Table ofContents

 

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

| **x**      | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES** |
|------------|-----------------------------------------------------------------------------------|
| ** ** | **EXCHANGE  ACT OF 1934.**                                                        |

** **

**For the quarterly periodended June 30, 2008.**

** **

**OR**

** **

| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES** |
|------------|------------------------------------------------------------------------------------|
| ** ** | **EXCHANGE  ACT OF 1934.**                                                         |

 

**For the transition period from                                        to**

 

**CommissionFile Number: 1-11388**

 

**PLCSYSTEMS INC.**

(Exact Name ofRegistrant as Specified in Its Charter)

 

| **Yukon  Territory, Canada**                | ** ** | **04-3153858**                        |
|---------------------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction of            |       | (I.R.S. Employer  Identification No.) |
| Incorporation or  Organization)             |       |                                  |
|                                        |       |                                  |
| **10  Forge Park, Franklin, Massachusetts** | ** ** | **02038**                             |
| (Address of  Principal Executive Offices)   |       | (Zip Code)                            |

 

Registrant’stelephone number, including area code: **(508) 541-8800**

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes  x    No  o

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, a non-accelerated filer, ora smaller reporting company.  See thedefinitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer o    |   | Smaller reporting company x |
|---------------------------|--------|---------------------|--------|----------------------------|--------|-----------------------------|
|                      |   |                |   | (Do not check if a smaller |   |                        |
|                      |   |                |   | reporting company)         |   |                        |
|                      |   |                |   |                       |   |                        |

 

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct)   Yes  o    No  x

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 

|   | Class                       |   | Outstanding at  August 8, 2008 |   |
|--------|-----------------------------|--------|-------------------------------------|--------|
|   | Common Stock, no  par value |   | 30,331,935                          |   |

 

 

 

 

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Table of Contents

 

 

**PLCSYSTEMS INC.**

 

**Index**

 
| Part I.  | Financial  Information: |                                                                                        |
|---------------|-------------------------|---------------------------------------------------------------------------------------------|
|          |                    |                                                                                        |
|          | Item 1.                 | Financial Statements                                                                        |   |
|          |                    |                                                                                        |   |
|          |                    | Condensed  Consolidated Balance Sheets (unaudited)                                          | 3 |
|          |                    |                                                                                        |   |
|          |                    | Condensed Consolidated Statements of Operations  (unaudited)                                | 4 |
|          |                    |                                                                                        |   |
|          |                    | Condensed  Consolidated Statements of Cash Flows (unaudited)                                | 5 |
|          |                    |                                                                                        |   |
|          |                    | Notes to  Condensed Consolidated Financial Statements (unaudited)                           | 6 |
|          |                    |                                                                                        |   |
|          | Item 2.                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 13 |
|          |                    |                                                                                        |   |
|          |                    |                                                                                        |   |
|          | Item 3.                 | Quantitative  and Qualitative Disclosures about Market Risk                                 | 22 |
|          |                    |                                                                                        |   |
|          | Item 4.                 | Controls and  Procedures                                                                    | 22 |
|          |                    |                                                                                        |   |
| Part II. | Other Information:      |                                                                                        |
|          |                    |                                                                                        |   |
|          | Item 1A.                | Risk Factors                                                                                | 22 |
|          |                    |                                                                                        |   |
|          | Item 4.                 | Submission of  Matters to a Vote of Security Holders                                        | 34 |
|          |                    |                                                                                        |   |
|          | Item 6.                 | Exhibits                                                                                    | 35 |
|          |                    |                                                                                        |   |

 

 

 

 

 

 

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**Part I.         Financial Information**

 

**Item 1.        FinancialStatements**

 

**PLCSYSTEMS INC.**

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 
| ** **                                                                                                            | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                            | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                       |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                            |       | $                       | 5,506      |                        | $          | 8,060 |   |
| Accounts  receivable, net of allowance of $34 and $23 at June 30, 2008 and  December 31, 2007, respectively |       | 781                     |       | 998                         |       |
| Inventories, net                                                                                                      |       | 1,418                   |       | 852                         |       |
| Prepaid expenses  and other current assets                                                                            |       | 671                     |       | 823                         |       |
| Total current  assets                                                                                                 |       | 8,376                   |       | 10,733                      |       |
| Equipment,  furniture and leasehold improvements, net                                                                 |       | 214                     |       | 269                         |       |
| Other assets                                                                                                          |       | 194                     |       | 198                         |       |
| Total assets                                                                                                          |       | $                       | 8,784      |                        | $          | 11,200 |   |

