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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the fiscal year
ended December 31, 1999, or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to _____
Commission file number: 0-13012
ESC MEDICAL SYSTEMS LTD.
(Exact name of registrant as specified in its charter)
Israel N.A.
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. Box 240, Yokneam, Israel 20692
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 972-4-959-9000
Securities Registered pursuant to Section 12(b) of the Act: None.
Name of exchange
Title of each class on which registered
- ------------------- -------------------
None None
Securities registered pursuant to Section 12(g)of the Act:
Ordinary Shares, NIS 0.10 par value per share
----------------------------------------------
(Title of Class)
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 number of Ordinary Shares, NIS 0.10 par value per share, of the
registrant outstanding as of March 17, 2000 was 27,629,017.
The aggregate market value of the Ordinary Shares held by non-affiliates of
the registrant, based on the closing price of the Ordinary Shares on March
17, 2000 as reported on the Nasdaq National Market, was approximately
$336,513,374. Ordinary Shares held by each current executive officer and
director and by each person who is known by the registrant to own 5% or
more of the outstanding Ordinary Shares have been excluded from this
computation in that such persons may be deemed to be affiliates of the
Company. Share ownership information of certain persons known by the
Company to own greater than 5% of the outstanding common stock for purposes
of the preceding calculation is based solely on information on Schedule 13G
filed with the Commission and is as of December 31, 1999. This
determination of affiliate status is not a conclusive determination for
other purposes.
Documents Incorporated by Reference
Portions of the registrant's Proxy Statement for the 2000 Annual Meeting of
Shareholders are incorporated herein by reference in response to items 10
through 13 in Part III of this report.
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ITEM 1. BUSINESS.
GENERAL
ESC Medical Systems Ltd. ("ESC" or the "Company") is a world leader in the
design, manufacture, and marketing of a broad range of pulsed light and
laser-based systems for the aesthetic and medical communities. The Company
is a pioneer in bringing new technologies and applications to these market
segments. ESC offers a broad line of products making ESC one of the largest
companies in each of its market segments. The primary markets served
include dermatology, plastic surgery, cosmetic surgery, general surgery,
ear, nose and throat (ENT), gynecology, oncology, urology, orthopedics,
veterinary medicine, oral surgery and dentistry.
The Company was incorporated in Israel on December 21, 1991. In January
1996, the Company completed an initial public offering ("IPO") in the
United States. Since its IPO, the Company has raised both equity and debt
finance in the public capital market.
The Company has historically expanded its product line through internal
development, joint ventures and strategic business acquisitions. The most
significant of those transactions was the acquisition of Laser Industries
Limited ("Laser Industries"), completed in February 1998. In particular,
the Company seeks products that enhance its ability to adapt to changing
market needs.
Unless the context otherwise requires, all references to the Company or ESC
shall mean ESC and each of its subsidiaries.
MARKET FOCUS
The Company's systems are designed for use in a variety of medical
environments, as well as aesthetic salons and clinics. The principal target
markets for the Company's aesthetic products are physicians with private
practices or clinics, as well as leading beauty/hair removal centers. These
are customers who wish to tap into the vanity market and are looking to
increase their revenues and reduce dependence on reimbursements. The target
market for the Company's surgical products are hospitals and outpatient
clinics that use lasers for surgical procedures.
TECHNOLOGY
Most of the Company's products are based on proprietary technologies using
intense pulsed light ("IPL") or state-of-the-art laser applications
pioneered by the Company.
INTENSE PULSED LIGHT TECHNOLOGY. The Company offers several products that
incorporate patented proprietary IPL technology. Applications of the
Company's IPL products are primarily aimed at the private aesthetic markets
and include: hair removal; non-invasive treatment of varicose veins and
other benign vascular lesions; and removal of benign pigmented lesions; such
as age spots and tattoos. The products include: MultiLight for vascular and
pigmented lesions; VascuLight for both deep and superficial vascular
lesions and pigmented lesions; and EpiLight Hair Removal System for hair
removal. The Company introduced the AestiLight, a compact, lightweight, IPL
hair removal system to selected markets outside the United States in 1999.
The Company has recently introduced several upgrades and added features to
its existing product line.
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LASER TECHNOLOGY. The Company offers many laser systems, utilizing CO2
ruby, alexandrite, Nd:YAG, erbium, holmium and diode technologies. The
lasers come in a variety of sizes and power levels designed to serve a
broad range of medical procedures in physician offices, out-patient clinics
and hospitals. In addition, the Company offers over 500 application-driven
laser accessories designed for integration with its laser systems. Many of
these accessories are disposables, which generate recurring revenue.
PHOTODYNAMIC THERAPY (PDT). The Company has developed two systems using
PDT, both of which are saleable internationally, but have not been cleared
for use in the United States by the Food and Drug Administration. The
Company holds exclusive worldwide rights to patented technology in the PDT
field, which are intended for use in the treatment of malignant and benign
skin and other tumors.
PRODUCTS AND APPLICATIONS
AESTHETIC APPLICATIONS. The Company's main focus in the past years has been
in the quickly growing aesthetic market, responding to the public's demand
to look better. The primary applications for ESC products are: hair
removal; removal of benign vascular lesions, including leg veins, spider
veins on legs and face, rosaceae and other red spots; removal of benign
pigmented lesions including brown spots, age spots, sunspots and tattoos;
skin rejuvenation and wrinkle removal; and cellulite therapy. In 1999,
aesthetic applications accounted for 53% of the Company's revenues.
SURGICAL APPLICATIONS. Laser Industries, which was acquired by the Company
in 1998, has been a leading force in the surgical applications marketplace
for close to thirty years, with a wide range of product offerings. In 1999,
surgical applications accounted for 22% of the Company's revenues. The
major specialties include:
EAR, NOSE AND THROAT (ENT). The Company has pioneered several
applications for ambulatory and operating room procedures including
snoring and nasal airways. The most recent product introduced to
the ENT market is OtoLam, for replacing the tubes inserted into
children's ears when suffering from otitis media. These chronic ear
infections affect 20% of all children.
GYNECOLOGY. The Company offers several systems for various
gynecologic applications including laparoscopy, endometrial
ablation, microsurgery and tubal infertility and lesions of the
lower genital tract. The Company's newest product, GyneLase, treats
menorraghia, excessive menstrual bleeding, using an in-office
procedure of endometrial ablation. Menorraghia affects 20% of all
menstruating women.
NEUROSURGERY. The Company offers lasers and accessories for brain
tumor and disk microsurgery, and neuroendoscopy.
ORTHOPEDICS. The Company offers a Holmium laser system for
orthopedic surgical procedures, including knee and shoulder
arthroscopic procedures.
UROLOGY. The Company offers a variety of Nd:YAG lasers in varying
power ranges and a broad range of fiber delivery devices for laser
treatment of the bladder, urethra, prostate and external genitalia.
In addition, the Company offers urologists its Holmium laser for
lithotripsy (a laser procedure which results in the breakage of
kidney, urethra and bladder stones) and for various soft tissue
procedures.
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VETERINARY. The Company has developed a compact, easy to use CO2
laser for the veterinary market. The many surgical applications
include: removal of cysts, tumors and warts; specialized internal
procedures, neutering, spaying and declawing.
ORAL SURGERY AND DENTAL APPLICATIONS. The Company has developed several
dental lasers to enable dentists to perform hard and soft tissue
applications including drilling, cavity preparation, gum trimming and
periodontic procedures, as well as teeth whitening.
INDUSTRIAL APPLICATIONS. The industrial unit develops and sells a number of
different laser systems for specialized applications based upon customer
requests. As part of the restructuring program, as described under in Item
7 below, Surgilase of Providence, Rhode Island, an industrial division of
Sharplan Laser Inc. in the United States, was integrated into Spectron UK
so that it could function as the United States sales and marketing arm
of Spectron UK.
PRODUCTS UNDER DEVELOPMENT
In order to maintain its competitive position, the Company believes it is
imperative to develop new products and introduce new technologies.
INTENSE PULSED LIGHT PRODUCTS (IPL). The Company is continuously
expanding the applicability of its IPL products. The Company has
developed an upgrade policy enabling its existing IPL customers to
enhance the capability of their (PhotoDerm) MultiLight, VascuLight
and EpiLight units. The Company is developing additional
applications for these devices and enhancing their safety and
effectiveness for a variety of aesthetic applications.
SURGICAL PRODUCTS. Several novel surgical applications are under
development. These include, among others, lithotripsy with a
Holmium laser, nasal office procedures for breath improvement with
a CO2 compact laser and the treatment of very deep veins with a
novel disposable catheter.
DENTAL PRODUCTS. The Company is developing a range of dental lasers
to enable dentists to treat hard tissue and soft tissue
applications. The most recent product that completed its
development and was introduced to markets outside of the United
States is the Opus 20. This device enables the dentist to perform
hard tissue drilling at speeds equal to high speed mechanical
drills. The advantage of this device is its painless application.
The Company is also developing a variety of hand-pieces and
accessories for its dental lasers.
BUSINESS STRATEGY
The Company intends to maintain its leadership position in the aesthetic
and surgical markets by providing leading edge high quality systems,
accessories and service. While its primary markets are cosmetic medical
practitioners and surgeons, the Company intends to broaden its sales
channels and product offerings to reach a wider audience for its products.
The Company intends to use the resources at its disposal to ensure that it
can compete effectively in each of the markets it has targeted.
5
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
Please refer to Note 14 of the Financial Statements with respect to
financial information about industry segments.
MARKETING, DISTRIBUTION AND SALES
As part of the restructuring (referred to in Item 7 hereafter) which took
place during 1999, the Company set up five business units that enable it to
address its markets more effectively. Three of the business units handle
the aesthetic and surgical markets and are organized geographically. The
other two units are the Dental Unit and the Industrial Unit. Each business
unit employs a variety of distribution channels such as direct sales by
Company personnel, independent representatives, and regional distributors,
depending upon the nature of the marketplace.
ESC Americas handles aesthetic and surgical sales for the Company in the
United States, Canada and South America. There is a direct sales force in
the United States in addition to distributors in the United States, Canada
and South America.
ESC Europe coordinates aesthetic and surgical sales for the Company's
European subsidiaries, in the United Kingdom, France, Italy, and Germany,
as well as sales via distributors in other European countries, the Middle
East and Africa.
ESC Asia coordinates aesthetic and surgical sales for the Company's
subsidiary in Japan, with a direct sales force as well as distributors in
Southeast and Northeast Asia.
The Dental Unit is setting up an international sales network made up
primarily of distributors and independent sales agents.
The Industrial Unit designs, manufactures and sells its products using a
direct sales force located in the United Kingdom and United States.
The Company's marketing and distribution practice is based upon the
manufacture and delivery of products to customers based upon specific
orders received from its customers. On average, the Company delivers a
customer order within two to three weeks of receipt of the order and
therefore, does not have, and does not rely upon, any material backlog.
Generally, the Company sells more of its products during the second and the
fourth fiscal quarters as compared with the first and third fiscal
quarters. The Company believes that this is because during the third fiscal
quarters many of the Company's physician customers take summer vacation and
during the first fiscal quarter many hospitals and medical organizations
have yet to assess their needs and budget for the upcoming year.
6
BREAKDOWN OF NET SALES BY REGION
FOR THE YEAR ENDED
DECEMBER 31
(dollar amounts in thousands)
-----------------------------------------------
1 9 9 9 1 9 9 8 1 9 9 7
-------------- -------------- ---------------
North America.................. $ 51,223 $ 117,377 $ 109,687
Europe......................... 40,774 69,968 43,167
Asia........................... 33,662 9,375 16,051
Central and South America...... 4,079 13,655 17,671
Other.......................... 12,413 14,831 7,407
-------------- -------------- ---------------
$ 142,151 $ 225,206 $ 193,983
============== ============== ===============
To assist customers in financing their purchases of the Company's products,
the Company or its distributors may introduce them to one of a number of
independent leasing companies. As is common in this industry, a substantial
portion of the Company's sales are completed in the last few weeks of each
calendar quarter.
SOURCES AND AVAILABILITY OF RAW MATERIALS
The Company's products are manufactured from a large number of parts, using
standard components and subassemblies supplied by subcontractors and
vendors to the Company's specifications.
The Company's policy is to maintain more than one source for each of its
major components, to the extent possible, although in some cases parts are
supplied by a sole source. Due to their sophisticated nature, certain
components must be ordered three to four months in advance, resulting in a
substantial lead time for each production run. In the event that such
limited source suppliers are unable to meet the Company's requirements in a
timely manner, the Company may experience an interruption in production
until an alternate source of supply can be obtained.
The Company uses an outsourcing vendor to store and stock its raw material
inventory.
The Company orders raw materials, including optical and electronic parts,
which it sends in kits to subcontractors for assembly of components and
subassemblies. Assembly (in part), integration, and quality assurance of the
components and subassemblies are conducted at the Company's manufacturing
facilities. In some cases, quality is tested on-site at the subcontractor's
facility.
RESEARCH AND DEVELOPMENT
The Company's research and development strategy is to develop high-quality
products and related accessories to maintain ESC's competitive advantage.
The Company's research and development expenses, net of participations by
the Israeli Office of the Chief Scientist, were approximately $15.35
million in 1999, $18.68 million in 1998 and $17.37 million in 1997. The
Company believes that the close interaction between its research and
development, marketing, and manufacturing groups allows for timely and
effective realization of the Company's new product concepts.
7
ESC receives certain grants and tax benefits from, and participates in,
programs sponsored by the Government of Israel.
Israeli tax law permits, under certain conditions, a tax deduction in the
year incurred for expenditures (including capital expenditures) in
scientific research and development projects, if the expenditures are
approved by the relevant Israeli Government Ministry (determined by the
field of research), and the research and development is for the promotion
of enterprise and is carried out by or on behalf of a company seeking such
deduction. Expenditures not approved as such are deductible over a three
year period; however; grants made available to the Company by the
Government of Israel are considered taxable income.
Under the Law for the Encouragement of Industrial Research and Development
1984 (the "Research Law"), research and development programs that are
approved by a research committee and meet certain criteria are eligible for
grants against payment of royalties from the sale of the products developed
in accordance with the program. Regulations promulgated under the Research
Law generally provide for the payment of royalties to the Office of the
Chief Scientist of Israel ranging from 3% to 5% on sales of products
developed as a result of a research project and so funded until 100% of the
dollar-linked amount of the grant (carrying an interest rate at LIBOR) is
repaid. The Research Law requires that the manufacture of any product
developed as a result of research and development funded by the Israeli
Government take place in Israel. It also provides that any know-how from
the research and development, that is used to produce the product, may not
be transferred to third parties without the approval of a research
committee. Such approval is not required for the export of any products
resulting from such research and development.
In connection with an initial program approved by the Office of the Chief
Scientist, the Company and an Israeli subsidiary received participation
payments from the State of Israel in the amount of approximately $275,000
for the year ended December 31, 1999. In return for the Government's
participation payments, the Company and its subsidiary are obliged to pay
in full royalties at a rate of 3% to 5% of sales of the developed product.
As of December 31, 1999, the balance of the Company's outstanding
obligation to the State of Israel in connection with the participation
payments is approximately $6,234,000, which will be repaid to the
government in the form of royalties on sales of those products that reach
the market.
COMPETITION
ESC faces keen competition in its different market niches. Competition
arises from utilizing other light products as well as alternate technologies.
Competitors range in size from small single product companies to large
multifaceted corporations, which may have greater resources than those
available to the Company. Major competitors in the aesthetic market place
are: Coherent, Inc., Candela Corporation, Cynosure, Inc., and Laserscope,
Inc.
In addition, the Company competes in a market subject to rapid
technological change. The entry of new companies or new technologies could
have a material adverse effect on the Company.
PATENTS AND INTELLECTUAL PROPERTY
The Company has obtained and now holds approximately 84 patents in the
United States and approximately 38 additional patents outside of the United
States, and has applied for approximately 34 and 64 additional patents in
the United States and outside of the United States, respectively. In
general, however, the Company relies on its research and development
program, production techniques and marketing and service programs to
8
advance its products. The Company also licenses certain of its technologies
from third parties pursuant to various license agreements. Patents filed
both in the United States and Europe have a life cycle of twenty years
from the filing date. However, patents filed in the United States prior to
June 1995 expire either twenty years from filing or seventeen years from
issue date. None of the Company's material patents are expected to expire
in the near future.
Technologies related to the Company's business, such as laser and IPL
technologies, have been rapidly developing in recent years. Numerous parties
have sought patent protection on developments in these technologies.
