share..................share $ (1.17) $ (.97) $ (.15) $ .12
The fair value of options issued at the date of grant were estimated using the Black-Scholes model with following weighted average assumptions:
1998 1997 1996 1995 ---- ---- --------- Expected life (years)................................. 2 2 2 Interest rate.........................................rate 5.53% 6.01% 5.65% 6.55% Volatility............................................Volatility .761 1.141 .576 .422
The Company has never declared nor paid dividends on any of its capital stock and does not expect to do so in the foreseeable future.F-15 The effects on 1997, 1996 and 1995 pro forma net income (loss) and net income (loss) per sharedisclosures of expensing the estimated fair value of stock optionsapplying FAS 123 are not necessarilylikely to be representative of the effects on reportingpro forma disclosures of future years. Because FAS 123 is applicable only to options granted subsequent to October 28, 1995, the results of operations for future years aspro forma effect has been fully reflected in the periods presented include only one and two years, respectively, of option grants under the Company's plans. Atyear ended December 31, 1995,1998. As of December 31, 1998, the Company had twothe following outstanding warrants to purchase common stock. The first warrant provided for the purchase of 145,000stock: 69,875 shares at $6.00$27.81 per share and 72,500expiring July 22, 2002; 80,125 shares at $4.80$15.78 per share. In March 1996, the majority of these warrants were exercisedshare expiring August 14, 2002 and the remaining 11,180 of the $6.00 warrants and 5,590 of the $4.80 warrants were exercised in 1997. The second warrant provided for the purchase of 150,0004,864 shares at $3.94$19.53 per share and was exercised in full in March 1996.expiring April 23, 2003. At December 31, 1997,1998, there were 2,810,0003,023,026 shares of authorized but unissued common stock reserved for issuance under all stock option plans and stock warrants. In conjunction with the conversion of the debentures, and related accrued interest in January and February 1998 and the FDA approval contingency shares, the Company has reserved an additional 1,076,606163,264 shares. See Note 6 for a further discussion. F-12 54 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)The Company has unlimited authorized shares of preferred stock. The Board of Directors is authorized to fix designations, relative rights, preferences and limitations in the preferred stock at time of issuance. In addition, the Company has unlimited authorized shares of common stock. The Company has never declared nor paid dividends on any of its capital stock and does not expect to do so in the foreseeable future. 8. LEASE COMMITMENTS AND CONTINGENCIES The Company occupies its worldwide facilities under operating leaseslease agreements, which expire through March 2002. The Company has the option to renew the U.S. facilities lease for up to sixfive years. In addition to the minimum lease payments, the agreement requires payment of the Company's pro-rata share of property taxes and building operating expenses. The Company also leases certain equipment. As of December 31, 1997,1998, future minimum lease payments are as follows (in thousands):
YEARYear ---- 1998........................................................ $ 372 1999........................................................ 372 2000........................................................ 337 2001........................................................ 223 2002........................................................ 6 ------ $1,310 ======1999 $374 2000 338 2001 224 2002 7 ---- $943 ---- ----
Total rent expense was $375,000 in 1998, $458,000 in 1997 and $370,000 in 1996 and $227,000 in 1995.1996. 9. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets as of December 31 are as follows (in thousands): F-16
1998 1997 1996 -------- ----------- ---- Net U.S. net operating loss carryforwards...................carryforwards $ 13,791 $ 7,682 $ 3,064 Foreign netNet foreign operating loss carryforwards................carryforwards 2,263 1,482 484 Intercompany profit.....................................profit 313 637 781 Accrued clinical costs..................................costs 406 516 373 Research & development credits..........................credits 679 561 350 Inventory and warranty reserves.........................reserves 497 331 162 Alternative minimum tax credit..........................credit 63 63 Other...................................................Accrued salaries 195 - Deferred revenue 173 - Other 4 56 22 -------- --------------- Total deferred tax assets..........................assets 18,384 11,328 5,299 Valuation allowance................................allowance (18,384) (11,328) (5,299) -------- --------------- Net deferred tax assets.......................assets $ -- $ -- ======== =======- -------- -------- -------- --------
