PLC SYSTEMS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
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, 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)

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(508) 541-8800
(Registrant's telephone number, including area code)

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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

Name of Each Exchange
Title of Each Class on which Registered
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COMMON STOCK, NO PAR VALUE AMERICAN STOCK EXCHANGE

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INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.

YES [X] NO [ ]

INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS 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 April 9, 1997,
was $268,463,528. As of April 9, 1997, 16,627,537 shares of Common Stock, no par
value per share, were outstanding.

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DOCUMENTS INCORPORATED BY REFERENCE
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PART OF FORM 10-K
ANNUAL REPORT IN WHICH
DOCUMENT DOCUMENT IS INCORPORATED
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Current Report on Form 8-K filed with
the Commission on July 19, 1995. Part IV

Annual Report on Form 10-K for the
year ended December 31, 1994. Part IV

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 comply with the
requirements of Section 6 of the Company Act Regulations (British Columbia).

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PART I

ITEM 1. BUSINESS.

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 U.S. Food and Drug Administration, 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.

GENERAL

PLC Systems Inc. ("PLC" or the "Company") has developed a patented
high-powered carbon dioxide ("CO2") laser system known as The Heart Laser(TM)1
for broad application in the treatment of coronary artery disease in a surgical
laser procedure developed by the Company and its clinical investigators known as
transmyocardial revascularization ("TMR"). The Company believes that TMR using
the Heart Laser may provide an alternative or adjunct therapy to conventional
revascularization treatments, such as coronary bypass surgery and balloon
angioplasty, which are currently used to bypass or reduce the blockage in
coronary arteries afflicted with coronary artery disease.

TMR, using the Heart Laser creates new channels in the heart that
permit oxygenated blood present in the left ventricle of the heart to flow
outwardly to the ischemic (oxygen starved) areas of the heart muscle affected by
atherosclerosis. Through a small incision made between the patient's ribs, the
Heart Laser is used to drill approximately 20-40 tiny holes from the exterior of
the heart muscle into the interior of the left ventricle. This procedure is
performed on a beating heart and does not require the use of a heart-lung
machine. Clinical test results have indicated that through the body's normal
healing process, the end of each hole on the exterior of the heart muscle
closes, but the channels created into the interior remain open resulting in
oxygenated blood flowing outwardly from the left ventricle to the ischemic areas
of the heart muscle. Studies conducted at the Max Planck Institut in Germany
using myocardial contrast echocardiography (MCE) 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. The Company believes successful TMR may eliminate the need to
bypass or clear the coronary arteries that normally supply oxygenated blood to
the heart muscle.

Under the Company's first indication for the Heart Laser, for which PLC
has submitted a PreMarket Approval application, the U.S. Food and Drug
Administration ("FDA") has authorized the Company to utilize the Heart Laser to
treat 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, that TMR using the Heart Laser is still in the
testing stage and that at this time no assurance can be given regarding the
ultimate safety or efficacy of the device as treatment for cardiovascular
disease.

Well over 2,500 patients have been treated with TMR using the Heart
Laser in the United States and overseas. The Heart Laser has been shipped to 19
sites in the United States and the Company had sold or placed (through December
31, 1996) 54 Heart Lasers overseas with an additional Heart Laser shipped for
clinical evaluation. 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 as an adjunct or alternative to bypass and angioplasty procedures.

Since January 1, 1996, the following accomplishments and significant
events have taken place:

PMA Application Receives "Filed" Status with the FDA. In February 1997,
the Company received notification from the FDA that its PMA application was
filed. Prior to this, the application was considered to be "submitted" and would
be evaluated as to the completeness of the data prior to making a determination
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1. The Heart Laser is a trademark of PLC Medical Systems, Inc.

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on its substance. Filing is the last essential step prior to a panel review and
approval. A PMA is considered filed with the FDA when sufficient information has
been received to allow a final substantiative review and a panel meeting. A
filed PMA with expedited review status is a top priority and should receive a
timely evaluation and panel meeting. Management believes that the Company's
Heart Laser study is the first and only PMA application for TMR to receive "
filed" status with the FDA.

Submission of Six Month Results of Controlled, Randomized Clinical
Trial. In August 1996, the Company submitted six month results of its
controlled, randomized clinical trial to the FDA comparing TMR using the Heart
Laser to medical therapy. The study covered 100 patients conducted at 12
clinical sites in the United States with approximately one half of the patients
being randomized to the group receiving TMR using the Heart Laser. The other
half of the patient group received only medical therapy. Six month results
showed that 71% of the TMR group demonstrated a decrease of at least two angina
classes while the medical therapy group remained the same or worsened. The study
also provided a direct comparison of mortality rates showing that patients
treated with TMR had a mortality rate of 6% as compared to 16% for those treated
with medical therapy.

FDA Notification of Randomization Halt. In September 1996, the Company
received notification from the FDA that the Company could halt the randomization
of patients to medical management group in its study comparing patients who
receive TMR using the Company's CO2 Heart Laser to patients receiving medical
therapy only. This decision followed the Company's submission of results of its
controlled, randomized study to the FDA in August.

Move to Expanded Facility and Increased Number of Employees. In
September 1996, the Company moved to a new 37,000 square foot facility in
Franklin, MA, increasing its manufacturing capability to 250 Heart Lasers per
year on a single shift. The number of employees both domestically and
internationally increased significantly over the prior year.

Continued Expansion of Sales and Marketing Activities. In 1996, the
Company incorporated four new international sales subsidiaries in Germany,
Switzerland, France and Singapore to further expand the Company's worldwide
sales and marketing activities. In addition, the development of a domestic sales
force was initiated with the hiring of a sales management team in anticipation
of an FDA approval of the Heart Laser.

Four International Patents Issued. During 1996, the Company was
notified that its key patent, the heart synchronization patent was issued by the
European Patent Office and by the Japanese Patent Office. In addition, two other
laser technology patents were issued, one in Japan and one in Canada.

Commencement of ISO 9001 Certification. In the spring of 1996, the
Company initiated a program to meet ISO 9001 quality standards. ISO 9001 is a
series of standards defining a quality system which is recognized
internationally and is required by the European Community in 1998. The Company
expects to receive this certification by the end of second quarter 1997.

BACKGROUND

In 1981, the Company's Chairman, Dr. Robert I. Rudko, formed Laser
Engineering, Inc. ("LEI"), now PLC Medical Systems, Inc., to commercialize the
development of sealed-off carbon dioxide ("CO2") lasers. In 1988, the San
Francisco Heart Institute advanced $250,000 to assist LEI in developing a high
powered CO2 laser which could be used for TMR on a beating heart.

In March 1991, PLC Systems Inc. ("PLC"), a publicly traded Canadian
investment company, entered into a joint venture agreement with LEI and provided
LEI with $3,000,000 in funding to continue development of the Heart Laser in
return for 22.5% of the outstanding common stock of LEI and 50% of the
outstanding common stock of Heart Laser, Inc. ("HLI"), a subsidiary of LEI
established to develop the Heart

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Laser. From February through June 1992, all of the stockholders of LEI exchanged
their securities in LEI for approximately 3,400,000 shares of common stock of
PLC, resulting in LEI and HLI becoming wholly owned subsidiaries of PLC. HLI was
merged into LEI effective January 1, 1993. LEI changed its name to PLC Medical
Systems, Inc. on January 1, 1995.

In November 1990, the Company received a Phase I Investigational Device
Exemption ("IDE") for its Heart Laser from the FDA. In granting the Phase I
study, the FDA permitted the use of the Heart Laser 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 include 201 patients at eight clinical sites. This
study has been completed and a PMA application was filed in February 1997. In
1995, the FDA granted three new IDEs for studies of TMR using the Heart Laser.
The first was a 100 patient randomized study comparing TMR patients to patients
receiving medical management. The second study is a 400 patient randomized trial
comparing TMR patients to patients receiving a second bypass surgery. The third
is a study comparing patients receiving TMR in conjunction with bypass surgery
to patients receiving only conventional bypass surgery.

Since April 1992, the Company has received nine U.S. patents relating
to the underlying laser technology, the use of a laser on a beating heart, the
Heart Laser handpiece, and other laser accessories. The Company also has 16 U.S.
patent applications pending that cover various aspects of the technology for the
Heart Laser and the process by which a laser is used to revascularize the
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 Act of British
Columbia, Canada on March 3, 1987 and has its principal offices and
manufacturing facilities 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
and PLC Medical Systems Asia/Pacific Pte Ltd.

CARDIOVASCULAR DISEASE AND CURRENT THERAPIES

Cardiovascular disease is the leading cause of death in the U.S. with
more than 950,000 deaths annually. This represents over 40% of all U.S. deaths.
Over 11 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 1997 Heart and Stroke Facts Statistics
published by the American Heart Association (the "AHA"), approximately 501,000
coronary bypass operations were performed on 318,000 patients and 404,000
balloon angioplasty procedures were performed in the U.S. on 394,000 patients in
1994. 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.

Management believes TMR utilizing the Heart Laser may provide a
superior treatment for atherosclerosis which is intended to lessen the risk and
improve the results compared to more traditional treatments. TMR is designed to
be less invasive and less expensive than bypass surgery, and may avoid the
restenosis problem inherent with bypass surgery and balloon angioplasty by not
targeting the coronary arteries for treatment.

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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. 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. Current
methods of bypass surgery typically cost between $25,000 to $45,000 and requires
prolonged hospitalization and extensive recuperation periods. Certain patients
are not suitable for bypass procedures, including those who have previously
undergone bypass surgeries, 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
inserted into a diseased artery. 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. 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. Newer
angioplasty-type treatment includes atherectomy devices and stents. Atherectomy
involves the use of a catheter that contains a rotating mechanical device to
cut, grind away and remove the plaque. Metallic stents are inserted into the
artery to permanently dilate the vessel.

In addition to the more conventional treatment described above, there
are a number of newer treatments and therapies including minimally invasive
direct coronary artery bypass ("MIDCAB") and "trap door" coronary bypass. Some
of these techniques may offer certain improvements in relation to conventional
bypass treatments. Management believes that TMR can be used in conjunction with
these less invasive procedures to more effectively revascularize the heart
muscle.

TMR UTILIZING THE HEART LASER

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 the Heart Laser 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, oxygen-rich blood cannot supply the metabolic demand
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 vessel
ischemic heart disease is typically treated with bypass surgery.