The Company's policy is to obtain patents by application, license or
otherwise, to maintain trade secrets and to operate without infringing on
the intellectual property rights of third parties. Loss or invalidation of
certain of these patents, or a finding of unenforceability of certain of
the Company's license agreements with respect to many third party patents,
could have a material adverse effect on the Company. The patent position of
many inventions in the areas related to the Company's business is highly
uncertain, involves many complex legal, factual and technical issues and
has recently been the subject of litigation industry-wide. There is no
certainty in predicting the breadth of allowable patent claims in such
cases or the degree of protection afforded under such patents. As a result,
there can be no assurance that patent applications relating to the
Company's products or technologies will result in patents being issued,
that patents issued or licensed to the Company will provide protection
against competitors or that the Company will enjoy patent protection for
any significant period of time.
It is possible that patents issued or licensed to the Company will be
successfully challenged, or that patents issued to others may preclude the
Company from commercializing its products under development. Litigation to
establish the validity of patents, to defend against infringement claims or
to assert infringement claims against others, if required, can be lengthy
and expensive, and may result in a determination which is adverse to the
Company. There can be no assurance that the products currently marketed or
under development by the Company will not be found to infringe patents
issued or licensed to others. Likewise, there can be no assurance that
other parties will not independently develop similar technologies,
duplicate the Company's technologies or, with respect to patents which are
issued to the Company or rights licensed to the Company, design around the
patented aspects of the technologies. Third parties could also obtain
patents that may require licensing of their patented technology for the
conduct of the Company's business.
Because of the rapid development of technologies which relate to the
Company's products, there may be other patents which relate to basic
relevant technologies and other technologies marketed by the Company. From
time to time, the Company receives inquiries from third-parties contending
that their patents are being infringed by the Company. If such
third-parties were to commence infringement suits against the Company, and
such patents were found by a court to be valid and infringed upon by the
Company, the Company could be required to pay damages and make royalty
payments. Depending on the nature of the patent found to be infringed upon
by the Company, a court order requiring the Company to cease such
infringement could have a material adverse effect on the Company.
GOVERNMENT REGULATION
The products manufactured and marketed by the Company are subject to
regulatory requirements mandated by the United States Food and Drug
Administration (FDA), the European Union and similar authorities in other
countries. The Company believes that its principal products will be
regulated as "devices" under United States Federal law and FDA regulations.
9
The process of obtaining clearances or approvals from the FDA and other
regulatory authorities is costly, time consuming and subject to
unanticipated delays.
Among the conditions for FDA approval of a medical device is the
requirement that the manufacturer's quality control and manufacturing
procedures comply with Good Manufacturing Practice (GMP), or the Quality
System Regulations (QSR), which must be followed at all times. The GMP and
QSR regulations impose certain procedural and documentation requirements
upon a company with respect to design, manufacturing and quality assurance
activities. These GMP and QSR requirements control every phase of design
and production from the receipt of raw materials, components and
subassemblies to the labeling of the finished product. It also includes the
tracing of consignees after distribution as well as documentation of
training, follow-up and customer complaint reporting. Design control was
implemented by the FDA in 1998 as part of the QSR Quality Systems
Requirements.
The Company received a Quality System Certification Award for being in
compliance with ISO 9001. ISO 9001 is a globally recognized standard
established by the International Standard Organization in Geneva,
Switzerland and has been adopted by more than 90 countries worldwide. ISO
9001 embraces all principles of the GMP and QSR and is the most
comprehensive of the quality assurance standards. ISO certification is
based upon adherence to established quality assurance standards and
manufacturing process control.
In 1998, the European Union (EU) determined that marketing or selling any
medical product or devices with the European community required a CE Mark.
The Company has complied with the EU standards and has received the CE Mark
for all our Intense Light and Laser Systems.
A company is now required to obtain the CE Mark prior to sale of certain
medical devices within the EU. It is the responsibility of member states to
ensure that devices capable of compromising the health and safety of
patients (and users) do not enter the market. Obtaining a CE Mark for
medical devices is regulated according to the European Medical Device
Directive. The medical device must comply with the requirements of the
European Medical Device Directive that applies at each stage, from design
to final inspection.
International sales are subject to specific foreign government regulation
and those regulations vary from country to country. The time required to
obtain approval by a foreign country may be longer or shorter than that
required for FDA approval, and the requirements may differ.
EMPLOYEES
As of December 31, 1999, the Company and its subsidiaries had 730 full-time
employees. In Israel there are 280 employees, in the United States 274
employees, in Europe 152 employees and in Asia 24 employees. As of December
31, 1999, there were about 55 employees who had been given a notice of
termination.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
Please refer to Note 14 of the Financial Statements with respect to
financial information about geographic areas of the Company's business.
The Company's worldwide business is subject to risks of currency
fluctuations, governmental actions and other governmental proceedings
abroad. The Company does not regard these risks as a deterrent to further
10
expansion of its operations abroad. However, the Company closely reviews
its methods of operations and adopts strategies responsive to changing
economic and political conditions.
Within the EU, there has been an evolution toward a single market in
pharmaceuticals, for which Economic and Monetary Union ("EMU"), including
the adoption of the euro as a single currency, marks an important step. The
Company has recognized the strategic significance of this development and
has adopted the euro in the beginning of year 2000 for use in EMU markets.
In this way, the Company is demonstrating its support for the European
Community's industrial policy. The Company is continually seeking to take
advantage of these opportunities to improve the efficiency and productivity
of its EU operations.
For risks related to the Company's operations in Israel, see "Conditions in
Israel."
CONDITIONS IN ISRAEL
GENERAL
The Company is incorporated under the laws of the State of Israel, and
substantially all of its research and development and significant executive
facilities are located in Israel. Accordingly, the Company is directly
affected by political, economic and military conditions in Israel. Our
operations would be materially adversely affected if major hostilities
involving Israel should occur or if trade between Israel and its present
trading partners should be curtailed.
POLITICAL CONDITIONS
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its neighbors. A state of
hostility, varying from time to time in intensity and degree, has led to
security and economic problems for Israel. However, a peace agreement
between Israel and Egypt was signed in 1979, a peace agreement between
Israel and Jordan was signed in 1994 and, since 1993, several agreements
between Israel and Palestinian representatives have been signed. In
addition, Israel and several Arab States have announced their intention to
establish trade and other relations and are discussing certain projects.
Israel has not entered into any peace agreement with Syria or Lebanon, and
there have been difficulties in the negotiations with the Palestinians. We
cannot be certain as to how the peace process will develop or what effect
it may have upon the Company. Despite the progress towards peace between
Israel, its Arab neighbors and the Palestinians, certain countries,
companies and organizations continue to participate in a boycott of Israeli
firms. The Company does not believe that the boycott has had a material
adverse effect on the Company, but restrictive laws, policies or practices
directed towards Israel or Israeli businesses may have an adverse impact on
the expansion of the Company's business. Generally, all male adult citizens
and permanent residents of Israel under a certain age are obligated to
perform up to 39 days, or longer under certain circumstances, of military
reserve duty annually. Additionally, all such residents are subject to
being called to active duty at any time under emergency circumstances.
Currently, some of our senior officers and key employees are obligated to
perform annual reserve duty. While we have operated effectively under these
requirements since we began operations, no assessment can be made as to the
full impact of such requirements on our workforce or business if conditions
should change, and no prediction can be made as to the effect on us of any
expansion or reduction of such obligations.
11
ECONOMIC CONDITIONS
Israel's economy has been subject to numerous destabilizing factors,
including a period of rampant inflation in the early to mid-1980s, low
foreign exchange reserves, fluctuations in world commodity prices, military
conflicts and civil unrest. The Israeli government has, for these and other
reasons, intervened in various sectors of the economy, employing, among
other means, fiscal and monetary policies, import duties, foreign currency
restrictions and controls of wages, prices and foreign currency exchange
rates. Until May 1998, Israel imposed restrictions on transactions in
foreign currency. These restrictions affected our operations in various
ways, and also affected the right of non-residents of Israel to convert
into foreign currency amounts they received in Israeli currency, such as
the proceeds of a judgment enforced in Israel. Despite these restrictions,
foreign investors who purchased shares with foreign currency were able to
repatriate in foreign currency both dividends (after deduction of
withholding tax) and the proceeds from the sale of the shares. In 1998, the
Israeli currency control regulations were liberalized significantly, as a
result of which Israeli residents generally may freely deal in foreign
currency and non-residents of Israel generally may freely purchase and sell
Israeli currency and assets. There are currently no Israeli currency
control restrictions on remittances of dividends on the ordinary shares or
the proceeds from the sale of the ordinary shares; however, legislation
remains in effect pursuant to which currency controls can be imposed by
administrative action at any time.
TRADE AGREEMENTS
Israel is a member of the United Nations, the International Monetary Fund,
the International Bank for Reconstruction and Development and the
International Finance Corporation. Israel is also a signatory to the
General Agreement on Tariffs and Trade, which provides for reciprocal
lowering of trade barriers among its members. In addition, Israel has been
granted preferences under the Generalized System of Preferences from
Australia, Canada and Japan. These preferences allow Israel to export the
products covered by such programs either duty-free or at reduced tariffs.
Israel has entered into preferential trade agreements with the European
Union, the United States and the European Free Trade Association. In recent
years, Israel has established commercial and trade relations with a number
of the other nations, including Russia, China and India, with which Israel
had not previously had such relations.
YEAR 2000 COMPLIANCE
The Company has not experienced any material Year 2000 computer or system
related problems or any supply failures resulting from Year 2000 issues. In
addition, the Company has not received any material Year 2000 complaints
from any of its customers relating to products purchased from the Company.
ITEM 2. PROPERTIES.
The Company's principal executive offices and principal engineering,
development, manufacturing, shipping and service operations are located in
a facility occupying an aggregate of approximately 30,000 square feet in
Yokneam, Israel. In March 1996, the Company signed a ten-year lease on the
facility in Yokneam from a non-affiliated lessor with annual lease payments
of approximately $200,000 payable in NIS linked to the Israeli CPI. In
March 1998, the Company signed an additional ten-year lease on a new
facility in Yokneam occupying an aggregate of approximately 30,000 square
feet.
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The Company also leases approximately 32,500 square feet at the Atidim
Science-Based Industrial Park, Neve Sharett, Tel Aviv, Israel which is
primarily utilized for research and development operations. The term of the
lease is for a period of one year ending in November 30, 2000, with an
option to extend the lease for up to nine years thereafter.
During the second half of 1999, the Company had consolidated most of the
manufacturing activities which were conducted at the Tel-Aviv facilities to
the Company's Yokneam headquarters. In addition, the Company's research and
development activities were reorganized, so that most of the research and
development activity for aesthetic/cosmetic lasers and IPL products is
conducted in Yokneam and most of the research and development activity for
medical/surgical and disposable products activity is conducted in Tel-Aviv.
In addition, the Company, through its subsidiaries, maintains the following
premises:
UNITED STATES
o ESC Medical Systems, Inc. Marketing and sales operations are
located in a facility in Norwood, Massachusetts.
o Sharplan Lasers, Inc. Service, marketing and sales operations
are located in a facility in Allendale, New Jersey.
o Luxar Corporation. Manufacturing, operations, administrative and
research and development facilities are located in Bothell,
Washington.
o Applied Optronics Corporation. Manufacturing, operations and
research and development facilities are located in South
Plainfield, New Jersey.
EUROPE
o Sharplan Lasers UK Limited. Operations are conducted from an
office in London, England.
o Sharplan Laser Europe Limited. Operations are conducted from an
office in London, England.
o ESC Medizintechnik Vertriebs GmbH. Operations are conducted from
an office in Munich, Germany.
o Sharplan Lasers Germany. Operations are conducted from an office
in Munich, Germany.
o Spectron. Operations are conducted from a facility in Rugby,
England.
o ESC Medical Systems (Italy) Srl. Operations are conducted from
an office in Rome, Italy.
o ESC Medical Systems (France) SARL. Operations are conducted from
an office in Paris, France.
JAPAN
o ESC Japan, K.K. Operations are conducted from an office in
Tokyo, Japan.
LEASE COMMITMENTS
The Company also operates sales offices and research and development and
manufacturing facilities in the United States, the United Kingdom, Italy,
Germany, Japan and France. Aggregate rental expense for the years 1996,
1997, 1998 and 1999 amounted to $1,746,000, $2,626,000, $3,423,000 and
$3,729,000 respectively.
13
Future minimum annual lease payments for operating leases are as follows:
Year Lease Payment
- ---- -------------
2000 $3,676,000
2001 $2,856,000
2002 $2,555,000
2003 $2,134,000
2004 $1,774,000
In connection with the Company's restructuring and the consolidation of its
facilities, $3,484,000 of the above amounts has been accrued and included
in restructuring costs for the year ended December 31, 1999.
ITEM 3. LEGAL PROCEEDINGS.
The Company is a party to various legal proceedings incident to its
business. Except as noted below, there are no legal proceedings pending or
threatened against the Company that management believes are likely to have
a material adverse effect on the Company's consolidated financial position.
The Company has been named in a number of purported class action securities
lawsuits filed in the fall of 1998 that have been consolidated in the
United States District Court for the Southern District of New York. The
consolidated action is captioned In Re ESC Medical Systems Ltd. Securities
Litigation, 98 Civ. 7530 (NRB). On July 9, 1999, a consolidated amended
complaint was filed naming the Company, Salomon Smith Barney Inc., and
several additional current and former directors and officers as defendants.
The consolidated amended complaint seeks damages and attorneys fees under
the United States securities laws for alleged irregularities in the way in
which the Company reported its financial results and disclosed certain
facts throughout 1997 and 1998 and for alleged "tipping" of non-public
information to Salomon Smith Barney Inc. in September 1998. On December 23,
1999, the Company moved to dismiss the consolidated amended complaint. The
plaintiffs' brief in opposition to the Company's motion has been filed and
the Company's reply brief is scheduled to be filed on March 28, 2000.
ESC subsidiaries Laser Industries, Ltd. ("Laser") and Sharplan Lasers, Inc.
("Sharplan") have settled their long-running litigation with Reliant
Technologies, Inc. entitled Laser Industries Ltd. and Sharplan Lasers, Inc.
v. Reliant Technologies, Inc. The litigation commenced in September 1995
when Laser and Sharplan filed suit against Reliant for, among other things,
patent infringement arising from Reliant's introduction of a new laser
resurfacing product. Reliant counterclaimed for antitrust and other
violations, and asserted that the patent was invalid. The Northern District
of California ("California Court") ultimately agreed with Reliant with
respect to the validity of the Laser patent, and held the patent invalid on
summary judgment. Thereafter, the court found that Laser's and Sharplan's
patent suit against Reliant was objectively baseless, and set a trial date
for April 2000 to consider whether filing and pursuing the suit constituted
an antitrust violation. In the meantime, Laser and Sharplan filed an appeal
with the U.S. Court of Appeals for the Federal Circuit of the court's
determination that the patent was invalid.
Under the terms of the settlement, Laser and/or ESC will pay Reliant the
sum of Seven Million Five Hundred Thousand Dollars (U.S.$7,500,000), which
is allocated as follows: (i) $5,750,000 is a lump-sum payment to Reliant;
(ii) $500,000 is the first installment of a three-year consultant
arrangement with Reliant whereby it will make Michael Black, President and
CEO of Reliant, available to provide consulting services to Laser and/or
14
ESC; and (iii) $250,000 is Laser's contribution to a final and complete
settlement of all claims by Reliant's insurer. In addition, ESC granted
Reliant incentive stock options to purchase 100,000 shares of ESC stock at
an exercise price of $9.75 per share.
Further included in the settlement is a complete and mutual release by all
parties of any and all claims that were asserted or might have been
asserted in the litigation. Consistent with this broad release, the parties
have dismissed their claims against each other with prejudice.
On November 5, 1998, Light Age, Inc. ("Light Age") instituted an ex-parte
application in the Tel-Aviv District Court (the "Tel-Aviv Court") against
the Company and others, seeking a temporary injunction against the
development, production and sale of the Company's Alexandrite laser for
dermatological or hair removal treatments. Light Age's principal
contentions are that the Alexandrite laser is based on technology developed
by Light Age and is competing with Light Age's Alexandrite laser, in breach
of the Company's non-disclosure and non-compete undertaking in a supply
agreement with Light Age. In addition, Light Age is seeking a permanent
injunction against the Company engaging in such activities. The Tel-Aviv
Court denied Light Age's request for an ex-parte injunction and ordered
that a hearing be held with both parties present. On March 21, 1999, the
Tel-Aviv Court denied Light Age's motion for a preliminary injunction. The
parties have since agreed to submit their dispute for arbitration.