 

**LIABILITIESAND STOCKHOLDERS’ EQUITY**

 
| Current  liabilities:                                                                                                                                                         |   |    |   |    |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|--------|---------|--------|
| Accounts payable                                                                                                                                                              |   | $       | 304    |    | $      | 623 |   |
| Accrued  compensation                                                                                                                                                         |   | 624     |   | 766     |   |
| Accrued other                                                                                                                                                                 |   | 216     |   | 326     |   |
| Deferred revenue                                                                                                                                                              |   | 2,104   |   | 2,096   |   |
| Total current  liabilities                                                                                                                                                    |   | 3,248   |   | 3,811   |   |
| Deferred revenue                                                                                                                                                              |   | 1,919   |   | 2,439   |   |
| Commitments and  contingencies                                                                                                                                                |   |    |   |    |   |
| Stockholders’  equity:                                                                                                                                                   |   |    |   |    |   |
| Preferred stock,  no par value, unlimited shares authorized,  none issued and outstanding                                                                                     |   | —  |   | —  |   |
| Common stock, no  par value, unlimited shares authorized,  30,332 and 30,329 shares issued and outstanding as of  June 30, 2008 and December 31, 2007, respectively |   | 93,892  |   | 93,891  |   |
| Additional paid  in capital                                                                                                                                                   |   | 367     |   | 270     |   |
| Accumulated  deficit                                                                                                                                                          |   | (90,331 | )      | (88,898 | )      |
| Accumulated  other comprehensive loss                                                                                                                                         |   | (311    | )      | (313    | )      |
| Total  stockholders’ equity                                                                                                                                              |   | 3,617   |   | 4,950   |   |
| Total  liabilities and stockholders’ equity                                                                                                                              |   | $       | 8,784  |    | $      | 11,200 |   |

 

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

 

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**PLCSYSTEMS INC.**

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands,except per share data)

(Unaudited)

 
| ** **                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                            | ** ** | **2008**                              | ** ** | **2007**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues:                             |       |                                  |       |                                |       |   |   |   |   |
| Product sales                         |       | $                                     | 1,032      |                                | $          | 1,520 |   | $ | 1 ,838 |   | $ | 2,654 |   |
| Service fees                          |       | 278                                   |       | 412                                 |       | 640 |   | 771 |   |
| Total revenues                        |       | 1,310                                 |       | 1,932                               |       | 2,478 |   | 3,425 |   |
|                                  |       |                                  |       |                                |       |   |   |   |   |
| Cost of  revenues:                    |       |                                  |       |                                |       |   |   |   |   |
| Product sales                         |       | 423                                   |       | 562                                 |       | 643 |   | 1,148 |   |
| Service fees                          |       | 150                                   |       | 213                                 |       | 335 |   | 421 |   |
| Total cost of  revenues               |       | 573                                   |       | 775                                 |       | 978 |   | 1,569 |   |
| Gross profit                          |       | 737                                   |       | 1,157                               |       | 1,500 |   | 1,856 |   |
|                                  |       |                                  |       |                                |       |   |   |   |   |
| Operating  expenses:                  |       |                                  |       |                                |       |   |   |   |   |
| Selling, general  and administrative  |       | 831                                   |       | 1,076                               |       | 1,801 |   | 2,089 |   |
| Research and development              |       | 602                                   |       | 556                                 |       | 1,210 |   | 1,047 |   |
| Total operating  expenses             |       | 1,433                                 |       | 1,632                               |       | 3,011 |   | 3,136 |   |
| Loss from  operations                 |       | (696                                  | )          | (475                                | )          | (1,511 | ) | (1,280 | ) |
|                                  |       |                                  |       |                                |       |   |   |   |   |
| Other income,  net                    |       | 25                                    |       | 112                                 |       | 78 |   | 231 |   |
| Net loss                              |       | $                                     | (671       | )                                   | $          | (363 | ) | $ | (1,433 | ) | $ | (1,049 | ) |
|                                  |       |                                  |       |                                |       |   |   |   |   |
| Basic and  diluted loss per share     |       | $                                     | (0.02      | )                                   | $          | (0.01 | ) | $ | (0.05 | ) | $ | (0.03 | ) |
| Weighted average  shares outstanding: |       |                                  |       |                                |       |   |   |   |   |
| Basic and  diluted                    |       | 30,330                                |       | 30,311                              |       | 30,330 |   | 30,311 |   |