The valuation allowance increased by approximately $6,000,000$7,000,000 primarily due to additional net operating loss carryforwards. The Company recorded the valuation allowance due to the uncertainty of the realizability of the related net deferred tax asset of $11,328,000.$18,384,000. Income (loss) before taxes consisted of the following (in thousands):
1998 1997 1996 1995 -------- ------- ---------- ---- ---- Domestic......................................Domestic $(14,137) $(11,340) $(1,244) $2,094 Foreign.......................................Foreign (2,472) (3,064) (296) (5)--------- -------- ------- -------------- $(16,603) $(14,404) $(1,540) $2,089 ======== ======= ======--------- -------- -------- --------- -------- --------
F-13 55 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Income taxes (benefit) computed at the federal statutory rate differ from amounts provided as follows (in thousands):
1998 1997 1996 1995 ------- ----- --------- ---- ---- Statutory income tax provision...................provision $(5,645) $(4,898) $(524) $ 710 Utilization of loss carryforwards................ -- -- (641)carryforwards (85) - - Unbenefited U.S. losses..........................losses 4,807 3,856 423 -- Unbenefited foreign losses.......................losses 923 1,042 100 -- Other............................................ --Other - - 1 16 ------- ------------ ----- Provision for income taxes.......................taxes $ --- $ --- $ 85 ======= ===== =====- ------- ------- ----- ------- ------- -----
The 1995 income tax provision of $85,000 represented the current liability due under the alternative minimum tax regulations. At December 31, 19971998 the Company had U.S. net operating loss carryforwards available to reduce future taxable income of approximately $19.2$34.5 million which expire at various dates through 2011.2012. In addition, the Company had foreign net operating loss carryforwards of approximately $3.7$5.7 million. F-17 10. SEGMENT INFORMATION The Company operates in one industry segment --- the development, manufacture and sales of medical lasers and related products. Net revenue, operating income and assets by geographic areasales to unaffiliated customers (by origin) are summarized below (in thousands). Transfers to foreign subsidiaries are at prices comparable to those charged to third party distributors.
NORTH AMERICA EUROPE OTHER ELIMINATIONS TOTAL ------- ------ ----- ------------ --------North America Europe Other Eliminations Total ------------------------------------------------------- 1998 Net sales to unaffiliated customers $3,992 $1,615 $ 86 $ - $ 5,693 Long-lived assets $ 558 $ - $ - $ - $ 558 1997 Net sales to unaffiliated customers......................Customers $4,092 $4,683 $ 4,092 $4,683 $166166 $ --- $ 8,941 Transfers between areas.......... 2,800 -- -- (2,800) -- ------- ------ ---- ------- -------- 6,892 4,683 166 (2,800) 8,941 Operating income (loss).......... (12,318) (1,650) (806) 370 (14,404) Identifiable assets.............. 22,652 5,363 597 (1,595) 27,017Long-lived assets $ 701 $ - $ - $ - $ 701 1996 Net sales to unaffiliated customers...................... $ 5,657Customers $5,657 $6,215 $ --- $ --- $11,872 Long-lived assets $ 11,872 Transfers between areas.......... 4,700 2,900 -- (7,600) -- ------- ------ ---- ------- -------- 10,357 9,115 -- (7,600) 11,872 Operating income (loss).......... (1,954) 272 (106) (264) (2,052) Identifiable assets.............. 15,430 5,517 425 (1,955) 19,417 1995 Net sales to unaffiliated customers...................... $10,231 $3,114 -- --537 $ 13,345 Transfers between areas.......... 4,050 -- -- (4,050) -- ------- ------ ---- ------- -------- 14,281 3,114 -- (4,050) 13,345 Operating income................. 3,149 43 -- (1,691) 1,501 Identifiable assets.............. 16,714 3,267 -- (1,691) 18,290- $ - $ - $ 537
Included in North America net sales for 1997 are export sales of $2,026,000 of which $1,023,000 related to the Far East and $563,000 to South America. Included in North American net sales for 1996 are export F-14 56 PLC SYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) sales of $3,980,000 of which $2,547,000 related to Asia. Included in North American net sales for 1995 are export sales of $9,199,000 of which $8,002,000 related to Asia. Approximately 20% of the Company's revenues for the year ended December 31, 1997 came from one customer. No one customer accounted for more than 10% of the Company's revenues for the year ended December 31, 1996.1998. Approximately 43%20% of the Company's revenues for the year ended December 31, 19951997 came from one customer.customer, Imatron Japan. No one customer accounted for more than 10% of the Company's revenues for the year ended December 31, 1996. The Company believes that its exposure to concentrations of credit risk is not significant based on experiences with these customers. In addition, letters of credit or payment in advance are required in credit risk situations. The Company does not believe its future revenues to be dependent on those generated from any single customer. F-1511. SUBSEQUENT