Accordingly, the parties filed a motion to stay the proceedings, which was
granted by the Tel Aviv Court on October 14, 1999.
On January 25, 1999, the Company, along with three affiliated entities,
brought an action seeking declaratory and injunctive relief in Superior
Court of New Jersey, Somerset County: Law Division, against Light Age,
Inc., entitled Laser Industries Ltd., ESC Medical Systems Inc., Sharplan
Lasers Inc., and ESC Medical Systems Ltd. v. Light Age, Inc., Docket No.
SOM-L-14199. The litigation relates to disputes arising out of an agreement
between Light Age and Laser Industries pursuant to which Light Age supplied
certain medical laser devices to Laser Industries. On March 5, 1999,
defendant Light Age answered the complaint and counterclaimed against
plaintiffs, seeking unspecified damages under thirteen counts alleging a
variety of causes of action such as breach of contract, tortious
interference with contract, unjust enrichment, and misappropriation. On
July 1, 1999 the court granted Light Age's motion to compel the Company and
the three affiliated entities to arbitrate. On August 13, 1999, Light Age
filed a demand for arbitration on its counterclaim with the American
Arbitration Association. On November 22, 1999 the Company and the three
affiliated entities filed a response to Light Age's demand. The parties are
currently awaiting the appointment of the arbitration panel.
On December 31, 1998, the Company and Luxar were named as defendants in an
action filed in the United States District Court for the Southern District
of Florida (the "Florida Court"), entitled LPG USA, Inc. v. ESC Medical
Systems Ltd. and Luxar Corporation, Civ. No. 98-7509 (S.D. Fla.). The
action alleged violations of the Lanham Act (including false advertising
and trade dress infringement) and related state laws (including trade
secret and unfair competition laws). The plaintiffs in the action sought an
injunction and monetary damages of an unspecified amount. The Company and
Luxar filed an answer on February 8, 1999, which also asserted
counterclaims for intentional interference with business relationships and
prospective business relationships, trade libel and product disparagement,
Lanham Act violations, unfair competition and related counterclaims. The
parties have since reached an out of court settlement pursuant to which,
among other things, the Company made a cash payment to the plaintiff and
agreed to become a distributor of LPG products in North America (see note
12 of the Company's financial statement).
15
On September 20, 1999, Dr. Richard Urso filed what purports to be a class
action lawsuit against the Company in the State District Court in Harris
County, Texas. Dr. Urso alleges a number of causes of action including,
breach of contract, breach of warranty, product liability,
misrepresentation and violations of the Texas Deceptive Trade Practices
Act. The complaint purports to be filed on behalf of a national class. The
Company has taken steps to remove the case to Federal court and intends to
vigorously deny all allegations and challenge Plaintiff's class
certification motion when it is filed.
In addition to the foregoing proceedings, the Company is a party in certain
actions in various countries in which the Company sells its products in
which plaintiffs have alleged that the Company's products did not perform
as promised and/or that the Company made certain misrepresentations in
connection with the sale of products to the plaintiffs. The largest single
such case presently pending against the Company is a case filed by H.K.
Hashalom Medical Centers Ltd. in Tel-Aviv District Court against the
Company and Dr. Shimon Eckhouse in connection with the sale of the
Company's EpiLight systems. H.K. Hashalom is seeking monetary damages in
the amount of NIS10,000,000 (approximately $2.5 million at current exchange
rates) but has reserved the right to increase such amount as well as a
declaratory judgment that, among other things, the Company indemnify it for
certain costs and expenses arising out of the transaction between the
parties. On July 15, 1999, the defendants filed a Statement of Defense. The
case has not yet been set for a first hearing.
Apart from H.K. Hashalom's action, management believes that none of the
other of these types of cases that are presently pending individually would
have a material adverse impact on the consolidated financial position
of the Company, although such other proceedings could have a material
effect on quarterly or annual operating results or cash flows when resolved
in a future period.
Finally, the Company also is a defendant in various product liability
lawsuits in which the Company's products are alleged to have caused
personal injury to certain individuals who have received treatments using
the Company's products. The Company maintains insurance against these types
of claims and believes that these claims individually or in the aggregate
are not likely to have a material adverse impact on the business, financial
condition or operating results of the Company.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S EQUITY AND RELATED STOCKHOLDER MATTERS.
The Ordinary Shares of the Company have been listed on the Nasdaq National
Market ("Nasdaq") under the symbol ESCMF since the commencement of the
Company's initial public offering on January 24, 1996. The Company began
trading on September 17,1999 under the new ticker symbol, "ESCM.".
The ticker symbol was changed as a result of ESC's new reporting status
under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
As of June 23, 1999, ESC was no longer considered a "foreign private
issuer" under the Exchange Act. Rather, the Company started to report under
disclosure obligations applicable to United States issuers, which are
16
broader than the obligations applicable to foreign private issuers which
ESC was subject to prior to June 23, 1999.
As of March 17, 2000, there were 340 shareholders of record of the Company.
The prices set forth below are high and low closing sale prices for the
Ordinary Shares of the Company as reported by the Nasdaq for the period
indicated. Such quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
1998 High Low
First Quarter $38.75 $31.63
Second Quarter $35.19 $26.81
Third Quarter $35.50 $ 6.50
Fourth Quarter $11.50 $ 6.06
1999 High Low
First Quarter $11.56 $4.84
Second Quarter $ 6.81 $5.50
Third Quarter $ 6.47 $3.78
Fourth Quarter $ 9.56 $4.13
In May 1996, the shareholders approved a two for three share dividend for
all outstanding Ordinary Shares. All shares, per share amounts and share
prices have been adjusted to give effect to this dividend.
The Company has never paid a cash dividend on its Ordinary Shares and does
not anticipate that it will pay any cash dividend on its Ordinary Shares in
the foreseeable future.
The Company intends to retain its earnings to finance the development of
its business. Any future dividend policy will be determined by ESC's Board
of Directors (the "Board") based upon conditions then existing, including
the Company's earnings, financial condition, tax position and capital
requirements as well as such economic and other conditions as the Board may
deem relevant. Pursuant to ESC's Articles of Association, certain
dividends, referred to as final dividends (which are comparable to annual
dividends) are customarily paid by some United States companies and are not
related to distributions on dissolution or liquidation or similar final
distributions. These dividends are recommended by the Board and may be
approved by shareholders at the annual meeting of shareholders, but only in
the amount per share equal to or less than the amount recommended by the
Board. In addition, depending upon the factors described above, the Board
may declare to pay interim dividends on account of the final dividend. ESC
may only pay dividends in any given fiscal year out of "profits," which
generally are defined for Israeli statutory purposes to be net after tax
earnings. In addition, because ESC has received certain benefits under the
Israeli law relating to "Approved Enterprises," the payment of dividends by
ESC may be subject to certain Israeli taxes to which it would not otherwise
be subject. Furthermore, pursuant to the terms of certain financing
agreements, the Company is restricted from paying dividends to its
shareholders. In the event that cash dividends are declared by the Company,
such dividends will be paid in NIS.
Dividends paid out of income derived from the Approved Enterprise is
subject to a 15% withholding tax. Approved Enterprises may receive
exemption from Israeli tax for up to ten years (see discussion provided
under the caption "Effective Corporate Tax Rate"). Should dividends be paid
out of income earned by the Company from an Approved Enterprise during the
17
period of the tax holiday, such income will be subject to tax at the rate
of up to 25%. The Company does not anticipate paying dividends from income
derived from the Approved Enterprise and any such earnings distributed upon
dissolution will not subject the Company to income taxes.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data was derived from the Company's
Consolidated Financial Statements, which have been prepared in accordance
with generally accepted accounting principles in the United States ("U.S.
GAAP"). The financial data set forth below should be read in conjunction
with, and are qualified in their entirety by, the Company's Consolidated
Financial Statements, related notes and other financial information
contained in this Annual Report.
18
FOR THE YEAR ENDED DECEMBER 31
-------------------------------------------------------------
1999 1998 1997 (*) 1996 (*) 1995(*)
(RESTATED) (RESTATED) (RESTATED)
----------- ----------- ----------- ---------- -----------
In thousands of US$ except for share data
Revenues
Net Sales $ 142,151 $ 225,206 $ 193,983 $ 119,578 $ 71,727
Other Revenues - 2,100 - -
----------- ----------- ----------- ---------- -----------
142,151 225,206 196,083 119,578 71,727
Cost of Sales 96,474 78,585 65,068 37,264 25,653
----------- ----------- ----------- ---------- -----------
Gross Profit 45,677 146,621 131,015 82,314 46,074
----------- ----------- ----------- ---------- -----------
Operating Expenses
Research and Development,
Net 15,351 18,680 17,371 9,835 5,689
Marketing and Selling 78,432 76,882 55,877 37,505 22,802
General and Administrative 25,799 14,667 16,091 9,430 8,215
Restructuring costs 20,530 - - - -
Settlement of litigations 23,780 - - - -
Impairment of intangible and
tangible assets 17,616 - - - -
Acquired research and development - 2,451 11,912 3,500 -
Other 4,987 - - - -
----------- ----------- ----------- ---------- -----------
Total Operating Expenses 186,495 112,680 101,251 60,270 36,706
----------- ----------- ----------- ---------- -----------
Operating Income (loss) (140,818) 33,941 29,764 22,044 9,368
Financing Income (expenses), Net (3,865) 1,211 1,409 1,608 (715)
----------- ----------- ----------- ---------- -----------
(144,683) 35,152 31,173 23,652 8,653
Nonrecurring Expenses - 28,951 4,650 - 8,125
----------- ----------- ----------- ---------- -----------
Income (loss) Before Income Taxes (144,683) 6,201 26,523 23,652 528
Taxes on Income 4,079 2,201 4,429 308 38
----------- ----------- ----------- ---------- -----------
Net Income (loss) before
extraordinary items $(148,762)$ 4,000 $ 22,094 $ 23,344 $ 490
Extraordinary gain on purchase of
Company's Subordinated
Convertible Notes 7,974 - - - -
Net income (loss) for the year $(140,788)$ 4,000 $ 22,094 $ 23,344 $ 490
=========== =========== =========== ========== ===========
Earning (loss) Per Share
Basic
Income (loss) before
extraordinary items $ (5.79)$ 0.15 $ 0.86 $ 1.00 $ 0.03
Extraordinary gain 0.31 - - - -
Net earnings (loss) per shar$ (5.48)$ 0.15 $ 0.86 $ 1.00 $ 0.03
=========== =========== =========== ========== ===========
19
Diluted
Income (loss) before
extraordinary items $ (5.79) $ 0.15 $ 0.86 $ 1.00 $ 0.03
Extraordinary gain 0.31 - - - -
Net earnings (loss) per shar $ (5.48) $ 0.15 $ 0.86 $ 1.00 $ 0.03
=========== =========== =========== ========== ===========
Weighted Average Number Of
Shares
Basic 25,674 26,027 25,604 23,445 17,313
=========== =========== =========== ========== ===========
Diluted 25,674 27,381 27,194 25,568 19,276
=========== =========== =========== ========== ===========
(*) Relates to the restatement as a result of the mergers with Laser Industries Ltd.
and Luxar Corporation.
BALANCE SHEET DATA:
1999 1998 1997 (*) 1996 (*) 1995(*)
(RESTATED) (RESTATED) (RESTATED)
----------- ----------- ----------- ---------- -----------
(In thousands of US$)
Cash and cash equivalents $24,524 $42,950 $54,616 $49,280 $6,944
Total assets $174,907 $327,666 $335,646 $142,218 $53,346
Long-term debt $96,691 $116,306 $127,427 $4,272 $14,462
Retained earning (deficit) $(113,975) $26,813 $22,813 $(144) $(23,065)
Shareholders' equity (deficit) $5,943 $155,508 $150,004 $110,834 $18,646
(*) Relates to the restatement as a result of the mergers with Laser Industries Ltd.
and Luxar Corporation.
ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS.
ESC is a world leader in the design, manufacture, marketing and servicing
of a broad range of medical devices that incorporate proprietary intense
pulsed light technology, state-of-the-art lasers and accessories as well as
other technologies. The Company's systems incorporate these technologies
for applications in aesthetic dermatology, plastic and re-constructive
surgery, ear, nose and throat procedures and oral and dental surgery, among
others. The Company's systems are designed for use in a variety of medical
environments, ranging from physicians' offices to acute care hospitals.
On September 14, 1999, the Board approved a comprehensive restructuring
program designed to align the Company's cost structure with its revenue
capabilities, while capitalizing on the market potential of its innovative
light technology products, including products in various development and
regulatory stages.
The restructuring plan was developed by the Company's senior management
team, together with the consulting firm of McKinsey & Company. The Company
expects the majority of the plan to be implemented by March 31, 2000. Under
the plan, ESC has:
20
o Reduced or eliminated certain fixed and variable costs from the
Company's organizational structure. If those cost savings would
have been implemented prior to January 1, 1999, management
estimates that expenses would have been over $40 million lower as
compared to annualized revenue and expense levels in the first half
of the year. The cost reductions include over $25 million in
selling, general and administrative expenses not considered
essential to the continued growth of sales.
o Implemented certain changes in management, reduced headcount in
certain departments, adjusted certain employee compensation plans
and reduced non-core research and development expenditures.
o Brought the selling and marketing teams closer to the customers and
markets being served by reorganizing into regional business units.
o Reorganized the internal reporting structure of the Company in a
manner intended to provide all management levels with greater
accountability.
A number of personnel changes took place during the year and especially
during the second half of the year, some of which were related to the
restructuring. Changes included the replacement of the Company's Chief
Executive Officer and Chief Financial Officer, and the elimination of
certain vice president level positions.
In addition, the Company organized itself into five business units
consisting of (1) three geographical units serving the aesthetic and
surgical market, (2) one unit serving the dental market and (3) one unit
serving the industrial market.
Year Ended December 31, 1999 Compared With Year Ended December 31, 1998
- -----------------------------------------------------------------------
(In thousands of dollars)
NET SALES. The Company's net sales decreased by 37% to approximately
$142,151 in 1999 compared to approximately $225,206 in 1998. In 1999, net
sales decreased due to a decrease in unit sales and lower selling prices in
the United States aesthetic market.
The competitive price pressure mainly on hair removal products resulted in
lower price and lower unit sales of the Company's high margin products.
In addition, sales are reflected net of reserves for sales returns.
GROSS PROFIT. Gross profit decreased by 69% to approximately $45,677 in
1999 from approximately $146,621 in 1998. Gross profits decreased mainly
due to the reduction in sales. In addition, in 1999, the Company recorded
inventory write-off and other charges of approximately $30,050.
Gross profit for the year ended December 31,1999 was 32% compared to 65% in
1998. Excluding a write-off of inventory and other reserves, gross profits
for the year ended December 31,1999 was $75,727 or 53% compared to $146,621
or 65% in 1998.
RESEARCH AND DEVELOPMENT COSTS, NET. Net research and development costs in
1999 decreased by 18% to approximately $15,351 from approximately $18,680
in 1998. As a percentage of sales, research and development costs were 11%
in 1999 as compared to 8% in 1998. The decrease in research and development
costs net is due to a reduction in staff and lower material consumption.
Research and development expenses are net of the participation of the
Office of the Chief Scientist in Israel.
21
MARKETING AND SELLING EXPENSES. Marketing and selling expenses increased by
2% to approximately $78,432 in 1999 from approximately $76,882 in 1998. As
a percentage of sales, marketing and selling expenses were 55% in 1999
compared to 34% in 1998.
The increase in marketing and selling expenses as a percentage of sales was
mainly due to the lower level of sales in 1999.
Increased marketing and selling expenses in 1999 were primarily attributed
to the expansion and reorganization of the Company's selling efforts in the
United States. Marketing and selling expenses include $4,800 which related
to the restructuring plan adopted in 1999.
The Company has adopted a restructuring plan which started to effect the
marketing and selling expenses by lowering them drastically. The Company
expects the majority of the plan to be implemented by March 31, 2000.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased by 76% to approximately $25,799 in 1999 from approximately
$14,667 in 1998. As a percentage of sales, general and administrative
expenses were 18% in 1999 and 7% in 1998.
General and administrative expenses for 1999 included bad debt charges of
$13,430 and litigation expenses of $4,400 which were not part of the legal
settlements which were recorded in settlement of litigations described
below.