During the TMR procedure, the patient is given general anaesthesia. An
incision is made in the patient's side between the ribs, exposing the heart. The
laser's output is computer synchronized with the patient's heartbeat, firing
when the left ventricle is filled with blood and is electrically insensitive.
The Company believes that synchronization minimizes arrhythmia (irregular heart
beat) and associated morbidity and mortality. In fact, research studies
conducted by the Texas Heart Institute indicated that failure to synchronize may
lead to an 18 time increase in life threatening arrhythmia. The synchronization
is covered

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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. The Heart
Laser is capable of drilling a transmural channel in less than 0.05 seconds in a
patient whose heart has not been stopped and who has not been placed on a heart
lung 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. Transesophageal (TEE) ultrasound is used to determine that complete
channels are made by the laser. Generally, 20-40 new channels are drilled during
the procedure to create new alternative channels for blood flow to the ischemic
heart muscle. 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 Phase II
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 of other reasons. This
mortality rate is well within the mortality range for second bypass surgery
despite the fact that the TMR patients were 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 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. For this study,
the FDA authorized a 350 patient enrollment at 20 clinical sites. 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 198 patients
randomized into the study, 97 patients have received TMR treatment and 101 were
placed in the control arm of the study. Three of the 97 TMR patients died within
30 days of the surgery. As of March 1997, nine TMR patients died during the 12
month follow-up period. An additional three TMR patients died of other reasons.
As of March 1997, 18 of the 101 patients randomized to the medical management
group died.

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, these patients are
followed informally. In fact, one of the early patients remains angina free six
years following the TMR procedure. Recent technical advances in echocardiography
technology has 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 which showed that the TMR channels
were still open after three and twelve months. These channels were active and
collateral growth (growth of new blood vessels) had occurred.

Under the most recent FDA protocols, patient selection for the TMR
procedure has been expanded to include patients, who while still challenging to
treat are not necessarily considered end-stage coronary artery disease patients.
The new FDA protocols include expanded applications for TMR (in lieu of repeat
bypass surgery or in conjunction with a bypass surgery). Internationally,
doctors have regularly been performing the TMR procedure in conjunction with
traditional as well as MIDCAB bypass surgery. In certain countries in the Middle
East, TMR is being employed as a first line intervention in the treatment of
coronary artery disease.

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POTENTIAL BENEFITS OF TMR

Based on clinical results to date, the Company believes that TMR using
the Heart Laser provides a number of benefits, although no assurance can be
given that any of the mentioned benefits will be received by patients and no
assurance can be given that the FDA will approve the Heart Laser. These
anticipated benefits include:

Potentially a Third Revascularization Option. In the future, TMR may be
used on patients as an option to bypass or angioplasty procedures.

Therapy for Patients Not Suitable for Coronary Bypass. TMR may allow
patients who 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. 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" procedure where coronary artery bypass graft
surgery is performed on a beating heart, management believes that TMR will 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" procedure usually
is only performed on the anterior wall of the heart.

Potentially Lower Medical Costs. Management believes the medical costs
associated with TMR using the Heart Laser will be less than the costs of
traditional bypass surgery which requires a larger surgical team, more
supporting equipment and a longer hospital stay. Management currently estimates
that the total cost for the TMR procedure will be approximately half of the cost
of bypass surgery. 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. Since TMR using the Heart Laser is less
invasive and does not involve stopping and starting the heart, the patient may
recover more quickly than if conventional bypass techniques were used, with
potentially reduced risk of complications compared with the risks associated
with bypass surgery.

Potentially Minimally Invasive Surgery. Management believes that
development of a thoracoscopic delivery device, which is currently being tested,
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. 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. Management expects to
submit an application for an IDE to study the results of TMR on transplant
patients suffering from chronic rejection atherosclerosis.
Presently, the only treatment for this condition is re-transplantation.

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DEVELOPMENT OF MARKETING STRATEGY

The Company's strategy is to establish TMR using the Heart Laser as an
appropriate means of treating patients suffering from atherosclerosis.
Currently, the Heart Laser is an investigational device in the U.S. and cannot
be marketed as a commercial product. The Heart Laser is commercially available
outside the U.S. with the exception of Japan, Australia and certain countries in
Southeast Asia, where governmental approval for commercialization is also
required.

The Company has also developed a number of single use surgical products
to be used with the Heart Laser 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 handpieces have been incorporated under the IDE with
the Heart Laser. In addition, the Company is seeking patent protection on these
handpieces.

The Company has developed a marketing strategy to address the
difficulties of marketing high dollar capital equipment. In markets with minimal
credit risk, economic stability, where health care is reimbursed, and where
government regulations permit, the Company intends to market TMR on a usage
basis whereby the hospital would receive a Heart Laser for an installation
charge and would pay the Company for the use of the machine each time a TMR
procedure is performed. The use of the machine would be subject to contractual
yearly minimums for a defined period of time with renewal options. The Heart
Laser would remain the property of the Company and would be depreciated.
Repairs, maintenance, upgrades and disposables would be the responsibility of
the Company. The Company refers to this approach as a placement contract. In
unstable economic markets where credit risks are high, the Company's plan would
be to sell the Heart Laser outright as capital equipment. The disposable sterile
kits would be sold for each procedure, along with yearly maintenance contracts
after expiration of the applicable warranty period. There is no single retail
price for the Company's Heart Laser. The Company has several different marketing
strategies to sell this product line depending upon the particular
circumstances, including direct sales, sales through distributors and placement
(leasing) type sale. Pricing varies depending upon the particular marketing
strategy used and the country in which the Heart Laser is sold.

United States. The Company's strategy is to obtain PMA approval from
the FDA for the Heart Laser initially for patients who are not suitable for
bypass surgery or other interventions. The Company submitted its PMA application
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.
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 be
received. While this PMA application is being evaluated by the FDA, the Company
expects to continue to study the effectiveness of the Heart Laser for other
indications. In the second quarter of 1995, the Company received clearance to
conduct a randomized clinical trial on 400 patients who would normally be
treated with a repeat bypass surgery. The Company also recently received
clearance to conduct a patient feasibility study comparing patients who receive
TMR in conjunction with bypass surgery to patients who receive only a
conventional bypass surgery. Additional IDE's to study TMR on transplant
patients and to study TMR performed through a thoracoscope are anticipated for
the near future. As these studies are completed, the Company will submit the
results to the FDA as a PMA supplement to expand the approved indications for
the Heart Laser. The Company hopes to eventually request FDA clearance to use
the Heart Laser as an alternative treatment for first bypass or angioplasty
patients, although no assurance can be given that such FDA approval will be
granted. (See "Government Regulation")

The Company presently intends to utilize a direct sales force in the
United States to market the Heart Laser to hospitals. In the fourth quarter of
1995, the Company hired a Vice President of Sales and Marketing for the
Americas, a sales management team was hired in the fourth quarter of 1996 and a
launch campaign is currently being established in anticipation of an FDA
approval of the Heart Laser.

9

International. The Company currently markets its Heart Laser 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
throughout Europe and the Middle East. In the fourth quarter of 1996, the
Company incorporated two additional subsidiaries in Switzerland and France. All
of the European subsidiaries include sales, service and clinical support
personnel.

PLC received the CE Mark for the Heart Laser in the third quarter of
1995. The CE Mark indicates that a product conforms to mandatory European safety
and efficacy requirements. The approval allows the Company to sell the Heart
Laser commercially in all European Community countries. In the spring of 1996,
the Company began to pursue ISO 9001 as set out by the International Standards
Organization which will be required by the European Community in 1998.

The Company hired a Managing Director for the Far East and Australia in
February 1995 to increase sales and marketing efforts of the Heart Laser in this
part of the world through both direct sales and the use of distributors. In the
third quarter of 1995, the Company signed a distributor agreement with IMATRON
Japan to manage, fund and distribute the Heart Laser in accordance with Ministry
of Health and Welfare ("MHW") clinical trials to be conducted in Japan. IMATRON
Japan has informed the Company that the earliest MHW approval would occur, if at
all, is in late 1997. IMATRON Japan is just one among several distributors
working with PLC in the Asia/Pacific territory. The Company incorporated a
subsidiary in Singapore in the fourth quarter of 1996 to handle sales and
service for that area of the world.

As of December 31, 1996, the Company had shipped 55 Heart Lasers to the
international markets which include 32 to the Europe and Middle East, 19 to the
Asia/Pacific and four to South America. Foreign sales may be subject to certain
risks, including foreign medical, electrical and safety regulations, export and
import restrictions, tariffs and currency fluctuations.

CUSTOMERS

The Company operates in one industry segment: the development,
manufacture and sales of medical lasers and related products. No one customer
accounted for more than 10% of revenues in Fiscal 1996, one customer accounted
for more than 43% of revenues in Fiscal 1995 and approximately 30% of product
revenues in Fiscal 1994 came from two customers accounting for 16% and 14% of
total revenues. In 1995, the customer, the Company's exclusive distributor in
Japan, purchased six Heart Lasers. In 1994, one customer purchased a Heart Laser
directly from the Company and the second customer was a distributor purchasing
two Heart Lasers. Management does not believe that the possible lack of future
relationships with any of these customers will have a material adverse effect on
future 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.

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
single sourced, management has entered into exclusive supplier agreements which
provide access to technologies, processes and bills of material to enable the
Company to 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 good
manufacturing

10

practices ("GMP") compliance inspections conducted by the FDA. The Company's
business is not subject to seasonal fluctuations.

GOVERNMENT REGULATION

The Heart Laser, 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 the clinical testing, manufacture, 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, 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.

The Heart Laser requires a PMA. The first step in the PMA application
process is 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.

After submitting an IDE application with the FDA in March 1990, the
Company received agency permission to conduct a Phase I clinical evaluation of
the Heart Laser in November 1990, although TMR procedures using the Heart Laser
were conducted with the FDA's consent as early as January 1990. 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 at Seton Medical Center in Daly City,
California. The Company submitted a Phase II supplement with the FDA in December
1991, which was allowed in April 1992. Under Phase II, up to 16 sites were
permitted to use the Heart Laser which lead to the treatment of 201 patients
with TMR, rather than the one site used for Phase I on 15 patients. The Phase II
study protocol involved patients who suffer from severe coronary artery disease
and who were not candidates for conventional CABG or angioplasty procedures. The
sites for Phase II testing are sites which perform a large number of open heart
procedures and are experienced in taking part in clinical trials.

In May 1995, the Company received expedited review status for its PMA
application. 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 July of 1995, the Company began a randomized control study comparing
TMR with the Heart Laser to continued medical therapy on end stage cardiac
patients (Phase III). The FDA permitted this study to be carried out at up to 20
sites with enrollment of 350 patients. Based on the early results of this study
submitted to the FDA in August of 1996, the FDA ended the randomization of the
Phase III study in September 1996 allowing all future patients enrolled to
receive TMR with the Heart Laser.

In December 1996, the Company submitted an amendment to its PMA
application to update and close the Phase II study with twelve month follow up
on all enrolled patients (201) as well as including all the most current data on
all patients enrolled in the Phase III study. On February 18, 1997, the FDA
filed the Company's PMA as it determined that adequate information had been
submitted to allow a substantive review and to commit its resources to this
review through the remaining review process.

The Company intends to submit future Heart Laser improvements to the
FDA under IDE or PMA supplements. PMA supplements require the submission of the
same type of information as required for a PMA application, but because the
supplements need only contain sufficient information to support the change, they
generally are more brief and the FDA attempts to act upon them in a shorter
period of time,

11

usually without an advisory panel review. However, the FDA may require full
review and no assurance can be given that approval from the FDA will be received
on a timely basis, if at all.