EVENT On March 4, 1999, the Company announced that it had obtained a provisional equity financing commitment of $8 million from a major institutional investor. The commitment contemplates the sale by the Company of up to $2 million in common stock during consecutive 20 day periods at prices based on the trailing volume weighted average price of the common stock on the American Stock Exchange on each day during such periods, less a seven percent discount. The Company is unable to use the commitment on any trading day to the extent that the volume weighted average price of the Company's common stock is less than $3.50 per share, unless the Company and the investor mutually agree to a reduction in such price. If the Company is unable to use the commitment on any given trading day, the commitment amount is automatically reduced by $100,000 on such day. The use of the commitment is also dependent upon the Company being eligible to sell shares of its common stock under a Form S-3 Registration Statement under the Securities Act of 1933, as amended, which form requires, F-18 57 SCHEDULEamong other things, that the Company have a market capitalization of at least $75 million held by non-affiliates of the Company during the immediately preceding 60-day period. There can be no assurance that the Company will be able to use this commitment in the future or that the Company will maintain its eligibility to use Form S-3. As of March 31, 1999, the Company had sold 323,231 shares of common stock under this commitment, resulting in proceeds to the Company (net of all issuance costs payable upon closing) of $885,000 and had $6 million in unused availability under the commitment. F-19 Schedule II PLC SYSTEMS INC. VALUATION AND QUALIFYING ACCOUNTSValuation and Qualifying Accounts
COLUMNColumn A COLUMNColumn B COLUMNColumn C COLUMNColumn D COLUMNColumn E -------- -------- -------- ---------- --------- Additions Deductions Balance at Charged to ---------- Balance at Beginning Costs and End of Description of Period Expenses Period ----------- --------- -------- -------- ADDITIONS DEDUCTIONS ---------- ---------- BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END OF DESCRIPTION OF PERIOD EXPENSES PERIOD ----------- ---------- ---------- ---------------- For the Year Ended December 31, 1998 Allowance for Doubtful Accounts $140,000 $100,000 $12,000 $228,000 For the Year Ended December 31, 1997 Allowance for Doubtful Accounts............... $28,000Accounts $ 28,000 $112,000 $ 0 $140,000 ------- -------- ------ -------- For the Year Ended December 31, 1996 Allowance for Doubtful Accounts............... $29,000Accounts $ 0 $1,000 $ 28,000 ------- -------- ------ -------- For the Year Ended December 31, 1995 Allowance for Doubtful Accounts............... $10,000 $ 19,00029,000 $ 0 $ 29,000 ------- -------- ------ --------1,000 $28,000
S-1 58 PLC SYSTEMS INC. QUARTERLY DATA (UNAUDITED)
MARCHMarch 31 JUNEJune 30 SEPTEMBERSeptember 30 DECEMBERDecember 31 TOTAL -------- ------- ------------ ----------- --------Total TOTAL REVENUE $ 945 $ 680 $1,615 $2,453 $ 5,693 GROSS PROFIT (LOSS) 257 (351) 320 900 1,126 LOSS FROM OPERATIONS (4,087) (5,569) (4,032) (3,372) (17,060) NET LOSS (3,936) (5,402) (4,006) (3,259) (16,603) LOSS PER SHARE, BASIC AND DILUTED (.21) (.28) (.21) (.17) (.86) 1997 Total revenue...................... $ 1,588 $ 3,422 $ 1,885 $ 2,046 $ 8,941revenue $1,588 $3,422 $1,885 $2,046 $8,941 Gross profit.......................profit 758 1,952 666 249 3,625 Loss from operations...............operations (3,130) (2,712) (3,590) (5,150) (14,582) Net loss...........................loss (3,022) (2,697) (3,562) (5,123) (14,404) Loss per share.....................share, basic and diluted (.18) (.16) (.21) (.28) (.84) 1996 Total revenue...................... 4,829 1,431 2,493 3,119 11,872 Gross profit....................... 3,439 1,055 1,584 1,728 7,806 Income (loss) from operations...... 1,229 (1,095) (696) (1,490) (2,052) Net income (loss).................. 1,277 (903) (562) (1,352) (1,540) Income (loss) per share............ .08 (.05) (.03) (.08) (.09)
The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128 "Earnings Per Share". For further discussion regarding the calculation of earnings per share, see Note 1 to the Consolidated Financial Statements. 59 EXHIBIT INDEX
EXHIBIT NO. TITLEExhibit No. Title - ------- ----- 21 Subsidiaries of the Registrant. 23 Consent of Ernst & Young LLP. 27a27 Financial Data Schedule for fiscal year ended December 31, 1997. 27b Restated Financial Data Schedule for the quarter ended September 30, 1997. 27c Restated Financial Data Schedule for the quarter ended June 30, 1997. 27d Restated Financial Data Schedule for the quarter ended March 31, 1997. 27e Restated Financial Data Schedule for fiscal year ended December 31, 1996. 27f Restated Financial Data Schedule for the quarter ended September 30, 1996. 27g Restated Financial Data Schedule for the quarter ended June 30, 1996. 27h Restated Financial Data Schedule for the quarter ended March 31, 1996.Schedule.