RESTRUCTURING COSTS. In the quarter ended March 31, 1999, the Company
developed and started the implementation of a restructuring plan. In
connection with that restructuring plan, the Company recorded charges in
1999 of $5,398 related to its sales and marketing operations and $16,608
related to inventory write-off (included in the cost of goods sold).
In the third quarter of 1999, the Company commenced another restructuring
program. In connection with that restructuring program, the Company
recorded write downs of inventories (included in cost of goods sold) of
approximately $3,130. The restructuring charge which amounted to $15,132 is
comprised of writedowns of fixed assets of $4,592 and severance charges and
a lease contract termination cost of $10,540. The majority of the
restructuring charge was attributable to the Company's divisions in the
United States. The restructuring program provides for a reduction of
approximately 200 employees. In addition, the Company recorded $4,983 of
expenses associated with the same plan which was charged to operating and
income tax expense. The Company expects approximately an additional $2,000
in charges related to the restructuring plan through the year 2000.
SETTLEMENT OF LITIGATIONS. During 1999 the Company had made several legal
settlements mainly related to the Reliant and LPG lawsuits. The total
amounts for the legal settlements was $23,780, which includes both
settlement fees and related legal fees incurred by the Company (see Item 3-
"Legal Proceedings" above).
WRITE-OFF OF INTANGIBLE AND TANGIBLE ASSETS. During 1999 the Company
wrote-off intangible assets for the amount of $16,049 which mainly related
to goodwill from acquisitions and acquired technology in prior years. In
addition, the Company wrote-off tangible assets in the amount of $1,567
that related to the restructuring plan adopted during 1999.
22
ACQUIRED RESEARCH AND DEVELOPMENT. In 1998, there was $2,451 of acquired
research and development expenses in connection with the acquisition of
technology from Ballard Purchase Corporation.
OTHER EXPENSES. For the year ended December 31, 1999, other expenses were
$4,987 comprised mainly of the following:
1. Fees in the amount of $1,412 related to the McKinsey & Co. work
on the restructuring plan.
2. $3,575 of expenses incurred during 1999 in connection with the
election contest relating to the Company's June 23, 1999
combined annual and extraordinary general meeting of
shareholders. The election contest resulted in the reimbursement
of expenses incurred by certain shareholders in connection with
the election contest, in accordance with the resolution adopted
by the Board of Directors and the audit committee of the
Company, during a meeting held on June 23, 1999, which resolved
that "all costs and expenses of Messrs. Arie Genger and Barnard
J. Gottstein and their affiliates in connection with the
election contest shall be reimbursed by the Company promptly on
submission of invoices therefor, subject to refund when such
reimbursement is submitted to shareholders and not approved by
such shareholders at a meeting noticed for such purpose." The
Company intends to present the foregoing expense reimbursement
arrangement to shareholders for approval at the next Annual
General Meeting of Shareholders. Messrs. Genger and Gottstein
have submitted to the Company invoices for a sum of
approximately $1,510. Separate from these shareholder incurred
expenses, the officers and directors of the Company incurred
expenses of $2,065 in connection with the election contest that
were charged to the Company.
OPERATING INCOME (LOSS)
FINANCING INCOME (EXPENSE), NET. For the year ended December 31, 1999,
financing expenses were approximately $3,865 from financing income of
$1,211 in 1998.
Financing income in 1999 consisted of interest income of $5,483 from the
Company's short term and long term investment securities which was offset
by interest and amortization of deferred expenses, in the amount of $7,626
attributable to the Company's 6% subordinated convertible notes and by
other interest and exchange rate differences of $1,722.
At December 31, 1999, approximately $43,841 was invested in short term bank
deposits.
NON-RECURRING EXPENSES. For the year ended December 31, 1998, the Company
incurred expenses in the amount of $28,951 related to the costs associated
with the Laser Industries acquisition.
TAXES ON INCOME. Taxes on income were approximately $4,079 for the year
ended December 31, 1999 compared to approximately $2,201 for the year ended
December 31, 1998. In 1999 the Company wrote off deferred tax assets of
approximately $ 3,300 which is reflected as tax expense in the period.
Because most of the Company's income in Israel is presently exempt from
income taxes, the Israeli statutory tax rate for the purposes of the
reconciliation of the reported tax expense is approximately zero. Income
tax expense in the financial statements relates primarily to the income
taxes of non-Israeli subsidiaries.
23
EXTRAORDINARY GAIN ON PURCHASE OF THE COMPANY'S SUBORDINATED CONVERTIBLE
NOTES. During 1999 the Company had purchased $22,071 principal amount of
its 6% Subordinated convertible notes. As a result of the repurchase the
Company had an extraordinary income of approximately $7,974.
NET INCOME. As a result of the foregoing factors, the Company's net loss
was $140,788 in 1999 from a net income of approximately $4,000 in 1998.
Year Ended December 31, 1998 Compared With Year Ended December 31, 1997
- -----------------------------------------------------------------------
(In thousands of dollars)
NET SALES. The Company's net sales increased by 16% to approximately
$225,206 in 1998 compared to approximately $193,983 in 1997. In the first
two quarters of 1998, net sales increased to approximately $123,200 from
$84,100 for the comparable period in 1997 due to an increase in sales of
the Company's intense pulsed light products, including the EpiLight and
PhotoDerm systems. A slowdown in revenue growth occurred in the second half
of the year. The third quarter decrease in revenue was due to a general
slowdown in activity during the summer months, mainly in Europe, as well as
lower sales volumes in South America. In addition, the uncertainty
surrounding elections in Germany and Brazil had delayed the decision making
of some of ESC's customers, thus impacting sales for the quarter. In the
fourth quarter, an additional slowdown in sales was noted. Most of this
shortfall can be attributed to strong price pressures on hair removal
products and by a general slowdown in the United States aesthetic markets.
The competitive price pressure on hair removal products resulted in the
Company reducing the price of its Alexandrite laser. In addition, there was
a decrease in the number of EpiLight hair removal units sold during this
quarter. These changes in the market reduced revenues in the fourth quarter
of 1998 compared to previous quarters, both due to the change in product
mix and a reduction in sales of IPL hair removal products.
GROSS PROFIT. Gross profit increased by 12% to approximately $146,621 in
1998 from approximately $131,015 in 1997. The Company's gross profit margin
in 1998 was 65% (excluding other revenues) as compared to 67% in 1997. In
the first two quarters of 1998, gross profit increased by 43% to
approximately $80,797 from approximately $56,664 for the comparable period
in 1997. The reduction was due to the changes in product price and product
mix discussed above.
RESEARCH AND DEVELOPMENT COSTS, NET. Net research and development costs in
1998 increased by 7.5% to approximately $18,680 from approximately $17,371
in 1997. As a percentage of sales, research and development costs were 8.3%
in 1998 as compared to 9% in 1997. Research and development expenses are
net of the participation of the Office of the Chief Scientist in Israel
which in 1998 were approximately $603.
MARKETING AND SELLING EXPENSES. Marketing and selling expenses increased by
38% to approximately $76,882 in 1998 from approximately $55,877 in 1997. As
a percentage of sales, marketing and selling expenses were 34% in 1998
compared to 29% in 1997. Increased marketing and selling expenses in 1998
were primarily attributable to expansion and re-organization of the
Company's selling efforts in the United States.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased by 10% to approximately $14,667 in 1998 from approximately
$16,091 in 1997. As a percentage of sales, general and administrative
expenses were 7% in 1998 and 8% in 1997. The reduced expenditure was
primarily attributable to the integration of Laser Industries into ESC.
Consequently, overlapping positions were consolidated and administrative
expenses were reduced.
24
OTHER EXPENSES. In 1998 there was $2,451 of acquired research and
development expenses in connection with the acquisition of technology from
Ballard Purchase Corporation.
FINANCING INCOME, NET. Financing income decreased to approximately $1,211
(net of $7,832 interest and amortization of deferred expenses attributed to
the Company's 6% subordinated convertible notes) in 1998, from financing
income of approximately $1,409 (net of $2,417 interest and amortization of
deferred expenses attributed to the Company's 6% subordinated convertible
notes) in 1997 (see note 18 to the Company's Financial Statements contained
in this Annual Report). The decrease in the financing income occurred due
to a significant decrease in interest rates in the United States, where the
Company invests in marketable securities, and amortization of deferred
expenses attributed to the Company's 6% subordinated convertible notes.
At December 31, 1998, approximately $46,867 was invested in short-term bank
deposits.
NON-RECURRING EXPENSES. For the year ended December 31, 1998, the Company
incurred expenses in the amount of $28,951 related to costs associated with
the Laser Industries acquisition.
TAXES ON INCOME. Taxes on income were approximately $2,201 for the year
ended December 31, 1998 compared to approximately $4,429 for the year ended
December 31, 1997.
Because most of the Company's income in Israel is exempt from income taxes,
the Israeli statutory tax rate for purposes of the reconciliation of the
reported tax expense is approximately zero. Income tax expense in the
financial statements relates primarily to the income taxes of non-Israeli
subsidiaries.
NET INCOME. As a result of the foregoing factors, the Company's net income
decreased to approximately $4,000 in 1998 from a net income of
approximately $22,094 in 1997. Net income as a percentage of revenues was
2% in 1998 compared to 11% in 1997.
VARIABILITY OF OPERATING RESULTS
The Company's sales and profitability may vary in any given year, and from
quarter to quarter, depending on the number and mix of products sold and
the average selling price of the products. In addition, due to potential
competition, uncertain market acceptance and other factors, the Company may
be required to reduce prices for its products in the future.
The Company's future results will be affected by a number of factors
including the ability to increase the number of units sold, to develop,
introduce and deliver new products on a timely basis, to anticipate
accurately customer demand patterns and to manage future inventory levels
in line with anticipated demand. These results may also be affected by
currency exchange rate fluctuations and economic conditions in the
geographical areas in which the Company operates. There can be no assurance
that the Company's historical growth in sales, gross profit and net income
will continue, or that sales, gross profit and net income in any particular
quarter will not be lower than those of the preceding quarters, including
comparable quarters.
25
LIQUIDITY AND CAPITAL RESOURCES
(In thousands of dollars)
As of December 31,1999, the Company had cash and cash equivalents of
$24,524 compared to $42,950 at the end of 1998, a decrease of $18,426. The
decrease in cash and cash equivalents was mainly attributable to the
following:
1. A decrease of trade receivables of $30,232 due to a decrease in
sales and a substantial increase in collection efforts and
increase in allowance for bad debt.
2. An increase in inventory and in prepaid expenses and other
receivables of $4,825 as a result of inventory and stock
reduction monitoring as well as a reduction in prepayments.
3. An increase in accounts payable and accrued expenses of $8,139
mainly due to the restructuring plan and provision for
settlement of litigations.
4. Maturity of long-term investments and purchasing of fixed assets
of $39,424.
5. Purchases of the Company's 6% subordinated convertible notes in
the amount of $14,264, repayment of a bank loan for $3,512 and
the repurchase of the Company's Ordinary Shares in the amount of
$10,660 pursuant to a share repurchase program implemented in
1999.
As of December 31, 1998 the Company had cash and cash equivalents of
$42,950 compared to $54,616 at the end of 1997, a decrease of $11,666. The
decrease in cash and cash equivalents was mainly attributable to the
following:
1. An increase of trade receivables of $25,521 due to an increase in
sales and longer payment terms for the distributors.
2. An increase in inventory of $21,302 due to a shift in mix of
products and decreased orders from customers.
3. Payments of long term loans in the amount of $15,025.
4. Purchase of $7,290 of the Company's Ordinary Shares pursuant to
a share repurchase program implemented in 1998, offset by
proceeds from the exercises of options of $7,864 and an increase
in short term bank debt of $2,373.
5. Maturity of investments of $39,921 offset by the purchase of
fixed assets of $4,611, investment in patents and know-how
totaling $5,523 and payment for the acquisition of new
technology for $2,450.
The Company does not currently have any plans, arrangements or
understandings with respect to incurring indebtedness in fiscal year 2000.
The Company believes that internally generated funds, together with
available cash, will be sufficient over at least the next 12 months to meet
its presently anticipated day-to-day operating expenses, material,
commitments, working capital and capital expenditure requirements.
26
INVESTING ACTIVITIES
(In thousands of dollars)
For the year ended December 31, 1999, cash provided by investing activities
was approximately $39,424.
The primary changes in the Company's investing activities for the year
ended December 31, 1999, as compared to the year ended December 31, 1998
were: a decrease of long term investments (mainly cash invested for a
period longer than one year) of approximately $43,439 and the purchase of
fixed assets of approximately $4,015.
For the year ended December 31, 1998, cash provided by investing activities
was approximately $27,846.
The primary changes in the Company's investing activities for the year
ended December 31,1998, as compared to the year ended December 31, 1997
were: maturity of investments of $39,921, $2,450 was invested for the
acquisition of Ballard Purchase Corporation, approximately $4,611 was
invested to purchase fixed assets and approximately $5,523 was used to
purchase of investments, patents and know-how.
FINANCING ACTIVITIES
(In thousands of dollars)
For the year ended December 31, 1999, cash used in financing activities was
$27,942.
The financing activities of the Company were primarily the purchase of the
Company's 6% subordinated convertible notes for approximately $14,264,
purchase of treasury shares of approximately $10,660, repayment of notes
payable to banks of approximately $3,531 which were offset by proceeds from
the exercise of warrants and options of approximately $513.
For the year ended December 31,1998, cash used in financing activities was
$12,078.
The financing activities of the Company were primarily the purchase of
treasury stock of approximately $7,290 and loan repayments of approximately
$15,025 mainly by Laser Industries and its subsidiaries. Funds from
financing activities which offset the above were primarily proceeds from
the exercise of warrants and options of approximately $7,864 and an
increase in short-term bank debt of approximately $2,373.
EFFECTIVE CORPORATE TAX RATE
INFLATIONARY ADJUSTMENTS. The Company and Laser Industries are subject to
the Income Tax Law (Inflationary Adjustments), 1985, which provides for an
adjustment to taxable income for the effects of inflation (based on the
Israeli Consumer Price Index) on that portion of shareholders' equity not
invested in inflation resistant assets.
APPROVED ENTERPRISE. The Company and Laser Industries have each received
approval for their investment programs in accordance with the Law for the
Encouragement of Capital Investments, 1959. The Company has chosen to
receive its benefits through the alternative benefits program, and, as
such, is eligible for various benefits. These benefits include accelerated
depreciation of fixed assets used in the investment programs, as well as a
full tax exemption on undistributed income that is derived from the
Approved Enterprise for a period of six years and reduced tax rates for an
additional period of up to four years. Laser Industries is entitled to a
27
full tax exemption for a period of two years and reduced tax rates for an
additional period of up to five years (the rate is dependent on the
percentage of non-Israeli shareholder ownership). The benefits commence
with the date on which taxable income is first earned. Income not derived
from the Approved Enterprise is subject to tax at a rate of 36%. The tax
exemption period for the Company commenced in 1995 and the tax exemption
period for Laser Industries has not yet commenced.
Dividends paid out of income derived from the Approved Enterprise is
subject to a 15% withholding tax. Should dividends be paid out of income
earned during the period of the tax holiday, such income will be subject to
tax at the rate of 25%. The Company does not anticipate paying dividends
from income derived from the Approved Enterprise and any such earnings
distributed upon dissolution will not subject the Company to income taxes.
The Company and Laser Industries have not received final income tax
assessments for years subsequent to 1991.
FORWARD LOOKING STATEMENTS
Certain statements made in this Report or made in press releases or in oral
presentations made by the Company's employees or agents reflect the
Company's estimates and beliefs and are intended to be, and are hereby
identified as, "forward looking statements" for the purposes of the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995.
The Company cautions readers that such forward looking statements involve
risks and uncertainties that could cause actual results to differ
materially from those expected by the Company or expressed in the Company's
forward looking statements. These factors include, but are not limited to,
the following: (1) uncertainty of market acceptance of the Company's
products; (2) uncertainties with respect to obtaining regulatory approvals
for new products or for the sale of existing products in new markets; (3)
uncertainties associated with the enforcement of intellectual property
rights by the Company and others; (4) limited number of customers for the
Company's products; (5) risks of downturns in economic conditions
generally, and in the health care industry specifically; (6) risks
associated with competition and competitive pricing pressures; and (7)
other risks described in the Company's filings with the Securities and
Exchange Commission.