International shipments of investigational medical devices are subject
to FDA export requirements. In September 1995, the Company received the CE Mark
under the European Medical Device Directive. The CE certification was forwarded
to the FDA whereupon the FDA granted the Company permission to export the Heart
Laser to any country within the European Community. For all other countries to
which the Company wishes to export the Heart Laser, it must first obtain
documentation from the medical device regulatory authority of such country
stating that the sale of the device is not in violation of that country's
medical device laws. This documentation is then submitted to the FDA with a
request for a permit for export to that country. The regulatory review process
varies from country to country. Through December 1996, the Company received
permission to ship the Heart Laser into 27 countries and continues to obtain
approval to ship into new foreign countries according to all the requirements of
the FDA and the new host country.

The Company is also required to register with the FDA as a device
manufacturer and to list its devices. As such, the Company is subject to
inspection on a routine basis for compliance with the FDA's GMP 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. The last such inspection occurred on October 3, 1988. The
Company anticipates that future GMP inspections may be more frequent and more
rigorous. Further, the Company is required to comply with various FDA
requirements for labeling. 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, 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 REIMBURSEMENTS

Heath care providers, such as hospitals and physicians, that purchase
medical devices such as the Heart Laser for use on their patients generally rely
on third party payors, 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 as Category B for the Health Care Financing Administration ("HCFA"),
the agency responsible for administering the Medicare program. This
classification meant that procedures performed with the Heart Laser 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 noncoverage instruction for
TMR based upon its belief that scientific evidence substantiating the safety and
effectiveness of TMR is not currently available. It is not unusual for HCFA to
deny reimbursement for procedures performed using devices which have not yet
received FDA approval. The noncoverage instruction will apply to procedures
performed on or after May 19, 1997 on Medicare beneficiaries. The Company has
been actively working with HCFA staff to seek

12

withdrawal or postponement of the noncoverage instruction. HCFA has agreed to
look at the Company's safety and effectiveness data at the time of the FDA panel
review.

The Company believes, although no assurance can be given, that FDA
approval may be granted this summer, and that the data submitted to support an
FDA approval may warrant a withdrawal of the noncoverage instruction made by
HCFA. The Company is not sure if any reversal in the coverage instruction will
be product specific to the Heart Laser or industry-wide for TMR. The Company is
also discussing the benefits of TMR and the potential adverse effects of HCFA's
noncoverage instruction on the Medicare population with selected members of
Congress.

Even if a device has FDA clearance, Medicare and other third party
payors may deny coverage if they conclude that TMR is not both reasonable,
necessary and/or cost-effective. 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. The Company believes that private
insurance companies and HMO's have already made reimbursement for TMR procedures
performed in some cases during its Phase II clinical trial. 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 the Heart Laser to date. The Company maintains
product liability insurance with aggregate coverage limits of $4 million. No
assurance can be given that product liability claims will not exceed such
insurance coverage limits, which could have a material adverse effect on the
Company, or that such insurance will be available at 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 eleven U.S. patents, of
which nine involve the Heart Laser 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). 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 the Heart Laser 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 the Heart Laser handpiece. The eleventh patent, which was issued in
April 1997, provides patent protection until 2014 and relates to the lens cell
for the Heart Laser. The Company also has 13 U.S. patent applications pending
relating to the Heart Laser handpiece, other technology used in the Heart Laser,
technology associated with minimally surgical techniques and technologies
associated with percutaneous TMR.

13

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. Additional Japanese issued patents cover 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 30 patents pending related to the Heart Laser and its components in
various international patent offices. The Company intends 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, although there can be no assurance that any additional patents will
be issued.

In September 1996, CardioGenesis Corporation, ("CardioGenesis") filed a
civil lawsuit in the United States District Court seeking to have 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 answer and counterclaim alleging that CardioGenesis infringes
on this patent. (See "Item 3. Legal Proceedings")

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 German courts
alleging infringement of its synchronization patent. (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.

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 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, the Company 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. (See "Item 3. Legal
Proceedings")

The Company believes that trademarks may be important to its business.
The Company has a U.S. registered trademark for "THE HEART LASER AND DESIGN"
which was issued on December 19, 1995 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, the

14

Company has three pending U.S. trademark applications for "TMR and DESIGN",
"HEART DESIGN" and "TMR TRANSMYOCARDIAL REVASCULARIZATION and Design" which were
filed on July 13, 1995, July 20, 1995 and July 24, 1995 respectively. There is
one pending foreign trademark application for "THE HEART LASER AND DESIGN" in
Germany.

COMPETITION

Many treatments are available for coronary artery disease. The Company
believes that if the Heart Laser receives approval for expanded indications, the
Heart Laser may be able to successfully compete with some of these technologies.

The Company is aware of several other companies who have entered the
TMR market or have announced their intention to enter the TMR market. Most of
these companies are using holmium lasers, two are using an excimer laser and the
third company recently announced its intention to develop a CO2 laser for TMR.
Most of these companies are in the early stages of clinical tests or in the
development of clinical testing. To date, the Company is not aware of any
published, peer reviewed results suggesting that either of these laser sources
are effective in performing TMR on humans. 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")

Several of the companies who have entered the TMR market are developing
percutaneous methods of performing TMR. To date, the Company is not aware of any
published, peer reviewed results suggesting that these approaches are effective.
The Company is currently developing a proprietary percutaneous program using a
CO2 laser.

The Company believes that the primary competitive factors in the
medical treatment of coronary artery disease are clinical efficacy, product
safety and reliability, 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 advanced technology, 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 would be the first FDA
approved TMR device and should enjoy a significant 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.

If the FDA grants a PMA for TMR using the Heart Laser, the 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 the Heart Laser, if approved for general sale by the FDA, will
compete primarily with conventional coronary bypass, balloon angioplasty and new
coronary procedures (including atherectomy, laser angioplasty and metallic
stents). Many of the companies manufacturing these devices 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 the Heart Laser, and may be more

15

successful than the Company in manufacturing and marketing their products. No
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 and advance existing 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 $2,835,000, $2,246,000 and
$2,211,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
Although the initial design of the Heart Laser is now completed, management
expects to continue to refine the Heart Laser design, to develop new less
invasive methods for use of the Heart Laser in 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 its leadership position in this marketplace.

EMPLOYEES

As of March 28, 1997 the Company had 64 full-time domestic employees,
including its executive officers. Of these, 13 are employed in general and
administrative activities, nine are involved in sales and marketing, 17 are
involved in research and development and 26 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 17 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 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. (See
"Propietary Processes, Patents, Licenses and Other Rights")

In September 1996, CardioGenesis Corporation, ("CardioGenesis") filed a
civil lawsuit in the United States District Court seeking to have 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 answer and counterclaim alleging that CardioGenesis infringes
on this patent. The counterclaim seeks both injunctive relief and monetary
damages against CardioGenesis. (See "Propietary 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 German courts
alleging infringement of its synchronization patent. (See "Propietary Processes,
Patents, Licenses and Other Rights")

16

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.

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 April 9, 1997 the closing sale price
of the Company's Common Stock as reported by the AMEX was $17.50 per share.

For the periods indicated, the following table sets for the range of
high and low sale prices for the Common Stock as reported by AMEX from January
1, 1995.

SALES
HIGH LOW
1995

First Quarter ....................................... $6.25 $3.58
Second Quarter....................................... $11.88 $5.63
Third Quarter ....................................... $20.63 $12.25
Fourth Quarter ...................................... $20.38 $15.00

1996

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 ........................................ $27.63 $16.63
Second Quarter (through April 9, 1997)................ $19.38 $17.25

As of March 31, 1997, there were approximately 596 record holders of
the Company's Common Stock. Management believes that there are approximately
4,000 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.

ITEM 6. SELECTED FINANCIAL DATA.

17

The following selected financial data with respect to the Company for
the five years ended December 31, 1996, 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.

18

SELECTED FINANCIAL DATA
(ALL AMOUNTS ARE IN THOUSANDS EXCEPT PER SHARE DATA)
For the years ended December 31

1996 1995 1994 1993 1992(a)
---- ---- ---- ---- -------
STATEMENT OF OPERATIONS DATA:

Revenue:
Product sales................. $ 9,082 $11,938 $ 5,068 $ 3,322 $ 2,431

Placement and service fees.... 2,790 1,407 111 -- --

Costs and Expenses:
Cost of product sales......... 2,911 4,177 2,851 2,982 2,096

Cost of placement and service fees 1,155 386 17 -- --

Selling, general and administrative 7,023 5,035 3,030 2,637 2,712

Research and development ..... 2,835 2,246 2,211 1,930 910

Write-off of purchased technology -- -- -- -- 24,287

Write-off of royalty interest. -- -- -- -- 375
------------ ------------- -------------- ------------- ------------

Income (loss) from operations. (2,052) 1,501 (2,930) (4,227) (27,949)

Other income (expense)........ 512 588 366 254 (187)
---------- ---------- ----------- ---------- -----------

Income (loss) before income taxes (1,540) 2,089 (2,564) (3,973) (28,136)

Provision for income taxes.... -- 85 -- -- --
------------ ----------- -------------- ------------- --------------

Net income (loss)............. $(1,540) $ 2,004 $(2,564) $(3,973) $(28,136)
======== ======== ======== ======= ========

Net income (loss) per share.. $ (.09) $ .12 $ (0.18) $ (0.31) $ (2.76)
========== ========== ========= ======== ==========

Shares used to compute net
income (loss) per share...... 16,376 16,590 14,372 12,868 10,189

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

(a) The Statement of Operations for the year ended December 31, 1992 reflects
the acquisition of Laser Engineering, Inc. ("LEI") as of March 6, 1992, using
the purchase method of accounting. Due to the acquisition of LEI, there was a
write-off of purchased technology which increased the net loss per share in that
year by $2.38.

AS OF DECEMBER 31

1996 1995 1994 1993 1992
---- ---- ---- ---- ----

BALANCE SHEET DATA:

Working capital ............... $11,245 $13,541 $12,431 $5,873 $4,702

Total assets................... 19,417 18,290 14,337 7,595 6,806

Long term obligations.......... 27 32 7 14 15

Stockholders' equity .......... 16,467 15,508 13,059 6,658 5,380

19

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

OVERVIEW

The Company was formed in 1987. In March 1991, the Company acquired a
22.5% interest in Laser Engineering, Inc. ("LEI") and a 50% interest in LEI's
subsidiary, Heart Laser, Inc. ("HLI"). From March 1991 to March 1992, the
Company's principal business activity was its investment in LEI and HLI. In
March 1992, the Company acquired the remaining shares of LEI in exchange for
shares of the Company. HLI was merged into LEI on January 1, 1993. LEI changed
its name to PLC Medical Systems, Inc. on January 1, 1995.

Prior to Fiscal 1994, a significant portion of the Company's product
sales, gross profit and operating expenses was related to its general purpose
CO2 surgical lasers, laser components and related accessories. The Company
exited this part of its surgical laser business by the end of 1995 to focus its
full resources on the Heart Laser. The exit strategy included fulfilling
existing contracts and orders, and a sale of technologies associated with a part
of this business.