 

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

 

 

4

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**PLC SYSTEMS INC.**

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 
| ** **                                                    | ** ** | **Six Months Ended  June 30** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                           | ** ** | **2007** | ** ** |
| Operating  activities:                                        |       |                               |       |   |   |
| Net loss                                                      |       | $                                  | (1,433     | ) | $ | (1,049 | ) |
|                                                          |       |                               |       |   |   |
| Adjustments to  reconcile net loss to net cash                |       |                               |       |   |   |
| provided by  (used for) operating activities:                 |       |                               |       |   |   |
| Depreciation and  amortization                                |       | 50                                 |       | 44 |   |
| Compensation  expense from stock options                      |       | 97                                 |       | 70 |   |
| Loss on  retirement of equipment                              |       | 35                                 |       | — |   |
| Change in assets  and liabilities:                            |       |                               |       |   |   |
| Accounts  receivable                                          |       | 217                                |       | (550 | ) |
| Inventory                                                     |       | (566                               | )          | 265 |   |
| Prepaid expenses  and other assets                            |       | 152                                |       | 132 |   |
| Accounts payable                                              |       | (319                               | )          | (71 | ) |
| Deferred revenue                                              |       | (515                               | )          | (357 | ) |
| Accrued  liabilities                                          |       | (253                               | )          | 202 |   |
| Net cash used for  operating activities                       |       | (2,535                             | )          | (1,314 | ) |
|                                                          |       |                               |       |   |   |
| Investing  activities:                                        |       |                               |       |   |   |
| Maturity of  investments                                      |       | —                             |       | 4,000 |   |
| Purchase of  equipment                                        |       | (27                                | )          | (82 | ) |
| Net cash  provided by (used for) investing activities         |       | (27                                | )          | 3,918 |   |
|                                                          |       |                               |       |   |   |
| Financing  Activities:                                        |       |                               |       |   |   |
| Net proceeds  from issuance of common stock                   |       | 1                                  |       | 1 |   |
|                                                          |       |                               |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents |       | 7                                  |       | 6 |   |
| Net increase  (decrease) in cash and cash equivalents         |       | (2,554                             | )          | 2,611 |   |
| Cash and cash  equivalents at beginning of period             |       | 8,060                              |       | 6,034 |   |
| Cash and cash  equivalents at end of period                   |       | $                                  | 5,506      |   | $ | 8,645 |   |

 

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

 

 

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**PLCSYSTEMS INC.**

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

 

***1.             Business***

 

                PLCSystems Inc. (“PLC” or the “Company”) is a medical device company specializingin innovative technologies for the cardiac and vascular markets.  The Company pioneered and manufactures the *CO**2** Heart Laser System* (the “Heart Laser System”) that cardiacsurgeons use to perform carbon dioxide (CO2) transmyocardial revascularization, orTMR, to alleviate symptoms of severe angina. The Company also manufactures *CO**2* surgical laser tubes and provides contractassembly services on general purpose *CO**2* lasers, which it sells to a single customer onan original equipment manufacturer (“OEM”) basis.

 

                Inaddition, the Company has begun initial commercialization in the European Union(“EU”) of its newest product, RenalGuardTM. RenalGuard is designedto reduce the potentially toxic effects that contrast media can have on thekidneys when it is administered to patients during certain medical imagingprocedures. It is believed that allowing contrast media to dwell in the kidneyscan lead to contrast-induced nephropathy (“CIN”), a potentially deadly form ofacute kidney injury. By inducing and maintaining a high urine flow rate before,during and after these medical imaging procedures, the Company believes the incidencerates of CIN in at-risk patients can be reduced. RenalGuard facilitates thisincreased urine clearance, enabling the body to more rapidly void the contrastmedia, thereby reducing its overall resident time and toxic effects in thekidney.