Readers are cautioned not to place undue reliance on forward-looking
statements made in this Annual Report, or made in press releases or in oral
presentations. Such forward-looking statements reflect management's
analysis only as of the date such statements are made and the Company
undertakes no obligation to revise publicly these forward-looking
statements to reflect events or circumstances that arise subsequently.
Readers should carefully review the risk factors set forth above and
described elsewhere in this document and in other documents the Company
files from time to time with the Securities and Exchange Commission.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The Company maintains an investment portfolio which consist mainly of
income securities with an average maturity of less than one year. The
portfolio consists of low risk corporate bonds and bank deposits. The
Company's policy is generally to hold its fixed income investments until
maturity and therefore the Company would not expect its operating results
or cash flows to be effected to any significant degree by the effect of a
sudden change in market interest rates on its securities portfolio.
28
The Company has fixed rate long-term debt of approximately $93 million. The
Company believes that a material decrease in interest rates would not have
a material impact on the fair value of this debt.
The Company has foreign subsidiaries, which sell and manufacture its
products in various markets. As a result, the Company's earnings and cash
flows are exposed to fluctuation in foreign currency exchange rates. The
company attempts to limit the exposure by selling and linking its products
to the United States dollar.
The Company does not hedge transactions nor does it use derivative
financial instruments for trading purposes.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 14(a) for an index to the consolidated financial statements and
supplementary information, which are set forth on the pages indicated
therein.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On February 10, 2000, the client/auditor relationship between the Company
and Luboshitz Kasierer ("LK"), the Company's independent accountants,
ceased. During the years ended December 31, 1998 and 1997, and the
subsequent interim period through February 10, 2000 (the date LK ceased to
be the Company's independent accountants), (i) there were no disagreements
with LK on any matters of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements,
if not resolved to the satisfaction of LK, would have caused LK to make a
reference to the subject matter of the disagreements in connection with its
reports in the financial statements for such years and (ii) there were no
"reportable events" as described in Items 304(a)(1)(iv) of Regulation S-K.
The independent accountant's report of LK on the Company's consolidated
financial statements for the years ended December 31, 1998 and 1997
contained no adverse opinion or disclaimer of opinion and were not
qualified or modified as to uncertainty, audit scope or accounting
principles.
The Company requested that LK furnish it with a letter addressed to the
Securities and Exchange Commission stating whether or not it agreed with
the above statements. A copy of such letter, dated February 10, 2000,
setting forth LK's agreement with the above statements, is filed as Exhibit
16 to this Form 10-K. On January 17, 2000, the Company decided to appoint,
with the approval of the Company's Board of Directors, the firm of
Brightman Almagor & Co., a member firm of Deloitte, Touche, Tohmatsu, as
its independent accountants replacing LK.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The required information for this item is incorporated by reference to the
Company's Proxy Statement for the 2000 Annual Meeting of Shareholders.
29
ITEM 11. EXECUTIVE COMPENSATION.
The required information for this item is incorporated by reference to the
Company's Proxy Statement for the 2000 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The required information for this item is incorporated by reference to the
Company's Proxy Statement for the 2000 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS.
The required information for this item is incorporated by reference to the
Company's Proxy Statement for the 2000 Annual Meeting of Shareholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K.
(A) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:
1. Financial Statements
Page
----
Independent Auditors' Report..................................... 36-37
Consolidated Financial Statements:
Consolidated Balance Sheets................................ 38
Consolidated Statements of Operations...................... 39
Consolidated Statements of Changes in Shareholders' Equity. 40
Consolidated Statements of Cash Flows...................... 41-42
Notes to Consolidated Financial Statements....................... 43-62
2. Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts.................. 63
30
3. Exhibits
Exhibit
Number Description
- ------- -----------
2.1 Agreement, dated as of November 9, 1997, between ESC Medical
Systems Ltd. ("ESC") and Laser Industries Ltd. ("Laser") *I
(included as Annex A-1 to the Joint Proxy
Statement/Prospectus forming part of such Registration
Statement)
2.2 Form of Agreement among Laser and its shareholders *I
(included as Annex A-2 to the Joint Proxy
Statement/Prospectus forming part of such Registration
Statement)
2.3 (4.2) Agreement and Plan of Merger by and among ESC, ESC
Acquisition Sub, Inc. and Luxar Corporation, dated February
19, 1997 *F
2.4 Agreement and Plan of Merger by and among ESC Medical
Systems Ltd., AOC Acquisition Corp. and Applied Optronics
Corporation, dated November 20, 1997 *O
2.5 Asset Purchase Agreement among Laser Industries Ltd., Orziv
(Z.K.Y.P.) Ltd., Yehiam Prior
and Ziv Karni, dated July 1998 *O
3.1 Memorandum of Association (English translation)*A
3.2 Articles of Association *A
3.3 (4.2) Articles of Association as amended September 5, 1996 *E
4.1 Specimen Certificate for Ordinary Shares *B
4.2 Luxar Corporation 1988 Stock Bonus and Option Plan *G, *N
4.3 Luxar Corporation 1994 Stock Option Plan *G, *N
4.4 Luxar Corporation 1995 Stock Option Plan G,*N
4.5 (4.1) Indenture, dated September 10, 1997, between ESC and
United States Trust Company of New York *H
4.6 (4.2) Registration Rights Agreement, dated September 10,
1997, between ESC, Goldman, Sachs & Co., Donaldson Lufkin &
Jenrette Securities Corporation, Montgomery Securities and
Smith Barney Inc. *H
4.7 (4.3) Specimen of Notes *H (included in Exhibit 4.1 from same filing)
4.8 (4.2) Laser Industries Limited 1988 Share Option Plan *J, *N
4.9 (4.3) Laser Industries Limited 1990 Share Option Plan *J, *N
4.10 (4.4) Laser Industries Limited 1991 Share Option Plan *J, *N
4.11 (4.5) Laser Industries Limited 1994 Share Option Plan *J, *N
4.12 (4.6) Laser Industries Limited 1995 Share Option Plan *J, *N
4.13 (4.7) Laser Industries Limited 1996 Share Option Plan *J, *N
4.14 (4.8) Laser Industries Limited 1997 Share Option Plan *J, *N
10.1 Preferred Shares Purchase Agreement, dated April 16, 1992,
among ESC, the Founders and the Investors *B
10.2 Share Purchase and Warrant Agreement, dated May 24, 1993,
among ESC, the Founders and the Investors *B
10.3 Share Purchase and Warrant Agreement, dated February 20,
1994, among ESC, the Founders, the Investors and Nitzanim *B
10.4 Personal Employment Agreement between ESC and Eli Talmor,
dated August 2, 1995 *B, *N
10.5 1993 Stock Option Plan, as amended *B, *N
10.6 1995 Section 102 Stock Option/Stock Purchase Plan *B, *N
10.7 Form of Stock Option Plan Restricted Stock Option Agreement
*B, *N
31
10.8 Form of Stock Option Plan Incentive Stock Option Agreement
*B, *N
10.9 Form of Section 102 Stock Option/Stock Purchase Plan
Restricted Stock Option Agreement *B, *N
10.10 Share Purchase Agreement, dated August 2, 1995 between ESC
and Technion Entrepreneurial Incubator Company Ltd. ("TEIC")
*B
10.11 Form of Stock Sale Agreement dated August 7, 1995 between
ESC and individual shareholders of Medic Lightech Ltd.
(English translation)*B
10.12 Agreement dated August 2, 1995 between ESC, Eli Talmor and
Medic Lightech Ltd. *B
10.13 Agreement dated August 2, 1995 between ESC, Eli Talmor, TEIC
and Medic Lightech Ltd. *B
10.14 Letter dated February 27, 1994 from the Technion Research
Development Foundation Ltd. ("Technion") to Medic Lightech
Ltd. (English translation) *B
10.15 Assignment of U.S. Patent Application No. 974,619 (Patent
No. 5,344,434) by Technion to Dimotech Ltd. dated March 13,
1994 *B
10.16 Assignment of U.S. Patent Application No. 974,619 (Patent
No. 5,344,434) by Technion to Dimotech Ltd. and Eli Talmor
dated May 9, 1994 *B
10.17 Letter dated August 2, 1995 from Technion (English
translation) *B
10.18 Letter dated November 2, 1995 from Dimotech Ltd. and Eli
Talmor to Dr. Shimon Eckhouse (English translation) *B
10.19 Letter dated December 6, 1995 from Dimotech Ltd. to Dr.
Shimon Eckhouse (English translation) *B
10.20 Letter dated December 6, 1995 from Technion to ESC *B
10.21 Letter dated December 7, 1995 from Eli Talmor to Dr. Shimon
Eckhouse (English translation) *B
10.22 Assignment of PhotoDerm Patent (U.S. Patent No. 5,405,368)
to ESC by Dr. Shimon Eckhouse dated October 16, 1992 *B
10.23 Form of Standard Confidential Disclosure Agreement *B
10.24 Confidentiality Agreement dated November 12, 1992 between
ESC and Andrie Katz *B
10.25 Letter of Intent between ESC and L.B.T. Ltd. dated May 22,
1996 *C
10.26(10.1) Employment Agreement, dated May 1, 1999, between ESC, ESC
Medical Systems Inc. and Louis Scafuri *K, *N
10.27(10.2) Stock Option Agreement, dated June 18, 1999, between
ESC and Louis Scafuri *K, *N
10.28(10.3) Letter of Agreement, dated June 23, 1999, from
Messrs. Genger and Gottstein to ESC *K
10.29(10.1) Employment Agreement, dated as of June 29, 1999,
between ESC and Yacha Sutton *L, *N
10.30 Purchase Agreement concerning the Purchase by ESC Medical
Systems of Certain Assets of Ballard Purchase Corporation,
effective September 10, 1998 *O
10.31 Lease Agreement between Scan Group Yokneam Ltd. and ESC
(English Translation) *O
10.32 Lease Agreement between Mario Laznik Industrial Buildings
Ltd. and ESC *O
10.33 Employment Agreement, dated as of October 1, 1996, between
ESC and Shimon Eckhouse *N, *O
10.34 Employment Agreement, dated as of January 15, 1999, between
ESC Japan Company, Ltd. and Alon Maor *N, *O
10.35 Amendment to Employment Agreement, dated November 12, 1999
between ESC Medizintechnik Vertriehs GmbH and Hans Edel *N,
*O
16(16) Letter, dated February 28, 2000, from Luboshitz
Kasierer to the Securities Exchange Commission *M
21 List of Subsidiaries *O
32
23.1 Consent of Brightman Almagor & Co. *O
23.2 Consent of Luboshitz Kasierer *O
25.1 Form T-1 Statement of Eligibility and Qualification under
the Trust Indenture Act of 1939, as amended, of United
States Trust Company of New York, as Trustee under the
Indenture *H
27 Financial Data Schedule *O
99.1 Form of letter to Laser shareholders for the cover page of
the Joint Proxy Statement *I
Note: Parenthetical references following the Exhibit Number of each
document relate to the exhibit number under which such exhibit was
initially filed.
*A Incorporated by reference to Registration Statement on Form F-1,
File #33-80199; filed on December 8, 1995.
*B Incorporated by reference to Amendment No. 2 to Registration
Statement on Form F-1, File #33- 80199, filed on January 19, 1996.
*C Incorporated by reference to Registration Statement on Form F-1,
File #333-4886, filed on May 28, 1996
*D Incorporated by reference to Registration Statement on Form F-1,
File #333-4886, filed on June 25, 1996
*E Incorporated by reference to Registration Statement on Form S-8,
File #333-5898, filed on October 31, 1996
*F Incorporated by reference to Registration Statement on Form F-3,
File #333-6610, filed on March 12, 1997
*G Incorporated by reference to Registration Statement on Form S-8,
File #333-6774, filed on April 11, 1997
*H Incorporated by reference to Registration Statement on Form F-3,
File #333-8056, filed on December 9, 1997
*I Incorporated by reference to Registration Statement on Form F-4,
File #333-8208, filed on January 14, 1998
*J Incorporated by reference to Registration Statement on Form S-8,
File #333-8352, filed on February 13, 1998
*K Incorporated by reference to Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1999, File #0-13012, filed on
August 13, 1999
*L Incorporated by reference to Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1999, File #0-13012, filed on
November 15, 1999
*M Incorporated by reference to Current Report on Form 8-K/A, filed on
February 29, 2000
*N Management contract or compensatory plan or arrangement *O Filed
herewith
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the three-month
period ended December 31, 1999.
33
ESC MEDICAL SYSTEMS LTD.
CONSOLIDATED FINANCIAL STATEMENTS
34
ESC MEDICAL SYSTEMS LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
INDEPENDENT AUDITORS' REPORTS 36-37
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets
as of December 31, 1999 and 1998 38
Consolidated Statements of Operations
for the years ended December 31, 1999, 1998 and 1997 39
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1999, 1998 and 1997 40
Consolidated Statements of Cash Flows
for the years ended December 31, 1999, 1998 and 1997 41-42
Notes to the Consolidated Financial Statements 43-62
# # # # # #
35
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
ESC Medical Systems Ltd.:
We have audited the accompanying consolidated balance sheet of ESC MEDICAL
SYSTEMS LTD. (the "Company") and its subsidiaries as of December 31, 1999,
and the related consolidated statement of operations, changes in
shareholders' equity and cash flows for the year then ended. These
financial statements are the responsibility of the Company's Board of
Directors and management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audit provides a reasonable basis for our opinion.
In our opinion, the aforementioned consolidated financial statements
present fairly, in all material respects, the consolidated financial
position of the Company and its subsidiaries as of December 31, 1999, and
the consolidated results of their operations, changes in shareholders'
equity and cash flows for the year then ended, in conformity with generally
accepted accounting principles in the United States.
Brightman Almagor & Co.
Certified Public Accountants
A member of Deloitte Touche Tohmatsu
Tel Aviv, Israel
March 30, 2000
36
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of
ESC Medical Systems Ltd.
We have audited the consolidated balance sheets of ESC Medical Systems Ltd.
(an Israeli Corporation) as of December 31, 1998, and the related
consolidated statements of operations, changes in shareholders' equity and
cash flows for each of the two years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the financial statements
of Laser Industries Ltd. for the year ended December 31, 1997. (Laser
Industries Ltd. was acquired during 1998 in transactions accounted for as a
pooling of interests, as discussed in Note 3). Such statements are included
in the consolidated financial statements of the Company and reflect total
sales constituting 42% in 1997 of the related consolidated totals. These
statements were audited by other auditors whose reports have been furnished
to us and our opinion, insofar as it relates to amounts included for Laser
Industries Ltd., is based solely upon the reports of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards in Israel and in the United States, including those prescribed
under the Auditors' Regulations (Auditor's Mode of Performance), 1973.
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 and
the reports of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other auditors,
the consolidated financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of December
31, 1998, and the results of its operations and its cash flows for each of
the two years in the period ended December 31, 1998, in conformity with
accounting principles generally accepted in the United States.
LUBOSHITZ KASIERER
Member Firm of Arthur Andersen
Haifa, Israel
February 10, 1999
37
T
ESC MEDICAL SYSTEMS LTD.