The Company has two marketing strategies for selling the Heart Laser and
its related products; placement and sales. In countries where health care is
reimbursed by the government or by private insurers, the Company's strategy is
to be reimbursed for the use of the Heart Laser on a per procedure basis under a
contractual agreement whereby the customer commits to a minimum number of
procedures on a yearly basis. These contracts typically run for a minimum of
three years and allow for the customer to exceed the contractual minimums. These
contracts, referred to as placement contracts, are preferred to the sale
strategy as the Company believes that the potential revenue stream is greater
and more profitable. Sterile handpieces and other disposables are included in
the per procedure fee.

In countries where health care is not reimbursed by the government or
insurance, or where credit risk is high, the Heart Laser is sold as capital
equipment and the related sterile handpieces and other disposables are sold
separately for each procedure. The Company sells Heart Lasers directly and
through distributors. These sales are classified as product sales.

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

Total revenues 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 were 30 units shipped, 13 of which were sales, as
compared with 23 shipped in 1995, 15 of which were sales. In addition, in 1995,
the Company had a significant sale to a distributor IMATRON Japan ("IMATRON") of
six Heart Lasers at approximately $5.7 million. In 1996, the Company did not
have a comparable contract with IMATRON or any other distributor.

Placement and service fees of $2,790,000 for the year ended December 31,
1996 increased 98% over placement and service fees of $1,407,000 for the year
ended December 31, 1995 which reflects an increase in the number of Heart Lasers
under placement contracts. In 1996 the Company had a total of 27 Heart Lasers
under placement contracts as compared with a total of 11 in 1995.

20

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. During the year ended December 31, 1995,
the Company expensed certain inventory related with the exit strategy of its
general purpose CO2 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.

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 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 for the year ended December 31, 1996 of
$1,540,000 when compared 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 1996 related to both international
and domestic expansion.

The $.09 loss per share for the year ended December 31, 1996 was
calculated using only the weighted average number of shares outstanding during
the year. Earnings per share of $.12 for the year ended December 31,1995 was
calculated using the weighted average number of shares outstanding during the
year plus common stock equivalents which consisted of stock options granted to
employees and stock warrants

21

granted to underwriters and placement agents associated with the Company's 1992
public offering and 1994 directed public offering.

YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994

Total revenues of $13,345,000 for the year ended December 31, 1995
increased $8,166,000 or 158% when compared to total revenues of $5,179,000 for
the year ended December 31, 1994. For the year ended December 31, 1995, product
sales of $11,938,000 increased $6,870,000 or 136% when compared to product sales
of $5,068,000 for the year ended December 31, 1994. This increase was the result
of the sale of six Heart Lasers approximating $5.7 million to IMATRON Japan
("IMATRON"). IMATRON is responsible for all matters related to obtaining full
Ministry of Health and Welfare approval in Japan which requires clinical trials
similar to those required by the Food and Drug Administration ("FDA") in the
United States. The Company reported a net loss of $2,564,000 for the year ended
December 31, 1994.

Placement and service fees of $1,407,000 for the year ended December 31,
1995 increased $1,296,000 over placement and service fees of $111,000 for the
year ended December 31, 1994. The first placement contracts were initiated in
the fourth quarter of 1994 at two hospitals for less than three months in the
1994 fiscal year. At December 31, 1995, there were a total of eleven placement
contracts covering time frames ranging from one month to the full fiscal year.
The Company also started selling service contracts in the year ended December
31, 1995 which generated approximately $70,000 in revenues for the year.

Total gross profit increased to $8,782,000 or 66% of total revenues for
the year ended December 31, 1995 as compared with $2,311,000 or 45% of total
revenues for the year ended December 31, 1994. Gross profit on product sales
increased to $7,761,000 or 65% of product sales for the year ended December 31,
1995 from $2,217,000 or 44% of product sales for the year ended December 31,
1994. The significant increase both in dollars and in percentage reflects the
significantly higher gross margins related to the IMATRON contract coupled with
the positive impact of certain fixed overhead costs being leveraged over
increased production.

Gross profit on placement and service fees of $1,021,000 for the year
ended December 31,1995 increased $927,000 when compared to $94,000 for the year
ended December 31, 1994. These increases reflect the eleven placement contracts
in effect for time frames ranging from one month to a full fiscal year in 1995
as compared with two placement contracts in effect for less than one quarter in
Fiscal 1994.

Selling, general and administrative expenses of $5,035,000 for the year
ended December 31, 1995 increased $2,005,000 or 66% when compared with
$3,030,000 for the year ended December 31, 1994. The majority of this increase
is the result of expanded sales operations in Europe and Asia Pacific which
accounted for approximately $1,313,000 or 65% of the increase coupled with
increased salary expense related to expanded staffing domestically, increased
legal expenditures associated with contract negotiations and increased
consulting expenses associated with investor and public relations.

Research and development expenditures of $2,246,000 increased $35,000 or
2% for the year ended December 31, 1995 when compared with $2,211,000 for the
year ended December 31, 1994. This small increase is the result of the offset
between expanded scientific subsidies, which increased approximately $400,000,
reduced by the transfer of personnel and their related expenses from research
and development into operations. This departmental transfer reflects the
evolution of the Heart Laser from a research product to a full production
product.

Other income of $588,000 for the year ended December 31, 1995 increased
$222,000 or 61% when compared to $366,000 for the year ended December 31, 1994.
This increase is the result of higher interest income due to higher cash
balances throughout 1995 as compared to 1994.

22

Although the Company has sufficient net operating loss carryforwards to
offset income taxes for 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. There
was no provision for income tax for the year ended December 31, 1994 due to the
net loss of $2,564,000.

Net income of $2,004,000 for the year ended December 31, 1995 reflects
the positive impact of the IMATRON contract which resulted in the Company's
first profitable year. IMATRON is the Company's exclusive distributor for the
Japanese market which is the second largest medical market in the world.

Earnings per share of $.12 for the year ended December 31,1995 was
calculated using the weighted average number of shares outstanding during the
year plus common stock equivalents which consisted of stock options granted to
employees and stock warrants granted to underwriters and placement agents
associated with the Company's 1992 public offering and 1994 directed public
offering. The $.18 loss per share for the year ended December 31, 1994 was
calculated using only the weighted average number of shares outstanding during
the year.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1996, the Company had cash and cash equivalents of
$3,039,000 and short-term investments of $5,470,000.

During the year ended December 31, 1996, the Company received
approximately $2,500,000 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 resulted 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.

During the year ended December 31, 1995, the Company received
approximately $399,000 in proceeds from the exercise of stock options, which
includes a tax benefit relating to those options, and $69,000 from the repayment
of shareholder loans. An additional $1,400,000 of cash resulted from the
maturities of short term investments which were not reinvested. Cash used in
operating activities approximated $3,200,000 principally related to its
$5,700,000 outstanding receivable from IMATRON, which was collected in January
1996, offset by investments in inventories and increased current liabilities
which include scientific subsidies. Approximately $1,600,000 was used to acquire
capital equipment, principally Heart Lasers used for placement contracts.

In February 1997, the Company's PreMarket Approval application
("PMA")was filed by the FDA. The Company believes this to be the final stage of
a definitive process toward FDA approval, which is anticipated to occur in 1997.
With this expectation of FDA approval, the Company is preparing to increase its
production requirements, sales and marketing efforts and overall operating
expenses. In order to be well positioned to meet these upcoming demands and the
short term cash flow requirements under the placement

23

strategy, the Company is currently exploring both debt and equity opportunities.
Unanticipated decreases in operating revenues, increases in expenses, or a 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.

The Company believes that periodic operating losses are possible until
after such time as the Company receives its PMA from the FDA for the Heart
Laser. The Company submitted its PMA application in April 1995. Although the
Heart Laser has been granted "expedited review" status by the FDA, given the
current uncertainties of the time required by the FDA to approve a PMA
application, the Company cannot project when, if at all, such approval would be
granted. Until PMA approval, future profitability will likely be determined by
the number of international shipments and the related mix of sales and
placements. In February 1997, the Company's PMA application was filed by the
FDA. The filing of this expedited PMA application indicated that the FDA is
prepared to prioritize and commit its resources to this application through the
remaining review process. No assurance can be given that a PMA approval will be
granted in 1997, if at all. 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. No assurance can be given that the Company
will be successful in marketing the Heart Laser or that the Company will be able
to operate profitably on a consistent basis.

At December 31, 1996 the Company had U.S. net operating loss
carryforwards available to reduce future taxable income which expire at various
dates through 2010, and the Company had foreign net operating carryforwards of
approximately $1.2 million. In addition, various other deferred tax assets have
been generated related primarily to intercompany profit, accruals, and research
and development tax credits.

Since the Company believes that as of December 31, 1996 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.

NEW ACCOUNTING PRONOUNCEMENT

None

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.

In July 1995, the Board of Directors of PLC Systems Inc. engaged Ernst
& Young LLP to audit the accounts of the Company for the fiscal year ending
December 31, 1995. Prior to the engagement of Ernst & Young, the Company had
retained Coopers & Lybrand as its independent accountants. In July 1995, the
Company requested that Coopers & Lybrand resign from the engagement. The
resignation of Coopers & Lybrand as the Company's independent accountants was
approved by the Company's Board of Directors based on a recommendation from the
accountants committee. Coopers & Lybrand complied with the resignation request.

There were no disagreements between the Company and its former
independent accountants regarding any matters of accounting principles or
practices, financial statement disclosure or auditing scope or procedures in
connection with the audit of each of the Company's fiscal years in the period
January 1, 1991 through December 31, 1994 or at any time subsequent thereto and
prior to such dismissal, which would have caused Coopers & Lybrand to make
reference to the subject matter of such disagreement in connection with its
report. There had been no "reportable events" (as defined by Regulation S-K Item
304(a) (1)(v)) during the period from January 1, 1991 through December 31, 1994
and during the period since December 31, 1994. In addition, the Company had not
consulted another accountant regarding the application of accounting principles
to a specified transaction.

24

The report of such independent accountants upon the Company's financial
statements for each of the Company's fiscal years in the period January 1, 1991
through December 31, 1994 contained neither an adverse opinion nor a disclaimer
of opinion nor was such report qualified or modified as to uncertainty, audit
scope or accounting principles.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS

The following table sets forth the ages of and positions and offices
presently held by each director of the Company.

CLASS TO
WHICH THE
DIRECTOR
NAME AGE POSITION BELONGS
---- --- -------- -------

Robert I. Rudko, Ph.D. 54 Chairman of the Board I
of Directors and Chief
Scientist

M. Lee Hibbs 50 President, Chief Executive II
Officer and Director

Edward H. Pendergast 63 Lead Outside Director I

Harold P. Capozzi 72 Director III

H.B. Brent Norton, M.D. 36 Director III

Kenneth J. Pulkonik 56 Director II

Roberts A. Smith, Ph.D. 68 Director III

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. Hibbs and Pulkonik are classified as Class II
directors and serve until the 1997 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.

25

The Company has agreed for five years from September 1992 to nominate
and use its best efforts to cause the election of a designee of H.J. Meyers &
Co., the Company's representative (the "Representative") in its September 17,
1992 public offering (the "Public Offering"), reasonably acceptable to the
Company for election to its Board of Directors. The Representative selected Dr.
Smith as its designee.