 

                TheCompany received full Food and Drug Administration (“FDA”) approval to conductits first human clinical trial utilizing RenalGuard under an investigationaldevice exemption (“IDE”). This pilot clinical trial was designed to evaluatethe safety of RenalGuard and its ability to accurately measure and balancefluid inputs and outputs on patients undergoing a catheterization imagingprocedure where contrast media would be administered.  In February 2008, the Company submittedan IDE supplement to the FDA seeking approval to move from its pilot study to apivotal clinical trial to study the safety and effectiveness of RenalGuard inthe prevention of CIN. In March 2008, the FDA granted the Companyconditional approval to begin this pivotal study. The Company is alsosupporting a randomized controlled trial utilizing RenalGuard that is beingconducted in Milan, Italy; it is designed to determine the effectiveness ofRenalGuard in preventing CIN in at-risk patients. The Company announced in July 2008that it will delay the start of the U.S. pivotal trial until such time as itcan obtain data from the clinical trial in Italy that it hopes will enable itto raise sufficient additional capital necessary to complete the U.S. study.

 

                RenalGuardis currently approved for sale in the EU as a general fluid balancing device.The RenalGuard System consists of a proprietary, closed loop,software-controlled console and accompanying single-use sets that can be usedby physicians and nurses to manage patient fluid levels. RenalGuard operates byfirst collecting and measuring patient urine outputs and then in real-timeprecisely matches these urine outputs with a prescribed replacement fluid bymeans of intravenous infusion. The RenalGuard System, with its matched fluidreplacement capability, is intended to minimize the risk of over- orunder-hydration during medical procedures where creating and maintaining highurine outputs is deemed beneficial to patients.

 

 

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                Thereare currently several medical procedures, such as cisplatin chemotherapy, whereinducing high urine flow rates is deemed beneficial for patients and is astandard of care. In addition, high urine flow rates are frequently seen inpost kidney transplant patients where the careful monitoring and replacement offluid losses is necessary to avoid the risk of damage to the transplantedkidney. Accurate and timely matching of replacement fluids is important inthese instances in order to best preserve and/or optimize kidney function.RenalGuard provides an automated method of measuring urine outputs and thenmatching these outputs with replacement fluid inputs, eliminating to a largedegree what is otherwise an intensive and time consuming manual balancing taskfor physicians and nurses in these situations. The Company is establishing adistribution network in the EU with the intent to market RenalGuard into thesealready existing markets for general balancing applications utilizing thedevice.

 

                OnMarch 20, 2007, the Company entered into a distribution agreement withNovadaq Corp. (“Novadaq”), a subsidiary of Novadaq Technologies Inc., pursuantto which the Company appointed Novadaq as its exclusive distributor in theUnited States for its TMR business.  Theagreement amended and restated the exclusive distribution agreement between theCompany and Edwards Lifesciences LLC (“Edwards”), which had been assigned byEdwards to Novadaq on the same date.  Theagreement with Novadaq reflects substantially the same roles, responsibilitiesand financial terms as the previous agreement with Edwards.

 

***2.            ******Basis of Presentation***

 

The accompanyingunaudited condensed consolidated financial statements of the Company have beenprepared in accordance with generally accepted accounting principles forinterim financial information and with the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly, they donot include all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring adjustments) considered necessary for a fairpresentation have been included. Operating results for the three and six months ended June 30, 2008are not necessarily indicative of the results that may be expected for the yearending December 31, 2008.  Thesefinancial statements should be read in conjunction with the consolidatedfinancial statements and footnotes thereto included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2007.

 

                The preparation of financialstatements in accordance with generally accepted accounting principles requiresthe Company to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates.

 

***3.             New Accounting Pronouncements***

 

InSeptember 2006, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements”**(“SFAS No. 157”).  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007.  On February 6, 2008, the FASB announcedit will issue a FASB Staff Position to allow a one-year deferral of adoption ofSFAS No. 157 for non-financial assets and non-financial liabilities thatare recognized at fair value on a nonrecurring basis. SFAS No. 157provides a common fair value hierarchy for companies to follow in determiningfair

 

 

7

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valuemeasurements in the preparation of financial statements and expands disclosurerequirements relating to how such fair value measurements are developed. SFAS No. 157clarifies the principle that fair value should be based on the assumptions thatthe marketplace would use when pricing an asset or liability, rather thancompany specific data.  The Company iscurrently assessing the impact that SFAS No. 157 will have on its resultsof operations and financial position.

 

                In February 2007, the FASBissued SFAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities*”* (“SFAS No. 159”). SFAS No. 159,which includes an amendment to SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”,permits entities the option to measure many financial instruments and certainother items at fair value. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. On January 1, 2008, the Company adopted SFAS 159, which did nothave a material effect on its results of operations or financial condition.