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
DECEMBER 31
----------------------------
NOTE 1999 1998
---- ----------- ----------
CURRENT ASSETS
Cash and cash equivalents $ 24,524 $ 42,950
Short-term investments 43,841 46,867
Trade receivables (net of allowances of $25,432 and
$10,480 in 1999 and 1998, respectively) 43,360 78,392
Prepaid expenses and other receivables 5 5,852 12,824
Inventories 6 39,516 61,200
----------- ----------
157,093 242,233
LONG-TERM INVESTMENTS
Bank deposits and securities 879 41,350
Other 5,566 5,469
FIXED ASSETS 7 6,549 13,877
OTHER ASSETS 8 4,820 24,737
----------- ----------
Total assets $ 174,907 $ 327,666
=========== ==========
CURRENT LIABILITIES
Short-term debt and current maturities of long-term loans $ 21 $ 3,533
Accounts payable and accrued expenses 9 72,252 52,319
----------- ----------
72,273 55,852
----------- ----------
LONG-TERM LIABILITIES
Bank loans 42 61
Restructuring accrual 4 2,472 -
Accrued severance pay 10 1,248 1,245
Convertible subordinated notes 11 92,929 115,000
----------- ----------
96,691 116,306
----------- ----------
Total liabilities 168,964 172,158
----------- ----------
COMMITMENTS AND CONTINGENT LIABILITIES 12
SHAREHOLDERS' EQUITY 13
Ordinary shares of NIS 0.1 par value:
Authorized - 50,000,000 shares;
Issued and outstanding - 27,579,020 shares and
27,314,601 Shares as of December 31, 1999 and 1998, 577 553
respectively
Paid-in capital 137,732 136,001
Unearned compensation (117) (245)
Retained earnings (accumulated deficit) (113,975) 26,813
Treasury stock, at cost 2,644,813 shares and 1,054,813
Shares as of December 31, 1999 and 1998,
respectively
(18,274) (7,614)
----------- ----------
Total shareholders' equity 5,943 155,508
----------- ----------
Total liabilities and shareholders' equity $ 174,907 $ 327,666
=========== ==========
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
38
ESC MEDICAL SYSTEMS LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
YEAR ENDED DECEMBER 31
--------------------------------------------
1999 1998 1997
NOTE (RESTATED)
---- ------------- -------------- -------------
REVENUES
Net sales 14 $ 142,151 $ 225,206 $ 193,983
Other revenues - - 2,100
------------- -------------- -------------
142,151 225,206 196,083
COST OF SALES 4 96,474 78,585 65,068
------------- -------------- -------------
Gross profit 45,677 146,621 131,015
------------- -------------- -------------
OPERATING EXPENSES
Research and development, net 15 15,351 18,680 17,371
Marketing and selling 4 78,432 76,882 55,877
General and administrative 25,799 14,667 16,091
Restructuring costs 4 20,530 - -
Settlement of litigations 12 23,780 - -
Impairment of intangible and tangible assets 3,7 17,616 - -
Acquired research and development 16 - 2,451 11,912
Other 17 4,987 - -
------------- -------------- -------------
Total operating expenses 186,495 112,680 101,251
------------- -------------- -------------
Operating income (loss) (140,818) 33,941 29,764
FINANCING INCOME (EXPENSES), NET 18 (3,865) 1,211 1,409
------------- -------------- -------------
(144,683) 35,152 31,173
NONRECURRING EXPENSES 3 - 28,951 4,650
------------- -------------- -------------
Income (loss) before income taxes (144,683) 6,201 26,523
TAXES ON INCOME 19 4,079 2,201 4,429
------------- -------------- -------------
Net income (loss) before extraordinary items (148,762) 4,000 22,094
EXTRAORDINARY GAIN ON PURCHASE OF
COMPANY'S CONVERTIBLE NOTES - -
11 7,974
------------- -------------- -------------
Net income (loss) for the year $(140,788) $ 4,000 $ 22,094
============= ============== =============
EARNINGS (LOSS) PER SHARE 20
Basic
Income (loss) before extraordinary item $ (5.79) $ 0.15 $ 0.86
Extraordinary gain 0.31 - -
------------- -------------- -------------
Net earnings (loss) per share $ (5.48) $ 0.15 $ 0.86
============= ============== =============
Diluted
Income (loss) before extraordinary item $ (5.79) $ 0.15 $ 0.81
Extraordinary gain 0.31 - -
------------- -------------- -------------
Net earnings (loss) per share $ (5.48) $ 0.15 $ 0.81
============= ============== =============
WEIGHTED AVERAGE NUMBER
OF SHARES
Basic 25,674 26,027 25,604
============= ============== =============
Diluted 25,674 27,381 27,194
============= ============== =============
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
39
ESC MEDICAL SYSTEMS LTD.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
(in thousands)
NOTE
RECEIVABLE
FROM RETAINED
SHAREHOLDERS AND EARNINGS
SHARE PAID IN UNEARNED (ACCUMULATED TREASURY
CAPITAL CAPITAL COMPENSATION DEFICIT) STOCK TOTAL
--------- ---------- ---------------- ------------ ------------ ----------
Balance as of
January 1, 1997 (restated) $ 520 $ 111,796 $ (1,234) $ (144) $ (104) $110,834
Purchase of treasury stock (220) (220)
Shares issued in connection
with acquisition of AOC 4 7,245 7,249
Tax benefit of options exercised
by employees 3,695 3,695
Exercise of options and warrants 1 4,740 4,741
Amortization of unearned
compensation 529 529
Net income of Luxar for the
three months ended
December 31, 1996 863 863
Collection of note receivable 140 140
Translation adjustments 79 79
Net income for the year 22,094 22,094
--------- ---------- ---------------- ------------ ------------ ----------
Balance as of
525 127,555 (565) 22,813 (324) 150,004
December 31, 1997 (restated)
Purchase of treasury stock (7,290) (7,290)
Exercise of options 28 7,836 7,864
Amortization of unearned
compensation 320 320
Tax benefit of options
exercised by employees 610 610
Net income for the year 4,000 4,000
--------- ---------- ---------------- ------------ ------------ ----------
Balance as of
553 136,001 (245) 26,813 (7,614) 155,508
December 31, 1998
Purchase of treasury stock (10,660) (10,660)
Gain from decrease in holding in
an affiliate 1,025 1,025
Exercise of options 24 489 513
Grant of options 217 217
Amortization of unearned
compensation 128 128
Net loss for the year (140,788) (140,788)
Balance as of
December 31, 1999 $ 577 $ 137,732 $ (117) $ (113,975) $ (18,274) $ 5,943
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
40
ESC MEDICAL SYSTEMS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31
1 9 9 9 1 9 9 8 1 9 9 7
------------- -------------- -------------
(RESTATED)
CASH FLOWS - OPERATING ACTIVITIES
Net income (loss) $ (140,788) $ 4,000 $ 22,094
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities -
Expenses (income) not affecting operating cash flows:
Deferred income taxes 4,093 (1,174) (2,264)
Amortization of deferred compensation 128 320 529
Nonrecurring expenses in connection with purchases - 8,938 11,912
Depreciation and amortization 8,457 8,922 4,959
Gain on purchase of Company's convertible notes (7,974) - -
Restructuring costs 45,068 - -
Impairment of intangible and tangible assets 17,616 - -
Other 296 543 (26)
Changes in operating assets and liabilities:
Decrease (increase) in trade receivables 30,232 (25,521) (25,899)
Decrease in prepaid expenses and other receivables 2,879 852 2,621
Decrease (increase) in inventories 1,946 (21,302) (19,811)
Increase (decrease) in accounts payable and accrued expenses 8,139 (3,012) 22,183
------------- -------------- -------------
Net cash provided by (used in) operating activities (29,908) (27,434) 16,298
------------- -------------- -------------
CASH FLOWS - INVESTING ACTIVITIES
Payment for purchase of businesses, net of cash acquired - (2,450) (17,158)
Sale of investment - 368 -
Purchase of fixed assets (4,015) (4,611) (7,507)
Investments in patents and know-how - (5,523) (4,270)
Maturity of (additions to) investments 43,439 39,921 (107,164)
Proceeds from disposal of fixed assets - 141 82
------------- -------------- -------------
Net cash provided by (used in) investing activities 39,424 27,846 (136,017)
------------- -------------- -------------
CASH FLOWS - FINANCING ACTIVITIES
Proceeds from issuance of convertible notes, net of expenses - - 110,500
Purchase of convertible notes (14,264) - -
Proceeds from exercise of warrants and options 513 7,864 4,086
Proceeds from long-term debt - - 10,260
Repayment of long-term loans (19) (15,025) (1,216)
Increase (decrease) in short-term bank debt, net (3,512) 2,373 728
Purchase of treasury stock (10,660) (7,290) (220)
Collection of note receivable from shareholders - - 140
------------- -------------- -------------
Net cash provided by (used in) financing activities (27,942) (12,078) 124,278
------------- -------------- -------------
NET INCREASE IN CASH OF LUXAR FOR THE
THREE MONTHS ENDED DECEMBER 31, 1996 - - 777
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (18,426) (11,666) 5,336
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 42,950 54,616 49,280
------------- -------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 24,524 $ 42,950 $ 54,616
============= ============== =============
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
41
ESC MEDICAL SYSTEMS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT.)
(in thousands)
YEAR ENDED DECEMBER 31
--------------------------------------------
1 9 9 9 1 9 9 8 1 9 9 7
------------- -------------- -------------
(RESTATED)
NONCASH ACTIVITIES
Conversion of subordinated debentures and interest payable to
common stock $ - $ - $ 481
------------- -------------- -------------
Tax benefit of options exercised by employees $ - $ 610 $ 3,695
------------- -------------- -------------
CASH PAID DURING THE PERIOD IN RESPECT OF:
Income taxes $ 649 $ 670 $ 272
------------- -------------- -------------
Interest $ 6,654 $ 7,510 $ 750
------------- -------------- -------------
PURCHASE OF BUSINESSES
Assets and liabilities at date of purchase:
Working capital (excluding cash) $ 556 $ (1,632)
Fixed assets (19) (1,453)
Intangibles and other assets (3,987) (12,763)
Research and development projects in process - (10,114)
Long-term liabilities - 1,555
-------------- -------------
(3,450) (24,407)
Short-term liabilities incurred in connection with purchase 1,000 -
Shares and warrants issued in connection with purchase - 7,249
-------------- -------------
Cash paid, net $ (2,450) $ (17,158)
============== =============
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
42
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 1 - GENERAL
A. ESC Medical Systems Ltd. (the "Company" or "ESC") is an
Israeli company engaged directly and through its
subsidiaries (together "the Group") in research,
development, production and sale of medical devices
based on proprietary intense pulsed light source and
laser technology. The market for the Group's devices
are principally cosmetic medical professionals
worldwide.
B. In 1997 and 1998, the Group entered into various
merger and acquisition agreements, the most
significant of which were with Luxar Corporation
("Luxar") and Laser Industries Limited ("Laser"),
which were recorded as pooling-of-interests and the
acquisition of Spectron (U.K.) Limited accounted for
by the purchase accounting method. See Note 3 for a
description of the merger and acquisition activity and
the accounting treatment applied thereto.
C. In 1999, the Group initiated a restructuring program
of its business operations (see Note 4). In the
framework of this program, the U.S.-based
marketing activity is to be consolidated, the
Israel-based manufacturing activity is to be
consolidated, and certain products are to be
eliminated. Management expects the restructuring
program to be fully implemented in 2000.
D. The Group's products use proprietary technology and
accordingly the Group holds numerous patents and
licenses. In addition, the industry in which the Group
operates is characterized by rapid technological
change and competition. Loss or invalidation of a
patent or a license or inability to remain competitive
in a rapidly changing economic environment could have
an adverse effect on the Group.
E. The preparation of financial statements in conformity
with generally accepted accounting principles requires
management to make estimates and assumptions that
affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported
amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
NOTE 2 - ACCOUNTING POLICIES
The financial statements have been prepared in conformity
with accounting principles generally accepted in the United
States. The significant accounting policies followed in the
preparation of the financial statements, on a consistent
basis, are:
A. The accompanying financial statements have been
prepared in U.S. dollars, as the currency of the
primary economic environment in which the operations
of the Group are conducted is the U.S. dollar. The
majority of the Group's sales are denominated in U.S.
dollars, as are the majority of purchases of materials
and components. Thus, the functional currency of the
Group is the U.S. dollar.
Transactions and balances originally denominated in
U.S. dollars are presented at their original amounts.
Transactions and balances in other currencies are
remeasured into U.S. dollars in accordance with
Statement No. 52 of the Financial Accounting Standards
Board of the United States (FASB). Accordingly, items
have been remeasured as follows:
o Monetary items - at the current exchange rate at
the balance sheet date.
43
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 2 - ACCOUNTING POLICIES (CONT.)
o Nonmonetary items - at historical exchange rates.
o Income and expense items (excluding items
deriving from nonmonetary items) - at exchange
rates current as of the date of recognition of
those items.
o Depreciation and other items deriving from
nonmonetary items - at historical exchange
rates.
o Exchange gains and losses from the
aforementioned remeasurement are reflected in
the statement of operations.
B. PRINCIPLES OF CONSOLIDATION
---------------------------
The consolidated financial statements include the
accounts of the Company and its subsidiaries. Material
intercompany balances and transactions have been
eliminated.
As a result of the business combinations with Luxar
and Laser in 1997 and 1998, all prior period financial
statements were restated to include the accounts of
Luxar and Laser (see Note 3).
C. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
-------------------------------------------
All highly liquid investments are considered as cash
equivalents if the investments mature within three
months from the date of investment. Investments in
bank deposits and in commercial paper with original
maturities longer than three months but less than a
year are reflected as short-term investments.
D. ALLOWANCE FOR DOUBTFUL ACCOUNTS
-------------------------------
The allowance for doubtful accounts is recorded on the
basis of specific accounts receivable whose
collectibility, based on management's estimate, is
uncertain.
E. INVENTORIES
-----------
Inventories are presented at the lower of cost or
market. Cost being determined as follows:
Raw materials - "First-in, first-out" method
Finished products and - Materials as above, labor and
work in process overhead costs on an average
basis.
F. LONG-TERM INVESTMENTS
---------------------
Investments in long-term bank deposits and in debt
securities in respect of which the Company has the
positive intent and ability to hold to maturity are
stated at amortized cost. Investments in nonmarketable
equity securities are stated at cost, unless the
Company has significant influence as defined in
Accounting Principles Board Opinion ("APB") No. 18 in
which case the investment is presented on the equity
method.
44
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 2 - ACCOUNTING POLICIES (CONT.)
G. FIXED ASSETS
------------
Fixed assets are presented at cost (see also I below),
net of accumulated depreciation.
Annual depreciation is calculated based on the
straight-line method over the estimated useful lives
of the related assets or terms of the related leases.
Annual depreciation rates are as follows:
%
------
Computers and equipment 10-33
Office furniture and equipment 7-20
Leasehold improvements Over the period of the lease
Vehicles 15
H. OTHER ASSETS
------------
Intangible assets (patents, know-how and goodwill) are
amortized by the straight-line method over periods of
principally between five and ten years (see also I
below). Debt issuance costs are amortized over the
term of the related debt by the straight-line method.
I. IMPAIRMENT OF LONG-LIVED ASSETS
-------------------------------
In accordance with SFAS No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," management reviews
long-lived assets for impairment periodically and
whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be
recoverable based on estimated future cash flows.
J. RESEARCH AND DEVELOPMENT COSTS
------------------------------
Research and development costs are charged to
operations as incurred. Amounts received or receivable
from the Government of Israel (through the Office of
the Chief Scientist) as its participation in certain
research and development are offset against the
Group's research and development costs.
K. REVENUE RECOGNITION
-------------------
Revenue is recognized upon shipment of products
provided that there are no significant uncertainties
regarding the customer's acceptance and the
collectibility is probable. The costs of insignificant
related obligations (initial installations) are
accrued when the related revenue is recognized.
Deferred revenues from service contracts are
recognized on a straight-line basis over the life of
the related service contracts. An allowance has been
recorded for estimated returns based on Group's
experience and management's estimates.
L. PRODUCT WARRANTIES
------------------
Accrued warranty costs are recorded at the time of
sale based on the Group's experience and management
estimates.
45
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 2 - ACCOUNTING POLICIES (CONT.)
M. STOCK-BASED COMPENSATION
------------------------
The Group accounts for employee stock-based
compensation in accordance with APB No. 25,
"Accounting for Stock Issued to Employees". Pursuant
to this accounting standard, the Group records
compensation for share options granted to employees at
the date of grant based on the difference between the
exercise price of the options and the market value of
the underlying shares at that date. Deferred
compensation is amortized to compensation expense over
the vesting period of the underlying options. See Note
13 for pro forma disclosures required in accordance
with SFAS No.123, "Accounting for Stock-Based
Compensation," ("SFAS 123") of the FASB. The Group
accounts for stock-based compensation to consultants
in accordance with SFAS 123.
N. DEFERRED TAXES
--------------
Deferred tax assets and liabilities are determined
based on differences between financial reporting and
tax bases of assets and liabilities measured using
enacted tax rates and laws expected to be in effect
when the differences are expected to reverse. A
valuation allowance is recorded to the extent that
realization is not considered more likely than not.
O. EARNINGS PER SHARE
------------------
Basic earnings per share is computed based on the
weighted average number of ordinary shares outstanding
and excludes any potential dilution. Diluted earnings
per share reflects potential dilution from exercise of
options and warrants or conversion of convertible
securities into ordinary shares.
P. RECLASSIFICATIONS
-----------------
Certain reclassification have been made to prior
years' financial statements to conform to the current
year's presentation.