Under British Columbia corporate law, a majority of the Company's
directors must 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.

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 in beneficial ownership on Form 5 with the Securities and
Exchange Commission ("SEC") and any national securities exchange on which the
Company's securities are registered. Executive officers, directors and greater
than ten percent (10%) beneficial owners are required 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 representations 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 1996, except for two Form 4's representing
the sale of an agreement of 4,250 shares by Harold P. Capozzi.

COMMITTEES

The Board of Directors established an Audit Committee, a Compensation
Committee and a Nominating Committee in January 1993.

Messrs. Pulkonik and Pendergast serve as members of the Audit
Committee. The Audit Committee is concerned primarily with recommending the
selection of, and reviewing the effectiveness of, the Company's independent
auditors and reviewing the effectiveness of the Company's accounting policies
and practices, financial reporting and internal controls. The Audit Committee
reviews any transactions which involve a potential conflict of interest and the
scope of independent audit coverages, the fees charged by the independent
auditors, and internal control systems.

Dr. Smith and Mr. Pendergast serve on the Compensation Committee. The
Compensation Committee is responsible for setting and administering the policies
which govern annual compensation for the Company's executives. The Compensation
Committee negotiates and proposes to the Board of Directors compensation
arrangements for officers, other key employees, certain consultants and
directors of the Company. Following review and approval by the Compensation
Committee of the compensation policies, all issues pertaining to executive
compensation are submitted to the Board of Directors for approval.

Dr. Rudko and Mr. Capozzi serve on the Nominating Committee, which was
established for the purpose of nominating potential new directors. The
Nominating Committee will consider nominees recommended by stockholders. A
stockholder wishing to nominate a candidate should forward the candidate's name
and a detailed background of the candidate's qualifications to the Secretary of
the Company.

26

No director or executive officer is related to any other director or
executive officer by blood or marriage.

BACKGROUND

The following is a brief account of the business experience of each
director:

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.

M. LEE HIBBS. Mr. Hibbs has served as a director of the Company since
June 1994 and President and Chief Executive Officer of the Company since October
1993. From 1991 to September 1993, Mr. Hibbs was the President and Chief
Operating Officer for Electro-Catheter Corp., a publicly traded, New Jersey
manufacturer of cardiac catheters. From 1987 to 1991, Mr. Hibbs was the General
Manager of the Interventional Cardiology Division for Mallinckrodt Medical,
Inc., a division of publicly traded Mallinckrodt Group, a company that
manufactures medical products and animal products. From 1985 to 1987, Mr. Hibbs
was the Business Development and Marketing Manager, and from 1983 to 1985, Mr.
Hibbs was a Product Manager, for the USCI International Division of C.R. Bard
Inc., a publicly traded manufacturer of medical products. Prior to 1983, Mr.
Hibbs held various sales and sales management positions in the surgical
instruments, life support systems equipment, medical disposables and
pharmaceuticals industries.

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 acting Chief
Executive Officer of Symbus Technology, Inc., 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 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. From 1986 to
1990, Mr. Capozzi served as the President of International Phoenix, a publicly
traded mining development company. From 1987 to 1991, Mr. Capozzi was a director
for Pineridge Capital Group Inc., a publicly traded venture capital company.
From 1989 to 1991, Mr. Capozzi served as a director for International Pastel
Food Corporation, a publicly traded food franchise company. He also served as a
director for Consolidated General Western Industries Inc., a publicly traded
holding company, from 1989 to 1991. From 1990 to 1991, Mr. Capozzi served as the
President of Unilens Optical Corp., a publicly traded contact lens manufacturing
company. From 1990 to 1993, Mr. Capozzi was a director of Aegis Resources Ltd.,
a publicly traded mining company. He has also served

27

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
Diagnatech Inc., a privately 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.

28

EXECUTIVE OFFICERS AND KEY EMPLOYEES

The executive officers and significant employees of the Company, their
ages and positions in the Company are as follows:

NAME AGE POSITION

Robert I. Rudko, Ph.D. 54 Chairman of the Board of Directors and Chief Scientist

M. Lee Hibbs 50 President, Chief Executive Officer and Director

Patricia L. Murphy 46 Chief Financial Officer and Treasurer

William Franks, Jr. 39 Vice President of Operations - PLC Medical

Stephen J. Linhares 40 Vice President of Research and Development and
Clinical Trials - PLC Medical

John R. Serino 49 Vice President of Sales and Marketing - PLC Medical

The following is a brief account of the business experience of each
officer and key employee of the Company, other than Dr. Rudko and Mr. Hibbs,
whose backgrounds are summarized above:

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
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.

WILLIAM S. FRANKS, JR. Mr. Franks has served as PLC Medical's Vice
President of Operations since January 1996. From 1993 to 1995, Mr. Franks served
as the Manager of Engineering Operations at Waters Corporation where he oversaw
the manufacturing of liquid chromatography instruments for medical and
pharmaceutical markets. From 1991 to 1993, Mr. Franks served as the Director of
Manufacturing and Operations at Pfizer Hospital Products Group, Infusaid, which
develops drug infusion pumps for use in chemotherapy. From 1988 to 1991, Mr.
Franks was employed by Datamarine International and Data Industrial, a
manufacturer of precision monitoring instrumentation as the Manager of
Manufacturing Engineering, Quality Control and Facilities. From 1985 to 1988,
Mr. Franks served as the Manager of Product Development and Instrument
Manufacturing Engineering at Ciba Corning Diagnostics Corporation, a
manufacturer of medical instruments. Mr. Franks also served in various
engineering and development roles with Xerox Corporation from 1980 to 1984.

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 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.

29

JOHN R. SERINO. Mr. Serino has served 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.

ITEM 11. EXECUTIVE COMPENSATION

During Fiscal 1996, the aggregate cash compensation paid or payable to
the Company's executive officers was approximately $999,415.

The following table sets forth the compensation paid to Dr. Rudko, the
Company's Chairman and Chief Scientist, Mr. Hibbs, the Company's President and
Chief Executive Officer, Patricia L. Murphy, the Company's Chief Financial
Officer, John R. Serino, PLC Medical System's Vice President of Sales and
Marketing and William F. Franks, Jr., PLC Medical System's Vice President of
Operations with respect to services rendered to the Company during Fiscal 1996,
Fiscal 1995 and Fiscal 1994.

SUMMARY COMPENSATION TABLE

Long Term
Compensation
Annual Compensation Awards
(a) (b) (c) (d) (e) (g) (i)

Securities
Name and Underlying
Principal Other Annual Options All Other
Position Year Salary(1) Bonus Compensation(3) (#) Compensation
-------- ---- --------- ----- --------------- --- ------------

Robert I. Rudko, Ph.D. 1996 $192,500 $ 38,500(1) $28,875 0 $ 0
Chairman of the 1995 $175,000 $ 84,000(1) $26,250 100,000 $ 0
Board and 1994 $132,692 $ 0 $12,193 0 $ 3,893(4)
Chief Scientist

M. Lee Hibbs 1996 $215,000 $ 43,000(1) $32,250 25,000 $ 23,540(5)
President, 1995 $195,000 $ 113,600(1) $29,250 100,000 $ 13,170(5)
Chief Executive Officer 1994 $171,665 $ 45,000(2) $ 6,000 0 $ 5,790(5)
and Director

Patricia L. Murphy 1996 $115,000 $ 23,000 $17,250 10,000 $ 0
Chief Financial 1995 $100,000 $ 15,000 $15,000 55,000 $ 0
Officer 1994 $ 83,335 $ 15,000 $ 6,000 30,714 $ 0

John R. Serino 1996 $125,000 $ 31,250 $ 6,000 50,000 $ 10,390(5)
Vice President of 1995(6) $ 4,800 $ 0 $ 0 0 $ 0
Sales and Marketing 1994(6) N/A N/A N/A N/A N/A

William F. Franks, Jr. 1996 $ 87,500 $ 11,375 $ 6,000 50,000 $ 0
Vice President of 1995(6) N/A N/A N/A N/A N/A
Operations 1994(6) N/A N/A N/A N/A N/A

30

(1) Amounts shown indicate annual cash compensation earned and received by
Dr. Rudko, Mr. Hibbs, Ms. Murphy, Mr. Serino and Mr. Franks. Executive
officers, including Dr. Rudko, Mr. Hibbs, Ms. Murphy, Mr. Serino and
Mr. Franks 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 new employment agreements which provide for
increases in the base salaries of Dr. Rudko and Mr. Hibbs from $100,000
and $160,000 to $175,000 and $195,000, respectively and benefits, to be
selected by the executive, equal to 15% of his base salary. These new
agreements, which expire on December 31, 1997, provide 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 salaries of Dr. Rudko and Mr. Hibbs increased from
$175,000 and $195,000 to $192,500 and $215,000, respectively. These
agreements also provide that each of Mr. Hibbs and Dr. Rudko may
receive a bonus, commencing 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 its
plan. In addition, Mr. Hibbs was entitled to receive a bonus of $10,000
for each $1,000,000 in net earnings before tax earned in Fiscal 1995.
Pursuant to the terms of these agreements bonuses in the amounts of
$39,000 and $84,000 were paid to Dr. Rudko and $43,000 and $113,600
were paid to Mr. Hibbs for Fiscal 1996 and 1995, respectively.

(2) During Fiscal 1994, Mr. Hibbs was entitled to receive incentive
compensation of $5,000 for each Heart Laser that the Company sold over
the first five, to a maximum payment of $50,000. In Fiscal 1994, Mr.
Hibbs received $35,000 as a result of such incentive compensation and
an additional $10,000 as a result of other incentive compensation.

(3) In Fiscal 1995, the Compensation Committee approved a benefit allowance
of up to 15% of base salary for Dr. Rudko and Mr. Hibbs. The
determination of such benefits is up to the individual. Ms. Murphy was
also given the same benefit allowance starting in Fiscal 1995. In
Fiscal 1994, the Company made monthly compensatory automobile and
insurance payments of approximately $1,016 for an automobile for Dr.
Rudko and Mr. Hibbs and Ms. Murphy each received a $500 per month
compensatory automobile allowance. In Fiscal 1996, the Mr. Serino and
Mr. Franks each received a $500 per month compensatory automobile
allowance.

(4) In Fiscal 1994, the Company paid on behalf of Dr. Rudko his share of
premiums under a $1,000,000 reverse split-dollar key person life
insurance policy, of which Dr. Rudko is a partial beneficiary.

(5) Represents payment of $23,540 in Fiscal 1996, $13,170 in Fiscal 1995
and $5,790 in Fiscal 1994 of a $42,500 moving allowance paid to Mr.
Hibbs in connection with moving expenses. In Fiscal 1996, $10,390 was
paid to Mr. Serino in connection with moving expense reimbursement.

(6) Mr. Serino joined the Company in mid December 1995 and Mr. Franks
joined the Company in January 1996.

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 1996 or is proposed to be paid

31

or distributed in a subsequent year. No other compensation was paid by the
Company to the executive officers during Fiscal 1996, 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.