 

***4.             Inventories***

 

                Inventories are stated at thelower of cost (computed on a first-in, first-out method) or market value andinclude allocations of labor and overhead. As of June 30, 2008 and December 31, 2007, inventoriesconsisted of the following (in thousands):

 

| ** **       | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------|------------|-------------------------|------------|-----------------------------|------------|
| Raw materials    |       | $                       | 921        |                        | $          | 560 |   |
| Work in progress |       | 171                     |       | 151                         |       |
| Finished goods   |       | 326                     |       | 141                         |       |
|             |       | $                       | 1,418      |                        | $          | 852 |   |

 

                At June 30, 2008 and December 31,2007, inventories are stated net of a specific obsolescence allowance of$617,000 and $524,000, respectively.

 

***5.             Stock-BasedCompensation***

 

                *Stock Option Plans*

 

                In May 2005, the Company’sshareholders approved the 2005 Stock Incentive Plan (the “2005 Plan”).  The 2005 Plan has replaced the 1997 ExecutiveStock Option Plan, 2000 Equity Incentive Plan, 2000 Non-Statutory Stock OptionPlan and 2000 Non-Qualified Performance and Retention Equity Plan(collectively, the “Previous Plans”), under which no further awards can begranted.

 

                On June 18, 2008, the Boardof Directors approved an amendment increasing the number of shares of commonstock authorized for issuance under the 2005 Plan by an additional 2,000,000shares.  The number of stock options thatmay be granted under the 2005 Plan is equal to 4,156,175 shares of common stock(subject to adjustment in the event of stock splits and other similar events),plus such number of shares as may become available under the Previous Plansafter the date of the adoption of the 2005 Plan because any award previouslygranted under any such plan expires or is terminated, surrendered or cancelledwithout having been fully exercised 

 

 

8

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oris forfeited in whole or in part or otherwise results in any common stock notbeing issued, provided that such number of additional shares may not exceed2,535,492.  Incentive stock options areissuable only to employees of the Company, while non-qualified stock optionsmay be issued to non-employee directors, consultants and others, as well as toemployees. The options granted under the Previous Plans and the 2005 Planbecome exercisable either immediately, or ratably over one to four years fromthe date of grant, and expire ten years from the date of grant.  Under the 2005 Plan, the per share exerciseprice of incentive stock options may not be less than the fair market value ofthe common stock on the date the option is granted.  The 2005 Plan provides that the Company maynot grant non-qualified stock options at an exercise price less than 85% of thefair market value of the Company’s common stock.

 

                The Company grants stock optionsto its non-employee directors. Generally, new non-employee directors receive aninitial grant of an option to purchase 30,000 shares of the Company’s commonstock that vests in installments over three years.  Once the initial grant has fully vested,non-employee directors (other than the Chairman of the Board) receive an annualgrant of an option to purchase 15,000 shares of the Company’s common stock thatgenerally vests in four equal quarterly installments. The Chairman of the Boardreceives an annual grant of an option to purchase 30,000 shares of the Company’scommon stock that generally vests in four equal quarterly installments. Allsuch options have an exercise price equal to the fair market value of theCompany’s common stock on the date of grant.

 

                Options granted during 2008 and2007 vest ratably annually over a three year period for employees and ratablyquarterly over a one year period for non-employee directors.

 

                Thefollowing is a summary of option activity under all plans (in thousands, exceptper option data):

 

| ** **                           | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Average  Remaining  Contractual  Life (Years)** | ** ** |
|--------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|---------------------------------------------------|------------|
| Outstanding,  December 31, 2007 |       | 5,298                   |       | $                                      | 0.96       |                                              |       |   |
| Granted                              |       | 549                     |       | 0.37                                   |       |                                              |       |
| Exercised                            |       | —                  |       | —                                 |       |                                              |       |
| Forfeited                            |       | (38                     | )          | 0.61                                   |       |                                              |       |
| Expired                              |       | (50                     | )          | 5.11                                   |       |                                              |       |
| Outstanding,  June 30, 2008     |       | 5,759                   |       | $                                      | 0.94       |                                              | 6.22       |   |
| Exercisable,  June 30, 2008     |       | 4,716                   |       | $                                      | 0.95       |                                              | 4.93       |   |

 

 