Q. NEW ACCOUNTING PRONOUNCEMENT
----------------------------
In June 1998, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging
Activities ("SFAS 133"). The Statement establishes
accounting and reporting standards requiring that
every derivative instrument be recorded in the balance
sheet at its fair value. The Statement requires that
changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting
criteria are met. Special accounting for qualifying
hedges allows a derivative's gains and losses to offset
related results on the hedged item in the income
statement.
SFAS 133, as amended, is effective for fiscal years
beginning after June 15, 2000. The Company believes
that the adoption of SFAS 133 will not have a material
effect on its financial statements.
46
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 3 - MERGERS AND ACQUISITIONS
A. LUXAR
-----
In March 1997, Luxar was merged with and into the
Company, which merger was accounted for as a pooling
of interests. Accordingly, all prior period financial
statements have been restated to include the accounts
of Luxar.
The statement of operations for the year ended
December 31, 1997, reflects nonrecurring expenses of
approximately $4,650 related to costs associated with
the merger.
B. LASER ACQUISITION
-----------------
In February 1998, Laser was acquired by ESC through
the issuance of 6,181,013 ordinary shares of ESC and
warrants and options exercisable for the purchase of
865,089 additional shares. The exchange with Laser was
accounted for as a pooling of interests, and
accordingly, all prior period financial statements
were restated to include the accounts of Laser and
reflect the issuance of the shares, warrants and
options by ESC.
The statement of operations for the year ended
December 31, 1998, reflects nonrecurring expenses of
approximately $28,951 related to costs associated with
the acquisition. Such amount includes principally
$7,226 for underwriters, legal and accounting
expenses, $7,149 for non-compete payments, bonuses and
severance, and $6,638 for inventory writedowns.
C. Combined and separate results of ESC and Laser during
1997 were as follows:
--------------------------------------------------------
ESC LASER COMBINED
Year ended December 31, 1997:
Revenues $114,854 $81,229 $196,083
Net income $ 21,824 $ 270 $ 22,094
D. SPECTRON ACQUISITION
--------------------
In April 1997, Laser acquired for cash consideration
all of the outstanding shares of Spectron (U.K.)
Limited, a U.K. based developer and manufacturer of
laser systems for the medical, industrial and
scientific markets, in a transaction accounted for
under the purchase of accounting method. The total
cost of the acquisition was $18,734, of which $4,900
was allocated to Spectron's tangible net assets,
$8,000 was allocated to acquired technology, and
$5,834 was written off as in-process research and
development projects. Spectron has been included in
the consolidated results of operations since April
1997. The results of operations of Spectron for the
periods prior to April 1997 are immaterial to the
consolidated results of operations.
Due to a determination by management regarding the
unrecoverability of the acquired technology, the Group
wrote off in 1999 an amount of $5,933 representing the
entire net book value of the acquired technology
recorded as a result of the 1997 acquisition.
47
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 3 - MERGERS AND ACQUISITIONS (CONT.)
E. AOC ACQUISITION
---------------
On December 18, 1997, the Company acquired Applied
Optronics Corp. ("AOC") for a total consideration of
$7,500. The consideration was comprised of
approximately $200 in cash, 164,356 ordinary shares
and 84,435 warrants to purchase shares of the Company
(see Note 13). AOC is a U.S. company engaged in
research, development, manufacturing and marketing of
laser diode optoelectronic components and systems.
The acquisition was accounted for under the purchase
of accounting method. Of the total purchase price,
$4,280 was allocated to AOC's research and development
projects in process. As these projects had no
alternative future use, they were written off as a
nonrecurring expense at the date of purchase.
Approximately $3,500 of the purchase price was
allocated to intangible assets. The balance of
approximately $300 represents the net liabilities
(deficit) of AOC assumed by the Company.
Due to a determination by management regarding the
unrecoverability of the intangible assets, the Group
wrote off in 1999 an amount of $3,040 representing the
entire net book value of the intangible assets
recorded as a result of the 1997 acquisition.
The operating results of AOC for the year 1997 were
immaterial in relation to the Company's consolidated
results of operations.
NOTE 4 - RESTRUCTURING COSTS AND OTHER CHARGES
- ------ -------------------------------------
In 1999 the Group recorded a $45,068 charge for comprehensive
restructuring plans approved on September 14, 1999 by the
Board of Directors. The plans include, among other things,
closing locations and reducing staff. The charge includes
$9,797 for lease terminations and related fixed asset
disposals, $19,738 for writedowns of inventories, $4,800 for
writedowns of receivables, $8,758 for severance, and $1,975
for other costs.
The writedowns of inventories, pertaining to the Group's
decision to eliminate the marketing of a number of products,
amounting to $19,738 were included in cost of goods sold. The
writedowns of receivables amounting to $4,800 were included
in the marketing and selling expenses.
The majority of the restructuring charges relate to the
Group's operations in the U.S. As of December 31, 1999, the
unutilized accrual amounted to $7,998, relating to $4,514 for
severance and $3,484 for lease terminations.
48
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 5 - PREPAID EXPENSES AND OTHER RECEIVABLES
- ------ --------------------------------------
DECEMBER 31
----------------------------
1 9 9 9 1 9 9 8
----------- -----------
Deferred income taxes $ 653 $ 4,732
Government agencies 2,278 4,081
Prepaid expenses 1,966 2,411
Other 955 1,600
----------- -----------
$ 5,852 $ 12,824
=========== ===========
NOTE 6 - INVENTORIES
DECEMBER 31
----------------------------
1 9 9 9 1 9 9 8
----------- -----------
Raw materials $ 15,998 $ 20,309
Work in process 8,052 10,106
Finished products 15,466 30,785
----------- -----------
$ 39,516 $ 61,200
=========== ===========
NOTE 7 - FIXED ASSETS
DECEMBER 31
----------------------------
1 9 9 9 1 9 9 8
----------- -----------
Computers and equipment $ 5,298 $ 23,480
Office furniture and equipment 1,851 8,456
Leasehold improvements 2,154 4,206
Vehicles 2,884 2,332
----------- -----------
12,187 38,474
Less - accumulated depreciation 5,638 24,597
----------- -----------
$ 6,549 $ 13,877
=========== ===========
Depreciation expense amounted to $3,116, $4,013 and $4,044
for the years 1997, 1998 and 1999, respectively.
In connection with the restructuring plans (see Note 4) and
in connection with the periodic review of long-lived assets (see
Note 2.I.), fixed assets with a net book value of $5,733 and
$1,567, respectively, were written off in 1999.
49
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 8 - OTHER ASSETS
DECEMBER 31
----------------------------
1 9 9 9 1 9 9 8
----------- -----------
Intangible assets (*) $ 1,928 $ 30,494
Debt issuance costs (**) 3,636 4,500
Other 793 1,961
----------- -----------
6,357 36,955
Less - accumulated amortization 1,537 12,218
----------- -----------
$ 4,820 $ 24,737
=========== ============
(*) In connection with the periodic review of long-lived
assets (see Note 2.I. and Note 3), intangible assets
with a net book value of $16,049 were written off in
1999.
(**) In respect of convertible subordinated notes - see Note
11.
NOTE 9 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
DECEMBER 31
-----------------------------
1 9 9 9 1 9 9 8
------------ ------------
Trade payables $ 8,722 $ 15,490
Deferred income 3,324 2,322
Government agencies 744 1,637
Accruals:
Payroll and related expenses 6,462 7,127
Commissions 5,591 5,020
Income taxes 4,543 4,975
Settlement of litigations (Note 12) 20,213 -
Restructuring (Note 4) 5,526 -
Interest 1,874 2,362
Warranty 3,913 3,093
Other expenses 11,340 10,293
------------ ------------
$ 72,252 $ 52,319
============ ============
50
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 10 - ACCRUED SEVERANCE PAY
The Company's obligation to make severance payments to its
employees is fully covered by the payment of insurance
premiums in respect thereof and by the accrual in the balance
sheet. The insurance policies, which are in the form of an
annuity and/or life insurance, are owned by the Company. The
amounts funded with insurance companies are not under the
management or control of the Company, and accordingly,
neither those amounts nor the corresponding accrual for
severance pay are reflected in the balance sheet. The
Company's obligation by law and labor agreements in respect
of severance pay for those employees not covered by managers'
insurance policies is presented as an accrued liability.
Severance pay expenses amounted to $747, $1,019 and $734 for
the years 1997, 1998 and 1999, respectively. The calculation
is based on the employee's latest salary and the period of
employment.
The subsidiaries in the United States ("U.S. subsidiaries")
have 401(k) savings plans covering substantially all of the
employees in the United States who have completed at least three
months of service. Each employee may contribute up to 15% of
his or her compensation per year, subject to maximum limits
imposed by U.S. tax law. The U.S. subsidiaries may make
discretionary matching contributions based on a formula as
defined in the plans. To date, the U.S. subsidiaries have
made no contributions to the plans.
NOTE 11 - CONVERTIBLE SUBORDINATED NOTES
In September 1997, the Company issued $115,000 in principal
amount of 6% convertible subordinated notes due September 1,
2002, with interest payable semiannually commencing March 1,
1998. The notes are convertible into approximately 2,470,461
ordinary shares of the Company at a conversion price of
$46.55 per share, subject to adjustments in certain events.
The notes are redeemable at the option of the Company, in
whole or in part, at 102.4% of their principal amount
beginning September 2000, and thereafter at prices declining
annually to 100% on September 1, 2002, plus accrued interest
to the date of redemption.
In 1999 the Company purchased $22,071 in principal amount of
the 6% convertible subordinated notes at a price of $14,264.
As a result of the purchase the Company recorded a gain of
$7,974. As of December 31, 1999, the outstanding liability
with regard to the convertible subordinated notes amounted to
$92,929.
51
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES
A. LEASE COMMITMENTS
-----------------
The Group leases its principal facilities in Yokneam
and Tel-Aviv in Israel, and also operates sales
offices and manufacturing facilities in the U.S.,
U.K., Italy, Germany, Japan and France. Rental expense
for the years 1997, 1998 and 1999, amounted to $2,626,
$3,423 and $3,729, respectively. Future minimum annual
lease payments for operating leases are as follows:
2000 $3,676
2001 $2,856
2002 $2,555
2003 $2,134
2004 $1,774
In connection with the Group's restructuring and the
consolidation of its facilities, $3,484 of the above
amounts have been accrued and included in restructuring
costs for the year ended December 31, 1999.
B. ROYALTIES
---------
The Group is a party to various licensing agreements
which require it to pay royalties on certain product
sales at various rates - up to 5% of the net selling
price of these products.
The Group is also obligated to pay to the State of
Israel and the BIRD Foundation royalties of 3-5% on
the sales of products for which participations were
received up to 100% of the amount of the
participations. As of December 31, 1999, the balance
of the royalty-bearing participations amounted to
approximately $6,234.
The Group paid royalties of $1,261, $824 and $534 in
1997, 1998 and 1999, respectively.
C. CONTINGENT LIABILITIES
----------------------
(1) In late 1998 the Company was named in a number
of purported class action securities lawsuits
that have been consolidated in the United
States District Court for the Southern District
of New York. In July 1999, a consolidated
amended complaint was filed naming among
others, the Company and several additional
current and former directors and officers of
the Company and Laser as defendants. The
consolidated amended complaint seeks damages
and attorneys' fees under the United States
securities laws for alleged "tipping" of
non-public information to an investment banker
in September 1998 and for alleged
irregularities in the way in which the Company
reported its financial results and disclosed
certain facts throughout 1997 and 1998. The
Company's insurance carrier has agreed to
assume the defense of the action under a
reservation of rights. Laser's insurance
carrier's decision as to coverage is currently
pending. No accrual has been recorded in the
financial statements for this matter.
52
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
C. CONTINGENT LIABILITIES (CONT.)
(2) On September 20, 1999, Dr. Richard Urso filed
what purports to be a class action lawsuit
against the Company in the State District Court
in Harris County, Texas. Dr. Urso alleges a
number of causes of action including breach of
contract, breach of warranty, product
liability, misrepresentation and violations of
the Texas Deceptive Trade Practices Act. The
complaint purports to be filed on behalf of a
national class. The Company has taken steps to
remove the case to Federal court and intends to
vigorously deny all allegations and challenge
plaintiff's class certification motion when it
is filed. No accrual has been recorded in the
financial statements for this matter.
(3) On May 10, 1999, the Company and a former
director and officer were named as defendants
in an action filed in Tel-Aviv Court by H.K.
Hashalom Ltd. in connection with the sale of
the Company's EpiLight systems. H.K. Hashalom
is seeking monetary damages in the amount of
$2,500 but has reserved the right to increase
such amount as well as a declaratory judgment
that, inter alia, the Company indemnify it for
certain costs and expenses arising out of the
transaction between the parties. On July 15,
1999, the defendants filed a Statement of
Defense. The case has not yet been set for a
first hearing. No accrual has been recorded in
the financial statements for this matter.
(4) On November 5, 1998, Light Age, Inc.
("Light Age") instituted an ex-parte
application in the Tel-Aviv District Court (the
"Tel-Aviv Court") against the Company and
others, seeking a temporary injunction against
the development, production and sale of the
Company's Alexandrite laser for dermatological or
hair removal treatments. On January 25, 1999, the
Company, along with three subsidiaries, brought
an action in the Superior Court of New Jersey,
Somerset County (the "US Court"), against Light
Age. The litigation relates to disputes arising
out of an agreement between Light Age and Laser
pursuant to which Light Age supplied certain
medical laser devices to Laser. On July 1,
1999, the U.S. Court granted defendant Light
Age's motion to compel the Company and the
three affiliated entities to arbitrate. On
August 13, 1999, Light Age filed a demand for
arbitration on its counterclaim with the
American Arbitration Association. On November
22, 1999, the Company and three affiliated
entities filed a response to Light Age's
demand. Pending the outcome of the U.S.
arbitration, Light Age and the Company agreed
to file a motion to stay the proceedings in
Tel-Aviv. On October 14, 1999, the Tel-Aviv
Court confirmed the motion as requested and
stayed the proceedings. No accrual has been
recorded in the financial statements for this
matter.
(5) As mentioned above, the Company and its
subsidiaries are involved in several legal
proceedings, claims and litigation in which no
accrual has been recorded in the financial
statements. Management of the Company is unable
to predict the outcome of such matters, the
likelihood of an unfavorable outcome or the
amount or range of potential loss, if any.
(6) The Company and its subsidiaries are involved
in further legal proceedings, claims and
litigation arising in the ordinary course of
business. In the opinion of management, the
outcome of such current legal proceedings,
claims and litigation could have a material
effect on quarterly or annual operating results
or cash flows when resolved in a future period.
However, in the opinion of management, each of
these matters individually is not likely to
materially affect the Group's consolidated
financial position.
53
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
D. SETTLEMENT OF LITIGATIONS
-------------------------
In 2000, the Group reached settlement agreements with
respect to litigation with Reliant Technologies, Inc.
and LPG USA, Inc., relating to alleged patent
infringement and violations of the Lanham Act and
related state laws, respectively. Under the various
settlements agreements the Company agreed to pay cash
in an aggregate amount of $9,500, to pay consulting
fees under a three-year consulting agreement in an
amount of $1,500, to purchase products in the amount
of $5,000 and to grant 300,000 stock options at
exercise prices of $5 to $9.75 (with fair value of
$381 as of the dates of the grants under the
Black-Scholes model).
NOTE 13 - SHARE CAPITAL
A. ORDINARY SHARES
---------------
In March 1997, the Company completed a merger with Luxar
and issued 1,976,473 shares under the terms of the
agreement - see Note 3. Convertible and redeemable
preferred stock of Luxar were converted into ordinary
shares of the Company in connection with the merger.
In December 1997, the Company issued 164,356 shares in
connection with the acquisition of AOC - see Note 3.
In February 1998, the Company completed a merger with
Laser and issued 6,181,013 ordinary shares and warrants
and options exercisable for the purchase of 865,089
additional shares.
B. SHARES SUBJECT TO OPTIONS
-------------------------
Until 1997, the Company issued ordinary shares to an
independent trustee. The use of these shares is
restricted to the granting of options to founding
shareholders, employees and consultants to acquire
such shares. No shares can be returned to the Company
and such shares have voting and dividend rights.
Shares issued to the trustee are deemed outstanding,
using the treasury stock method, for purposes of
earnings per share computations. As of December 31,
1999, 315,037 shares were held by the trustee.
54
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 13 - SHARE CAPITAL (CONT.)