The following table sets forth the options granted to the named
executive officers in Fiscal 1996.

OPTION GRANTS IN FISCAL YEAR 1996
Potential Realizable Value
at Assumed Annual Rates of
Stock Price Appreciation
Individual Grants For Option Term (5)
- ------------------------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e) (f) (g)
- ------------------------ ------------ -------------- ------------ ------------ ----------------- -------------
% of Total
Number of Options
Securities Granted to
Underlying Employees Exercise or
Options in Fiscal Base Price Expiration
Name Granted (#) Year(3) ($/Sh) Date(4) 5% 10%
- ------------------------ -------------- ------------ -------------------------- ------------------ ---------

M. Lee Hibbs .............. 25,000(1) 5% $14.88 07/16/2006 $226,000 $ 573,000

Patricia L. Murphy ........ 10,000(2) 2% $16.31 01/01/2006 $102,600 $ 260,000

John R. Serino ............ 50,000(2) 10% $16.31 01/01/2006 $513,000 $1,300,000

William F. Franks, Jr. .... 50,000(2) 10% $16.31 01/01/2006 $513,000 $1,300,000

(1) These options were granted on July 17, 1996 and vest on the earlier of
January 1, 2001 or when the PMA is received from the FDA.

(2) These options were granted on January 2, 1996 and vest in equal
installments over a three year period beginning January 2, 1997.

(3) In Fiscal 1996, options to purchase 482,250 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

32

and are not intended to forecast possible future price appreciation, if
any, of the Company's Common Stock.

The following table indicates the options that were exercised in Fiscal
1996 and sets forth the value of outstanding options held by executive officers,
directors and other employees of the Company as of December 31, 1996.

AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1996
AND FY-END OPTION VALUES

(a) (b) (c) (d) (e)
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options Options
Shares at FY-End at FY-End
Acquired Exercisable/ Exercisable/
Name on Exercise Value Realize ($) Unexercisable Unexercisable(1)(2)
---- ----------- ------------- --- ---------------- -------------------

Robert I. Rudko, Ph.D. 27,100 $303,249(3) 139,567/233,333 $2,550,990/$4,254,660

M. Lee Hibbs 25,000 $693,750(3) 341,667/158,333 $6,166,840/$2,593,410

Patricia L. Murphy 25,293 $276,362(3) 55,422/ 34,999 $1,019,640/$ 519,415

John R. Serino 0 0 0/ 50,000 $ 0/ $ 294,000

William F. Franks, Jr. 0 0 0/ 50,000 $ 0/ $ 294,000

(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 1996
($22.19) 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, 1996) and the exercise price of the options
granted. Since the fair market value at the end of Fiscal 1996 was
greater than or equal to the exercise price of the options held, all of
the options included in this table are In-the-Money.

(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 directors other than Dr. Rudko and Mr. Hibbs receives a fee
of $650 for each meeting of the Board of Directors plus reimbursement for
related travel expenses and an additional $2,000 per quarter. Eligible directors
also receive stock options pursuant to the Company's 1994 Formula Stock Option

33

Plan. 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 $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 $1,000 per day for other consulting activities
provided to the Company 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 1996 or
thereafter, except as described above.

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 and an employment agreement was entered into in October 1993
between Mr. Hibbs and the Company providing for payment of 24 months' base
salary and prior bonus to Dr. Rudko and 12 months' base salary and prior bonus
to Mr. Hibbs. The agreements were 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 or Mr. Hibbs' employment is
terminated without cause, or if Dr. Rudko or Mr. Hibbs are transferred outside
of Eastern Massachusetts or if either individual 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, these employment agreements, as
modified, provide that if either executive 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.

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.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth, as of March 31, 1997, certain
information concerning stock ownership of the Company by (i) each person who is
known by the Company to own of record or beneficially more than five percent
(5%) of the Company's Common Stock, (ii) each of the Company's directors and
(iii) all directors and executive officers as a group. Except as otherwise
indicated, the stockholders listed in the table have sole voting and investment
powers with respect to the shares indicated.

34

NUMBER
OF SHARES
NAME OF BENEFICIALLY PERCENTAGE
BENEFICIAL OWNER(1) OWNED(2) OF CLASS

Robert I. Rudko, Ph.D.(3) ........................................ 1,269,013 7.6%

M. Lee Hibbs(4)................................................... 316,667 1.9%

Edward H. Pendergast(5)(6)(7)(8).................................. 98,892 *

Harold P. Capozzi(6)(9)(10)....................................... 42,850 *

Kenneth J. Pulkonik(5)(6)(9)...................................... 65,000 *

Roberts A. Smith, Ph.D.(6)(9)(11)................................. 45,000 *

Brent H. B. Norton, M.D.(9)(12)................................... 37,000 *

Arab Banking Corporation.......................................... 747,100 4.5%

All directors and officers
as a group (11 persons).......................................... 2,087,371 12.6%
(3)(4)(5)(6)(7)(8)(9)(10)(11)(12)(13)(14)(15)

- --------------------
* Less than 1%.

(1) Each of such persons, with the exception of Arab Banking Corporation,
may be reached through the Company at 10 Forge Park, Franklin,
Massachusetts 02038. The address for Arab Banking Corporation is c/o
Hughes Hubbard & Reed, One Battery Park Plaza, New York, New York
10004.

(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 PreMarket Approval ("PMA")
of the Heart Laser 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 of the Company's stock to an acquiring party. The
figures in this table also include 39,567 shares of an option granted
on March 3, 1995 to purchase up to 72,900 shares of Common Stock at an
exercise price of $3.69 per share which fully vests 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.

35

(4) Includes 66,667 shares of Common Stock owned by M. Lee Hibbs, the
Company's Chief Executive Officer. The figures presented in the table
also include 250,000 shares of an option granted on September 23, 1993
to purchase up to 350,000 shares of Common Stock at an exercise price
of $4.25 per share which fully vests on October 12, 1998 or earlier
upon receipt of PMA of the Heart Laser 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 of the Company's stock to an
acquiring party. The options expire five years from the date on which
the options vest in full. Excludes (i) an option granted on March 3,
1995 to purchase up to 33,333 shares of Common Stock at an exercise
price of $3.69 per share, which vests on December 2, 1997 and
terminates on March 2, 2005 and (ii) an option to purchase up to 25,000
shares of Common Stock granted on July 17, 1996 at an exercise price of
$14.88 per share, which vests on the earlier of January 1, 2001 or when
the PMA letter of approval is received from the FDA and terminates on
July 16, 2006.

(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.

(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 20,000
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 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.

(10) Includes an option granted on September 16, 1993 to purchase up to
5,662 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 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.

(12) 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.

(13) Includes an aggregate of 105,715 shares owned by Patricia L. Murphy,
the Company's Chief Financial Officer, consisting of (i) 50,293 shares
of Common Stock owned by Patricia L. Murphy, the Company's Chief
Financial Officer; (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) 6,667 shares of an option granted on July 28,
1994 to purchase up to 13,333 shares of Common Stock at an exercise
price of $3.97 per share, such option vests on July 28, 1997 and
terminates on July 27, 2004; and (iv) 35,184 shares of an option
granted on March 3, 1995 to purchase up to 53,517 shares of Common
Stock at an exercise price of $3.69 per share, which vests on December
2, 1997 and terminates on March 2, 2005. Excludes an option to purchase
up to 10,000 shares of Common Stock

36

granted on January 2, 1996 at an exercise price of $16.31 per share,
which vests in equal installments over three years beginning January 2,
1997 and terminates on January 1, 2006.

(14) Includes an aggregate of 74,000 shares of Common Stock owned by Stephen
J. Linhares, the Vice President of Research and Development and
Clinical Trials of PLC Medical Systems, Inc. consisting of (i) 64,040
shares of Common Stock, (ii) 2,460 shares of an option granted on July
28, 1994 at an exercise of $3.97 per share, such option vests on
December 31, 1996 and terminates on December 31, 2003; (iii) 5,000
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,
such option vests in equal installments over three years beginning on
August 4, 1996 and terminates on August 3, 2005; and (iv) 2,500 share
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 one half upon filing of the Company's PMA
application with the FDA and one half upon receipt of the PMA from the
FDA. Such option terminates on July 16, 2006.

(15) Includes an aggregate of 33,334 shares which includes 16,667 shares of
an option to purchase up to 50,000 shares of Common Stock granted to
each of Messrs. Franks and Serino 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.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In February 1992, in connection with the acquisition of PLC Medical,
several of PLC Medical's officers and directors issued non-recourse promissory
notes (the "Notes") to PLC Medical to exercise their PLC Medical options, which
options if not exercised would otherwise have been canceled. As of December 31,
1995, $119,000 of the Notes were outstanding from the following individuals; Ms.
Murphy, the Company's Chief Financial Officer ($60,000), Mr. Linhares, PLC
Medical's Vice President of Research and Development and Clinical Trials
($50,000) and a third party who is not an officer or director ($9,000). All of
the Notes were paid during 1996.

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 1996 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.

37

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a)(1) Financial Statements. The financial statements required to be
filed by Item 8 herewith are
as follows:

PLC SYSTEMS INC. PAGE
Report of Independent Auditors..................................................... F-2
Report of Independent Accountants.................................................. F-3
Consolidated Balance Sheets as of December 31, 1996 and 1995 ...................... F-4
Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994................................................. F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1996, 1995 and 1994................................................. F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994................................................. F-7
Notes to Consolidated Financial Statements......................................... F-8

(a)(2) Financial Statement Schedules. The following financial statement schedules are filed herewith:

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.

(i) The following exhibits, required by Item 601 of Regulation S-K, are
filed herewith:

EXHIBIT
NO. TITLE
--- -----

11 Statement regarding computation of per share earnings.

21 Subsidiaries of the Registrant.

23a Consent of Coopers & Lybrand.

23b Consent of Ernst & Young LLP.

27 Financial Data Schedule.

(ii) The following exhibit was filed as part of the Company's Report on
Form 8-K filed with the Commission on July 19, 1995 and is herein incorporated
by reference:

38

EXHIBIT
NO. TITLE

16 Letter from Coopers & Lybrand to the Securities and Exchange
Commission dated July 18, 1995 confirming certain disclosures.

(iii) 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** Revised Form of Key Employee Agreement for Dr. Robert I. Rudko.

10b** Revised Form of Key Employee Agreement for M. Lee Hibbs.

10c** 1995 Stock Option Plan.

(iv) 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** 1993 Stock Option Plan.

10b 1993 Formula Stock Option Plan.

(v) 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.

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

** These exhibits relate to executive compensation plans and arrangements.

39

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 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.

PLC SYSTEMS INC.

Date: April 15, 1997 By: /s/ Robert I. Rudko, Ph.D.
-----------------------------------
Robert I. Rudko, Ph.D.
Chairman of the Board of Directors
and Principal Executive Officer

PURSUANT 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.