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                Thefollowing table summarizes unvested option activity during the six months endedJune 30, 2008:

 

| ** **                        | ** ** | **Number  of  Options**                          | **   ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------------------|-----------------------------------------------|------------|
| ** **                        | ** ** | **(In thousands, except weighted average data)** | ** **             |
| Unvested,  December 31, 2007 |       | 895                                              |                   | $                                             | 0.47       |   |
| Granted                           |       | 549                                              |                   | 0.25                                          |       |
| Vested                            |       | (363                                             | )            | 0.46                                          |       |
| Forfeited                         |       | (38                                              | )                      | 0.43                                          |       |
| Unvested,  June 30, 2008     |       | 1,043                                            |                   | $                                             | 0.35       |   |

 

                *SFAS No. 123(R)*

 

                The Company records share-based compensationpursuant to SFAS No. 123 (revised 2004), “Share-based Payment”.  The Company recorded compensation expense of $48,000and $97,000 in the three and six months ended June 30, 2008, respectively,as compared to $37,000 and $70,000 in the three and six months ended June 30,2007, respectively.  As of June 30,2008, the Company had $343,000 of total unrecognized compensation cost relatedto its unvested options, which is expected to be recognized over a weightedaverage period of 1.9 years.

 

                The weighted average fair valueof options issued during the three and six months ended June 30, 2008 wasestimated using the Black-Scholes model.

 

| ** **               | ** ** | **Three and  Six Months Ended  June 30, 2008** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|
| Expected life  (years)   |       | 5.50-6.00                                           |       |
| Interest rate            |       | 2.92%-3.55%                                         |       |
| Volatility               |       | 63.9%-73.6%                                         |       |
| Expected  dividend yield |       | None                                                |       |
| Value of option  granted |       | $0.22-$0.27                                         |       |

 

                The expected life was calculatedin 2008 and 2007 using the simplified method. The risk-free interest rate isbased on the U.S. Treasury yield curve in effect at the time of the grant forthe expected term period.  Expectedvolatility is based exclusively on historical volatility data of the Company’scommon stock.  The Company estimates anexpected forfeiture rate based on its historical forfeiture activity.  Actual results, and future changes inestimates, may differ substantially from the Company’s current estimates.  The weighted average fair value of optionsgranted during the three months ended June 30, 2008 was $0.25.

 

*Stock Purchase Plan*

 

TheCompany has a 2000 Employee Stock Purchase Plan (the “Purchase Plan”) for alleligible employees whereby shares of the Company’s common stock may bepurchased at six-month intervals at 95% of the closing price of the Company’scommon stock on the last business day of the relevant plan period.  Employees may purchase shares having a valuenot exceeding 

 

 

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10%of their gross compensation during an offering period, subject to certainadditional limitations.  Under thePurchase Plan, employees of the Company purchased 2,455 shares of common stockin the six months ended June 30, 2008 at an average price of $0.37 pershare and 5,179 shares of common stock in the year ended December 31, 2007at an average price of $0.47. At June 30, 2008, 313,618 shares werereserved for future issuance under the Purchase Plan.

 

***6.             Revenue Recognition***

 

TheCompany records revenue from the sale of TMR kits at the time of shipment toNovadaq.  TMR kit revenues include theamount invoiced to Novadaq for kits shipped pursuant to purchase ordersreceived, as well as an amortized portion of deferred revenue related to apayment of $4,533,333 received in February 2004.  This payment was made in exchange for areduction in the prospective purchase price the Company receives upon a sale ofthe kits.  The Company is amortizing thispayment into its Consolidated Statements of Operations as revenue over a sevenyear period (culminating in 2010) under the units-of-revenue method asprescribed by Emerging Issues Task Force 88-18, “Sales of Future Revenue”.  The Company determined that a seven yeartimeframe was the most appropriate amortization period based on a valuationmodel it used to assess the economic fairness of the payment. Factors theCompany considered in developing this valuation model included the estimatedforegone revenues over a seven year period resulting from the reduction in theprospective purchase price payable to the Company, a discount rate deemedappropriate to this transaction and an estimate of the remaining economicuseful life of the current TMR kit design, without any benefit being given topotential future product improvements the Company may make.  The Company reviews annually, and adjusts ifnecessary, the prospective revenue amortization rate for kits based on its bestestimate of the total number of kits likely remaining to be shipped to hospitalcustomers by Novadaq through 2010. The Company recorded amortization of$167,000 and $347,000 in the three and six months ended June 30, 2008,respectively, as compared to $181,000 and $371,000 in the three and six monthsended June 30, 2007, respectively, which is included in revenues in theConsolidated Statements of Operations.