B. SHARES SUBJECT TO OPTIONS (CONT.)
Transactions during the three years ended December 31,
1999, are summarized as follows:
WEIGHTED
AVERAGE
EXERCISE PRICE
NO. OF SHARES U.S.$
------------- --------------
Outstanding January 1, 1997 2,466,443
Granted 1,143,084 21.80
Exercised (1,156,380) 2.58
Forfeitures (32,713) 3.57
-----------------
Outstanding December 31, 1997 2,420,434
Granted 233,000 23.35
Exercised (663,753) 15.40
Forfeitures (80,839) 25.00
-----------------
Outstanding December 31, 1998 1,908,842
Granted 4,639,000 5.25
Exercised (364,522) 1.41
Forfeitures (1,084,176) 7.48
-----------------
Outstanding December 31, 1999 5,099,144
=================
The weighted average fair values of options
granted in 1997, 1998 and 1999 were $11.94,
$19.00 and $3.11, respectively.
The following table summarizes information about
options outstanding at December 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ -----------------------------------
RANGE OF NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
EXERCISE OUTSTANDING AT AVERAGE AVERAGE EXERCISABLE AT AVERAGE
PRICES DECEMBER 31 REMAINING EXERCISE PRICE DECEMBER 31 EXERCISE PRICE
U.S.$ 1 9 9 9 CONTRACTUAL LIFE U.S.$ 1 9 9 9 U.S.$
----------- --------------- ---------------- -------------- -------------- ---------------
0.02-2.90 185,799 5-7.5 0.70 172,097 0.69
5.03-6.00 4,133,600 5-9.5 5.25 2,100 5.12
7.94-8.67 534,650 6-9 8.00 151,810 8.12
13.80-18.87 68,845 2.5 16.15 68,845 16.15
25.50-27.00 176,250 6.5-7.5 25.85 100,375 26.40
-------------- --------------
5,099,144 495,227
============== ==============
55
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 13 - SHARE CAPITAL (CONT.)
B. SHARES SUBJECT TO OPTIONS (Cont.)
-------------------------
The Company has received approval from the Israeli
Income Tax Authority for a share option plan under
Section 102 of the Income Tax Ordinance. This plan
provides certain tax benefits to employee participants
and restricts the disposal of the shares under option
for a period of not less than two years.
The option exercise price is determined by the Board
of Directors and, if granted below fair market value,
compensation expense is recorded over the vesting
period of the option in accordance with APB 25. Under
APB 25, the compensation cost charged to operations
for the years ended December 31, 1997, 1998 and 1999
amounted to $529, $320 and $128, respectively.
Had compensation cost been determined under the
alternative fair value accounting method provided for
under FASB Statement No. 123, "Accounting for
Stock-Based Compensation", the Company's net income
and earnings per share for the years 1997, 1998 and
1999 would have been reduced to the following pro
forma amounts:
1999 1998 1997
-------------- ------------ ------------
Net income As reported $ (140,788) $ 4,000 $ 22,094
Pro forma $ (147,250) $ (446) $ 18,326
Basic
earnings (loss) As reported $ (5.48) $ 0.15 $ 0.86
per share
Pro forma $ (5.74) $ (0.02) $ 0.72
Diluted
earnings (loss)
per share As reported $ (5.48) $ 0.15 $ 0.81
Pro forma $ (5.74) $ (0.02) $ 0.67
Under Statement No. 123 the fair value of each option
grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 1997,
1998 and 1999: (1) expected life of 3 years; (2)
dividend yield of 0%; (3) expected volatility of 62%
in 1997, 150% in 1998 and 87% in 1999; and (4)
risk-free interest rate of 6% in 1997, 5% in 1998, and
6% in 1999.
C. WARRANTS
--------
Pursuant to the agreement for the acquisition of AOC
entered into in December 1997, warrants to purchase
84,435 ordinary shares at a price of $47.25 per share
were issued. These warrants are exercisable until
December 2002.
56
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 13 - SHARE CAPITAL (CONT.)
D. TREASURY STOCK
--------------
During 1998 and 1999, the Board of Directors of the
Company authorized the purchase of up to 3,000,000
ordinary shares, to facilitate the exercise of
employee share options under the various plans. As of
December 31, 1999, 2,644,813 shares had been
repurchased and held as treasury shares in trust.
57
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 14 - NET SALES
A. GEOGRAPHICAL BREAKDOWN OF SALES
-------------------------------
YEAR ENDED DECEMBER 31
---------------------------------------------
1 9 9 9 1 9 9 8 1 9 9 7
---------- ------------ -----------
Export and international $ 140,097 $ 220,633 $ 192,348
Domestic - Israel 2,054 4,573 1,635
---------- ------------ -----------
$ 142,151 $ 225,206 $ 193,983
========== ============ ===========
B. COMPOSITION OF SALES BY GEOGRAPHIC AREAS
YEAR ENDED DECEMBER 31
---------------------------------------------
1 9 9 9 1 9 9 8 1 9 9 7
---------- ------------ -----------
North America $ 51,223 $ 117,377 $ 109,687
Europe 40,774 69,968 43,167
Asia 33,662 9,375 16,051
Central and South America 4,079 13,655 17,671
Other 12,413 14,831 7,407
---------- ------------ -----------
$ 142,151 $ 225,206 $ 193,983
========== ============ ===========
NOTE 14 - NET SALES (CONT.)
C. GEOGRAPHICAL SEGMENTS OF PRODUCTION
The Company's activities fall within two reporting
segments: the U.S.A. segment and the rest of the world
(ROW). The following table sets forth segments
information for the years ended December 31, 1999,
1998 and 1997:
YEAR ENDED DECEMBER 31
---------------------------------------------
1 9 9 9 1 9 9 8 1 9 9 7
---------- ------------ -----------
Revenues
U.S.A. $ 51,223 $ 117,376 $ 109,687
ROW 90,928 107,830 84,296
----------- ------------- -----------
Consolidated 142,151 225,206 193,983
=========== ============= ===========
Operating income (loss):
U.S.A. (91,738) (19,905) 4,159
ROW (4,264) 53,846 25,605
Expenses not allocated to a
particular segment (44,816) - -
----------- ------------- -----------
Consolidated (140,818) 33,941 29,764
----------- ------------- -----------
Financing income (expenses),
net (3,865) 1,211 1,409
Nonrecurring expenses - (28,951) (4,650)
----------- ------------- -----------
Income (loss) before income
taxes $(144,683) $ 6,201 $ 26,523
=========== ============= ===========
Identifiable assets
U.S.A. $ 47,847 $ 100,762 $ 90,653
ROW 116,399 211,776 231,804
Assets not allocated to a
particular segment 10,661 15,128 13,189
----------- ------------- -----------
Consolidated $ 174,907 $ 327,666 $ 335,646
=========== ============= ===========
Depreciation and amortization
U.S.A. $ 2,061 $ 2,577 $ 876
ROW 4,352 3,953 2,787
Depreciation and amortization
not allocated to a particular
segment 2,044 2,392 1,296
----------- ------------- -----------
Consolidated $ 8,457 $ 8,922 $ 4,959
=========== ============= ===========
58
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 15 - RESEARCH AND DEVELOPMENT COSTS, NET
YEAR ENDED DECEMBER 31
---------------------------------------
1 9 9 9 1 9 9 8 1 9 9 7
---------- ---------- ----------
Total costs $ 15,626 $ 19,283 $ 18,889
Less - participation primarily by
the Government of Israel 275 603 1,518
---------- ---------- ----------
$ 15,351 $ 18,680 $ 17,371
========== ========== ==========
NOTE 16 - ACQUIRED RESEARCH AND DEVELOPMENT
Nonrecurring expenses in connection with mergers and
acquisitions of businesses were as follows:
YEAR ENDED
-----------------------------
DECEMBER 31
1 9 9 8 1 9 9 7
------------ -----------
Purchase of Spectron - 5,834
Purchase of AOC - 4,280
Other acquisitions 2,451 1,798
----------- -----------
$ 2,451 $ 11,912
=========== ===========
NOTE 17 - OTHER EXPENSES
A. Other expenses were as follows:
YEAR ENDED DECEMBER 31
-----------------------
1 9 9 9
----------
Proxy expenses (see B below) $ 3,575
Other 1,412
---------
$ 4,987
=========
B. In connection with the director election contest, the
Company incurred expenses of $2,065. In addition, in
accordance with the resolution of the Board of Directors
of the Company in a meeting held on June 23, 1999, all
costs and expenses of two major shareholders and their
affiliates in connection with the director election
contest were reimbursed by the Company.
59
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 18 - FINANCING INCOME (EXPENSES), NET
YEAR ENDED DECEMBER 31
----------------------------------------
1 9 9 9 1 9 9 8 1 9 9 7
--------- ---------- ----------
Interest income $ 5,483 $ 8,921 $ 5,722
--------- ---------- ----------
Less - Financing expenses
Interest and amortization in
respect of convertible notes 7,626 7,832 2,417
Other interest 136 871 1,146
Exchange rates, net 1,586 (993) 750
--------- ---------- ----------
9,348 7,710 4,313
--------- ---------- ----------
$ (3,865) $ 1,211 $ 1,409
========= ========== ==========
NOTE 19 - TAXES ON INCOME
Inflationary adjustments - The Company and Laser are subject
to the Income Tax Law (Inflationary Adjustments), 1985, which
provides for an adjustment to taxable income for the effects
of inflation (based on the Israeli Consumer Price Index) on
that portion of shareholders' equity not invested in
inflation resistant assets.
"Approved enterprise" - The Company and Laser have received
approval for their investment programs in accordance with the
Law for the Encouragement of Capital Investments, 1959. The
Company has chosen to receive its benefits through the
alternative benefits program, and, as such, including
accelerated depreciation of fixed assets used in the
investment programs, as well as a full tax exemption on
undistributed income that is derived from the approved
enterprise for a period of six years and reduced tax rates
for an additional period of up to four years. Laser is
entitled to a full tax exemption for a period of two years
and reduced tax rates for an additional period of up to five
years (the rate and the length of the benefit period are
dependent on the percentage of non-Israeli shareholder
ownership). The benefits commence with the date on which
taxable income is first earned. Income not derived from the
approved enterprise is subject to tax at a rate of 36%. The
tax exemption period for the Company commenced in 1995 and
the tax exemption period for Laser has not yet commenced.
Dividends paid out of income derived from the approved
enterprise is subject to 15% withholding. Should dividends be
paid out of income earned during the period of the tax
holiday, such income will be subject to tax at the rate of up
to 25%. The Company and Laser do not anticipate paying
dividends from income derived from the approved enterprise
and any such earnings distributed upon dissolution will not
subject the Company and Laser to income taxes.
60
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 19 - TAXES ON INCOME (CONT.)
The Company and Laser have not received final income tax
assessments for years subsequent to 1991.
The provision for income taxes consists of the following:
YEAR ENDED DECEMBER 31
-------------------------------------------
1 9 9 9 1 9 9 8 1 9 9 7
------------- ----------- ------------
Current taxes $ - $ 3,375 $ 7,693
Deferred taxes (4,079) (1,174) (3,264)
------------- ----------- ------------
$ (4,079) $ 2,201 $ 4,429
============= =========== ============
As most of the income in Israel is exempt from income taxes,
the Israeli statutory tax rate for the purposes of the
reconciliation of the reported tax expense is approximately
zero. Income tax expense in the financial statements relates
primarily to the income taxes of subsidiaries.
The current tax provisions are recorded net of the benefit of
utilizing net operating loss carryforwards and tax credit
carryforwards of subsidiaries. Significant components of
deferred tax assets and liabilities are as follows:
DECEMBER 31
-------------------------------
1 9 9 9 1 9 9 8
------------- -----------
Deferred tax assets:
Accrued liabilities - 1,521
Inventory adjustments - 657
Allowance for doubtful accounts - 449
Net operating loss carryforwards 653 2,300
------------- -----------
653 4,927
------------- -----------
Deferred tax liabilities:
Accelerated depreciation - (164)
Other - (31)
------------- -----------
- (195)
------------- -----------
Net deferred tax assets - included in
other receivables 653 4,732
============= ===========
61
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
NOTE 20 - EARNINGS PER SHARE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1 9 9 9 DECEMBER 31, 1 9 9 8 DECEMBER 31, 1 9 9 7
--------------------------------- ----------------------------- ----------------------------
PER SHARE PER SHARE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT
-------------------------------------------------------------------------------------------------
Net income (loss) (140,788) 4,000 22,094
========== ====== ========
Basic earnings per share
Income (loss) before (148,762) 25,674 (5.79) 4,000 26,027 0.15 22,094 25,604 0.86
extraordinary items
Extraordinary gain 7,974 25,674 0.31 - 26,027 - - 25,604 -
--------- ------ ------ ------ ------- -------
Income available to
ordinary shareholders $(140,388) 25,674 (5.48) $4,000 26,027 0.15 $22,094 25,604 0.86
====== ====== =======
Effect of dilutive securities
Options - 741 961
Warrants - 613 629
Debentures - - -
-------- ------- ------
Diluted earnings per Share
Income (loss) before
extraordinary items (148,762) 25,674 (5.79) 4,000 27,381 0.15 22,094 27,194 0.81
Extraordinary gain 7,974 25,674 0.31 - 27,381 - - 27,194 -
--------- ------ ------ ------ ------- -------
Income (loss) available to
ordinary shareholders (140,388) 25,674 (5.48) 4,000 27,381 0.15 22,094 27,194 0.81
====== ====== =======
The diluted EPS calculation did not take into account subordinated notes
convertible into weighted average of 2,289,590, 2,470,469 and 1,646,974
ordinary shares, in 1999, 1998 and 1997 respectively, because their effect
is antidilutive.
NOTE 21 - FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
- ------- ------------------------------------------------------
Financial instruments which potentially subject the Group to
a concentration of credit risk consist principally of cash,
short-term and long-term investments and trade receivables.
Short-term cash investments are placed with high credit-quality
financial institutions. Other investments are in securities
of various banks, in U.S. Government securities and in
commercial paper of industrial companies with high credit
ratings. The Group performs ongoing credit evaluations of
its customers and generally does not require collateral. The
Group maintains allowances for estimated credit losses.
The carrying amounts of cash, investments, receivables and
accounts payable approximate fair value. The market value of
its convertible notes is approximately 75% of the book value.
62
ESC MEDICAL SYSTEMS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share data)
ESC MEDICAL SYSTEMS LTD.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT CHARGE CHARGE BALANCE AT
BEGINNING TO COSTS AND TO OTHER END OF
OF YEAR EXPENSES ACCOUNTS DEDUCTIONS YEAR
Year ended December 31, 1999:
Allowance for Doubtful accounts $10,480 $14,952 ----- ----- $25,432
Reserve for Warranty $3,029 $884 ----- ----- $3,913
Year ended December 31, 1998:
Allowance for Doubtful accounts $2,235 $8,245 ----- ----- $10,480
Reserve for Warranty $1,172 $1,857 ----- ----- $3,029
Year ended December 31, 1997:
Allowance for Doubtful accounts $804 $1,431 ----- ----- $2,235
Reserve for Warranty $0 $1,172 ----- ----- $1,172
63
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.
ESC MEDICAL SYSTEMS LTD.
By:/S/ Yacha Sutton
_____________________________
Yacha Sutton,
Chief Executive Officer
Dated: March 30, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/Yacha Sutton
- ------------------ Chief Executive Officer March 30, 2000
Mr. Yacha Sutton (Principal Executive Officer)
/s/Sagi Genger
- ------------------ Chief Financial Officer March 30, 2000
Mr. Sagi Genger (Principal Financial Officer)
/s/Raanan Yehiely
- ------------------ Corporate Controller March 30, 2000
Mr. Raanan Yehiely
/s/Jacob A. Frenkel
- ------------------ Chairman of the March 30, 2000
Prof. Jacob A. Frenkel Board of Directors
/s/Aharon Dovrat
- ------------------ Director March 30, 2000
Mr. Aharon Dovrat
/s/Philip Friedman
- ------------------ Director March 30, 2000
Mr. Philip Friedman
/s/Thomas G. Hardy
- ------------------ Director March 30, 2000
Mr. Thomas G. Hardy
/s/Darrell S. Rigel
- ------------------ Director March 30, 2000
Prof. Darrell S. Rigel
/s/S.A. Spencer
- ------------------ Director March 30, 2000
Mr. S.A. Spencer
/s/Mark H. Tabak
- ------------------ Director March 30, 2000
Mr. Mark H. Tabak
/s/Zehev Tadmor
- ------------------ Director March 30, 2000
Prof. Zehev Tadmor
64