Name Capacity Date
---- -------- ----

/s/ Robert I. Rudko, Ph.D. Chairman of the Board of Directors April 15, 1997
- ------------------------------------------
Robert I. Rudko, Ph.D. (Principal Executive Officer)

/s/ Patricia L. Murphy Chief Financial Officer April 15, 1997
- ---------------------------------------------
Patricia L. Murphy (Principal Financial and Accounting
Officer)

President and Chief Executive Officer April 15, 1997
- ----------------------------------------------
M. Lee Hibbs

/s/ Harold P. Capozzi Director April 15, 1997
- ---------------------------------------------
Harold P. Capozzi

/s/ H.B. Brent Norton, M.D. Director April 15, 1997
- ----------------------------------------
H.B. Brent Norton, M.D.

/s/ Edward H. Pendergast Director April 15, 1997
- ------------------------------------------
Edward H. Pendergast

/s/ Kenneth J. Pulkonik Director April 15, 1997
- --------------------------------------------
Kenneth J. Pulkonik

/s/ Roberts A. Smith, Ph.D. Director April 15, 1997
- -----------------------------------------
Roberts A. Smith, Ph.D.

40

PLC SYSTEMS INC.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1996, 1995, 1994

PLC SYSTEMS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGE

Report of Independent Auditors.........................................................................F-2

Report of Independent Accountants......................................................................F-3

Consolidated Balance Sheets as of December 31, 1996 and 1995...........................................F-4

Consolidated Statements of Operations for the years ended December 31, 1996, 1995
and 1994............................................................................................F-5

Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996,
1995 and 1994.......................................................................................F-6

Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995
and 1994............................................................................................F-7

Notes to Consolidated Financial Statements.............................................................F-8

Financial Statement Schedule:

Schedule II - Valuation and Qualifying Accounts......................................................S-1

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, 1996 and 1995, and the related consolidated statements of
operations, stockholders' equity and cash flows for the two year period ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our 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, 1996 and 1995, and the consolidated results of its
operations, stockholders' equity and cash flows for the two year period ended
December 31, 1996 in conformity with generally accepted accounting principles.

Ernst & Young LLP

Boston, Massachusetts
February 21, 1997

F-2

REPORT OF INDEPENDENT ACCOUNTANTS

To the Stockholders of
PLC Systems Inc:

We have audited the consolidated balance sheets of PLC Systems Inc. as at
December 31, 1994, and the related consolidated statement of operations,
stockholders' equity, and cash flows for the year then ended. In connection with
our audit of the above mentioned consolidated financial statements, we have also
audited the related consolidated financial statement schedule, for the year
ended December 31, 1994, listed in Item 14 (a)(2) of this Form 10-K. These
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with Canadian generally accepted auditing
standards, which are substantially in accordance with United States 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.

In our opinion, these financial statements present fairly, in all material
respects, the financial position of the Company as at December 31, 1994 and the
results of its operations and its cash flows for the year then ended in
conformity with United States generally accepted accounting principles. In
addition, in our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein. As required by the British Company Act we report that, in our
opinion, these principles have been applied on a consistent basis.

Coopers & Lybrand

Vancouver, B.C.
March 1, 1995

F-3

\

PLC SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
(In thousands)

1996 1995
---- ----
ASSETS

Current assets:
Cash and cash equivalents ........................................... $ 3,039 $ 704
Marketable securities ............................................... 5,470 6,500
Accounts receivable, net ............................................ 2,635 6,749
Inventories, net .................................................... 2,345 1,789
Prepaid expenses and other current assets ........................... 679 488
------- -------
Total current assets ............................................ 14,168 16,230

Equipment, furniture and leasehold improvements, net .................... 4,712 1,692
Other assets ............................................................ 537 368
------- -------
Total assets ..................................................... $19,417 $18,290
======= =======

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable .................................................... $ 867 $ 546
Accrued clinical costs .............................................. 935 854
Accrued compensation ................................................ 467 777
Deferred revenue .................................................... 339 166
Other accrued liabilities ........................................... 315 346
------- -------
Total current liabilities ........................................ 2,923 2,689

Deferred revenue ........................................................ - 61
Capital lease obligations ............................................... 27 32
Commitments and contingencies

Stockholders' equity:
Common stock, no par value, 25,000 shares
authorized, 16,513 and 15,944 shares issued
and outstanding in 1996 and 1995, respectively ................. 54,030 51,411
Accumulated deficit ..................................................... (37,129) (35,589)
Foreign currency translation ............................................ (434) (314)
------- -------
........................................................................ 16,467 15,508
------- -------
Total liabilities and stockholders' equity ....................... $19,417 $18,290
======= =======

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

F-4

PLC SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS For
The Years Ended December 31, 1996, 1995 and 1994
(In thousands, except per share data)

1996 1995 1994
---- ---- ----

Revenues:
Product sales ........................................... $ 9,082 $11,938 $ 5,068
Placement and service fees .............................. 2,790 1,407 111
------- -------- -------
Total revenues ....................................... 11,872 13,345 5,179

Cost of revenues:
Product sales ............................................. 2,911 4,177 2,851
Placement and service fees ................................ 1,155 386 17
------- -------- -------
Total cost of revenues ............................... 4,066 4,563 2,868
------- -------- -------

Gross profit ................................................. 7,806 8,782 2,311

Operating expenses:
Selling, general and administrative ....................... 7,023 5,035 3,030
Research and development .................................. 2,835 2,246 2,211
------- -------- -------
Total operating expenses ............................... 9,858 7,281 5,241
------- -------- -------

Income (loss) from operations ................................ (2,052) 1,501 (2,930)
Other income, net ............................................ 512 588 366
------- -------- -------
Income (loss) before provision for income taxes .............. (1,540) 2,089 (2,564)

Provision for income taxes ................................... - 85 -
-------- --------- ------
Net income (loss) ............................................ $(1,540) $ 2,004 $(2,564)
======== ======== =======

Net income (loss) per share .................................. $(.09) $.12 $(.18)

Shares used to compute net income (loss) per share ........... 16,376 16,590 14,372

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

F-5

PLC SYSTEMS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS'
EQUITY For The Years Ended December 31, 1996,
1995 and 1994
(In thousands)

Foreign
Common Stock Accumulated Currency
Shares Amount Deficit Translation Total
- -------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1993 .................. 13,338 41,975 (35,029) (288) 6,658

Public offering, net of offering
costs of $872 ............................ 2,500 8,502 8,502

Exercise of stock warrants .................. 7 25 25

Repayment of stockholder notes .............. - 441 441

Net loss .................................... (2,564) (2,564)

Currency translation adjustment ............. (3) (3)
- -------------------------------------------------------------------------------------------------------------------

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 .................. 15,944 51,411 (35,589) (314) 15,508

Exercise of stockholder warrants ............ 351 1,680 1,680

Exercise of stock options ................... 218 820 820

Repayment of stockholder notes .............. - 119 119

Net loss .................................... (1,540) (1,540)

Currency translation adjustment ............. (120) (120)
- -------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1996 .................. 16,513 $54,030 $(37,129) $(434) $16,467
=====================================================================

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

F-6

PLC SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS For
The Years Ended December 31, 1996, 1995 and 1994
(In thousands)

1996 1995 1994
---- ---- ----

Operating activities:
Net income (loss) ......................................... $(1,540) $2,004 $(2,564)

Adjustments to reconcile net income (loss) to
net cash provided by (used for) operating activities:
Depreciation and amortization .......................... 1,228 565 418
Change in assets and liabilities:
Accounts receivable ............................... 4,149 (6,387) 182
Inventory ......................................... (556) (435) 254
Prepaid expenses and other assets ................. (359) (399) (181)
Accounts payable .................................. 303 220 117
Deferred revenue .................................. 107 33 194
Accrued liabilities ............................... (252) 1,225 48
-------- --------- -------
Net cash provided by (used for) operating activities ......... 3,080 (3,174) (1,532)

Investing activities:
Purchase of marketable securities ......................... (19,419) (8,500) (7,858)
Maturities of marketable securities ....................... 20,449 9,858 -
Purchase of fixed assets .................................. (4,216) (1,584) (400)
-------- --------- -------
Net cash used for investing activities ....................... (3,186) (226) (8,258)

Financing activities:
Net proceeds from sale of common stock .................... 2,499 388 8,527
Tax benefit relating to stock option plans ................ - 11 -
Repayment of stockholder notes ............................ 119 69 441
Principal payments on capital lease obligations ........... (13) (17) (17)
-------- --------- -------
Net cash provided by financing activities .................... 2,605 451 8,951

Effect of exchange rate changes on cash and cash
equivalents ................................................. (164) (46) (4)
-------- --------- -------
Net increase (decrease) in cash and cash equivalents ......... 2,335 (2,995) (843)

Cash and cash equivalents at beginning of year ............... 704 3,699 4,542
-------- --------- --------
Cash and cash equivalents at end of year ..................... $ 3,039 $ 704 $ 3,699
======== ========= =======

Supplemental disclosure:
Interest paid ............................................. $ 1 $ 6 $ 4
Income taxes .............................................. $ 91 $ - $ -

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

F-7

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996

1. NATURE OF BUSINESS

The Company is a multinational manufacturer of medical lasers and
related products operating primarily in the United States with sales offices in
Europe and the Pacific Rim. The Company's primary product is The Heart
Laser(TM)1 ("Heart Laser") which is a patented CO2 laser used for a surgical
technique known as Transmyocardial Revascularization. The Company is currently
conducting clinical tests of the Heart Laser in the United States under the
regulation of the Food and Drug Administration. The Heart Laser is being
marketed internationally in countries where it has received regulatory approvals
and in other countries where no approval is required.

2. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include the accounts of PLC
Systems Inc. (PLC or the "Company") and its six 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
and PLC Medical Systems France. All intercompany accounts and transactions have
been eliminated.

Cash 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, 1996, 1995 or 1994. As of December 31, 1996, cash and cash equivalents
include $200,000 reserved for the guarantee of a certain inventory purchase
under a standby letter of credit. The standby letter of credit will be reduced
by actual purchases made.

Inventory

Inventory is stated at the lower of average cost or market value.

Equipment, 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.

(Continued)
- --------------------

1. The Heart Laser is a trademark of PLC Medical Systems, Inc.

F-8

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996

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. Revenues from service
contracts are recognized ratably over the life of the contract.

As of December 31, 1996, future minimum revenues under existing
placement contracts are as follows (in thousands):
Minimum
Contract
Year Revenue

1997 .................................. $ 3,631
1998 .................................. 3,669
1999 .................................. 2,360
2000 .................................. 1,659
2001 .................................. 1,794
Thereafter .............................. 93
-------
$13,206
=======

Foreign 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 Share

Net income per share is calculated using the weighted average number of
shares and share equivalents outstanding during the period which consist of
stock options and stock warrants. The net loss per share is calculated using the
weighted average number of shares outstanding and does not include share
equivalents.

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 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. Accordingly, no compensation cost has
been recognized for the stock option plans.

F-9

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996

Use 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.

Impact of Recently Issued Accounting Standards

In March 1995, the FASB issued Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,
which requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. Statement 121 also addresses the accounting for long-lived
assets that are expected to be disposed of. In 1996 the Company adopted
Statement 121 which did not have a material impact on the financial statements.

3. INVENTORIES

Inventories consist of the following at December 31 (in thousands):

1996 1995
---- ----

Raw materials ............. $1,043 $ 644
Work in process ........... 306 56
Finished goods ............ 996 1,089
------ ------
$2,345 $1,789
====== ======

4. EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS

Equipment, furniture and leasehold improvements consist of the following at
December 31 (in thousands):

1996 1995
---- ----

Equipment ............................... $1,995 $1,447
Equipment under placement contracts ..... 3,387 1,240
Office furniture and fixtures ........... 834 327
Equipment under capital lease ........... 284 278
Leasehold improvements .................. 576 47
------ ------
7,076 3,339
Less accumulated depreciation
and amortization .................... 2,364 1,647
------ ------
$4,712 $1,692
====== ======

F-10

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996

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.

5. STOCKHOLDERS' EQUITY

The Company has three stock option plans, the 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 nonqualified options. Incentive stock options are
issuable only to employees of the Company, while nonqualified options may be
issued to nonemployee directors, consultants, and others, as well as to
employees. The options granted 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 the 1993 Formula Stock Option Plan (the "Formula
Plan") that provides for the grant of nonqualified options to nonemployee
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 nonemployee 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.

The following is a summary of option activity under all Plans (in
thousands, except per option data):

1996 1995 1994
---- ---- ----

Outstanding at beginning of year ......... 1,635 1,153 965
Granted .............................. 500 615 188
Exercised ............................ (220) (99) 0
Canceled ............................. (1) (34) 0
----- ------ -----

Outstanding at end of year ............... 1,914 1,635 1,153
===== ===== =====

Exercisable at end of year ............... 874 693 271

Available for grant at end of year ....... 521 321 202

F-11

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996

1996 1995 1994
---- ---- ----

Weighted - average exercise price:
Outstanding at beginning of year .................... $ 4.67 $4.15 $4.13
Granted ............................................. $17.83 $5.49 $4.22
Canceled ............................................ $ 3.97 $3.69 -
Exercised ........................................... $ 3.73 $4.09 -
Outstanding at end of year .......................... $ 8.18 $4.67 $4.15
Exercisable at end of year .......................... $ 5.34 $4.22 $4.19

Weighted - average fair value of
options granted during the year ......................... $ 5.56 - -

Price range per share of outstanding options ............ $ 3.69 - $24.50 $3.69 - $16.25 $3.94 - $7.25
Price range per share of options granted ................ $14.88 - $24.50 $3.69 - $16.25 $3.97 - $5.38
Price range per share of options exercised .............. $ 3.69 - $16.25 $3.69 - $ 7.25 -

Exercise prices for options outstanding as of December 31, 1996 ranged
from $3.69 to $24.50. The weighted - average contractual life of those options
is 7.2 years.

Range of Exercise Prices

$3.69 - $5.38 $8.06 - $12.56 $14.88 - $21.63 $24.50
------------- -------------- --------------- ------

Options Outstanding:
Number (In thousands) ....................... 1,281 105 468 60

Weighted-Average Remaining
Contractual Life ....................... 6.3 8.5 9.4 9.5
Weighted-Average
Exercise Price ......................... $4.02 $10.90 $16.85 $24.50

Options Exercisable:
Number (In thousands)........................ 776 62 11 30
Weighted-Average
Exercise Price ......................... $4.03 $10.71 $15.18 $24.50

Pursuant to the exercise of certain options for the purchase of common
stock issued prior to the adoption of the above stock option plans, the Company
had promissory notes receivable of approximately $119,000 at December 31, 1995
which balances are included in stockholders' equity in the accompanying
consolidated balance sheet. In 1996, these notes were paid in full.

F-12

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996

Pursuant to the requirements of FAS 123, the following are the pro
forma net income (loss) and net income (loss) per share for 1996 and 1995, as if
the compensation cost for the option plans had been determined based on the fair
value at the grant date for grants in 1996 and 1995, consistent with the
provisions of FAS 123.

1996 1995
---- ----
Proforma net income (loss)(in thousands) ......... $(2,404) $1,868
Proforma net income (loss) per share ............. $ (.15) $ .11

The fair value of options issued at the date of grant were estimated
using the Black- Scholes model with following weighted average assumptions:

1996 1995
---- ----
Expected life (years) ................... 2 2
Interest rate ........................... 5.65% 6.55%
Volatility .............................. .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.

The effects on 1996 and 1995 pro forma net income (loss) and net income
(loss) per share of expensing the estimated fair value of stock options are not
necessarily representative of the effects on reporting the results of operations
for future years as the periods presented include only one and two years,
repectively, of option grants under the Company's plans.

At December 31, 1995, the Company had two outstanding warrants to
purchase common stock. The first warrant provided for the purchase of 145,000
shares at $6.00 per share and 72,500 shares at $4.80 per share. In March 1996,
the majority of these warrants were exercised with 11,180 of the $6.00 warrants
and 5,590 of the $4.80 warrants outstanding at December 31, 1996. These warrants
are currently exercisable and expire in 1997. The second warrant provided for
the purchase of 150,000 shares at $3.94 per share and was exercised in full in
March 1996.

At December 31, 1996, there were 2,462,164 shares of authorized but
unissued common stock reserved for issuance under all stock option plans and
stock warrants.

6. COMMITMENTS AND CONTINGENCIES

The Company occupies its U.S. facilities under an operating lease
agreement which expires in August 2001. The Company has the option to renew the
lease for up to six 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.

F-13

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996

As of December 31, 1996, future minimum lease payments are as follows
(in thousands):

Year

1997 ....................... $ 296
1998 ....................... 296
1999 ....................... 296
2000 ....................... 296
2001 ....................... 198
------
$1,382
======

Total rent expense was $370,000 in 1996, $227,000 in 1995 and $135,000
in 1994.

7. 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):
1996 1995
---- ----

Net U.S. operating loss carryforwards ......... $ 3,064 $1,945
Net foreign operating loss carryforwards ...... 484 -
Intercompany profit ........................... 781 675
Accrued clinical costs ........................ 373 -
Research & development credits ................ 350 340
Inventory and warranty reserves ............... 162 246
Alternative minimum tax credit ................ 63 85
Other ......................................... 22 54
------- ------
Total deferred tax assets ................ 5,299 3,345
Valuation allowance ...................... (5,299) (3,345)
------- ------
Net deferred tax assets ............. $ - $ -
======= ======

The valuation allowance increased by approximately $2,000,000 primarily
due to additional net operating loss carryforwards. The valuation allowance
decreased from 1994 to 1995 by approximately $900,000 primarily due to the use
of previously unbenefited loss carryforwards to offset current year income.

Income (loss) before taxes consisted of the following (in thousands):

1996 1995 1994
---- ---- ----

Domestic ............ $(1,244) $2,094 $(2,583)

F-14

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996

Foreign ............. (296) (5) 19
------- ------ -------
$(1,540) $2,089 $(2,564)

Income taxes (benefit) computed at the federal statutory rate differ
from amounts provided as follows (in thousands):

1996 1995 1994
---- ---- ----

Statutory income tax provision ......... $(524) $ 710 $(872)
Utilization of loss carryforwards ...... - (641) -
Unbenefited U.S. losses ................ 423 - 878
Unbenefited foreign losses ............. 100 - -
Other .................................. 1 16 (6)
----- ----- -----
Provisions for income taxes ............ $ - $ 85 $ -
===== ===== =====

The 1995 income tax provision of $85,000 represented the current
liability due under the alternative minimum tax regulations.

At December 31, 1996 the Company had U.S. net operating loss
carryforwards available to reduce future taxable income of approximately $7.7
million which expire at various dates through 2010. In addition, the Company had
foreign net operating loss carryforwards of approximately $1,210,000. The
Company also has net operating loss carryforwards generated from its previous
operations in Canada which the Company does not believe will be available to use
and, therefore, has not accounted for such losses.

8. 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 area are summarized below (in
thousands). Transfers to foreign subsidiaries are at prices comparable to those
charged to third party distributors.

F-15

PLC SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996

Consolidated
North
America Europe Other Eliminations Total
---------------------------------------------------------------------------

1996
Net sales to unaffiliated
customers ........................... $5,657 $6,215 $ - $ $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 - $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

1994
Net sales to unaffiliated
customers ........................... $ 4,479 $ 700 - - $ 5,179
Transfers between areas .............. 450 - - (450) -
----------------------------------------------------------------------------
4,929 700 - (450) 5,179

Operating income (loss) .............. (3,140) 210 - - (2,930)
Identifiable assets .................. 13,654 683 - - 14,337

Included in North American net sales for 1996 are export 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. Included in North American net sales for 1994 are export sales of
$3,324,000, of which $1,610,000 related to Europe and $759,000 related to Asia.

No one customer accounted for more than 10% of the Company's revenues
for the year ended December 31, 1996. Approximately 43% of the Company's
revenues for the year ended December 31, 1995 came from one customer.
Approximately 30% of the Company's revenues for the year ended December 31, 1994
came from two customers accounting for 16% and 14% of total revenues. 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-16

Schedule II

PLC SYSTEMS INC.
Valuation and Qualifying Accounts

Column A Column B Column C Column D Column E
- ------------------------------------------- ----------------- --------------- --------------- --------------
Addition Deductions

Balance at Charged to Balance at
Beginning Costs and End of
Description of Period Expenses Period
- ------------------------------------------- ----------------- --------------- --------------- --------------

For the Year Ended December 31, 1996

Allowance for Doubtful Accounts $ 29,000 $ 0 $ 1,000 $ 28,000
- ------------------------------------------- ------------------ --------------- --------------- -----------------

For the Year Ended December 31, 1995

Allowance for Doubtful Accounts $ 10,000 $ 19,000 $ 0 $ 29,000
- ------------------------------------------- ------------------ --------------- --------------- -----------------

For the Year Ended December 31, 1994

Allowance for Doubtful Accounts $ 10,000 $ 0 $ 0 $ 10,000

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

S-1

PLC SYSTEMS INC.
QUARTERLY DATA (UNAUDITED)

March 31 June 30 September 30 December 31 Total

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 ................ .07 (.05) (.03) (.08) (.09)

1995
Total revenue .......................... 2,868 1,487 1,591 7,399 13,345
Gross profit ........................... 1,778 870 630 5,504 8,782
Income (loss) from operations .......... 6 (743) (942) 3,180 1,501
Net income (loss) ...................... 163 (578) (789) 3,208 2,004

Income (loss) per share ................ .01 (.04) (.05) .19 .12

1994
Total revenue .......................... 1,356 1,046 985 1,792 5,179
Gross profit ........................... 625 483 188 1,015 2,311
Loss from operations ................... (747) (640) (1,028) (515) (2,930)
Net loss ............................... (703) (607) (911) (343) (2,564)

Loss per share ......................... (.05) (.05) (.06) (.02) (.18)

EXHIBIT INDEX

Exhibit
No. TITLE
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11 Statement regarding calculation of net income (loss) per share.

23a Consent of Coopers & Lybrand.

23b Consent of Ernst & Young LLP.