 

TMRlasers are billed to Novadaq in accordance with purchase orders that theCompany receives.  Invoiced TMR lasersare recorded as other current assets and deferred revenue on the Company’sConsolidated Balance Sheet until such time as the laser is shipped to ahospital, at which time the Company records revenue and cost of revenue.

 

Underthe terms of the Novadaq TMR distribution agreement, once Novadaq has recovereda prescribed amount of revenue from a hospital for the use or purchase of a TMRlaser, any additional revenues earned by Novadaq are shared with the Companypursuant to a formula established in the distribution agreement. The Companyonly records its share of such additional revenue, if any, at the time therevenue is earned.

 

The Company records all other product revenue, includingsales of TMR lasers and kits to international customers, sales of RenalGuardconsoles and single-use sets and OEM sales of surgical tubes and generalpurpose CO2 lasers, at the time of shipment.

 

                Revenuesfrom service and maintenance contracts are recognized ratably over the life ofthe contract.

 

 

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                Installationrevenues related to a TMR laser transaction are recorded as a component ofservice fees when the laser is installed.

 

***7.             Loss per Share***

 

Inthe three and six months ended June 30, 2008 and 2007, basic and dilutedloss per share have been computed using only the weighted average number ofcommon shares outstanding during the period without giving effect to anypotential future issuances of common stock related to stock option programs,since their inclusion would be antidilutive.

 

Forthe three months ended June 30, 2008 and 2007, 5,759,000 and 5,322,000shares, respectively, and for the six months ended June 30, 2008 and 2007,5,759,000 and 5,322,000 shares, respectively, attributable to outstanding stockoptions were excluded from the calculation of diluted earnings per sharebecause the effect would have been antidilutive.  The following table sets forth thecomputation of basic and diluted loss per share:

 
| ** **                                                                                             | ** ** | **Three Months Ended  June 30,**     | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                             | ** ** | **2008**                                  | ** ** | **2007**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                             | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                                                                                             | ** ** | ** **                                | ** ** |
| Basic:                                                                                                 | ** ** | ** **                                | ** ** |
| Net loss                                                                                               |       | $                                         | (671       | )                                   | $          | (363 | ) | $ | (1,433 | ) | $ | (1,049 | ) |
| Weighted average  shares outstanding                                                                   |       | 30,330                                    |       | 30,311                              |       | 30,330 |   | 30,311 |   |
| Basic loss per  share                                                                                  |       | $                                         | (0.02      | )                                   | $          | (0.01 | ) | $ | (0.05 | ) | $ | (0.03 | ) |
| Diluted:                                                                                               |       |                                      |       |                                |       |   |   |   |   |
| Net loss                                                                                               |       | $                                         | (671       | )                                   | $          | (363 | ) | $ | (1,433 | ) | $ | (1,049 | ) |
| Weighted average  shares outstanding                                                                   |       | 30,330                                    |       | 30,311                              |       | 30,330 |   | 30,311 |   |
| Assumed impact  of the exercise of outstanding dilutive stock options using the treasury  stock method |       | —                                    |       | —                              |       | — |   | — |   |
| Weighted average  common and common equivalent shares                                                  |       | 30,330                                    |       | 30,311                              |       | 30,330 |   | 30,311 |   |
| Diluted loss per  share                                                                                |       | $                                         | (0.02      | )                                   | $          | (0.01 | ) | $ | (0.05 | ) | $ | (0.03 | ) |

 

***8.             Comprehensive Loss***

 

                Total comprehensive loss for the three and six monthsended June 30, 2008 amounted to $673,000 and $1,431,000, respectively, ascompared to $360,000 and $1,044,000 in the three and six months ended June 30,2007, respectively.  Comprehensive lossis comprised of net loss plus the increase/decrease in currency translationadjustment.

 

# ***9.             Warrantyand Preventative Maintenance Costs***

# ** **

TheCompany warranties its products against manufacturing defects under normal useand service during the warranty period. The Company obtains similar warranties from a majority of its suppliers,including those who supply critical Heart Laser System components.  In addition, 

 

 

12

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underthe terms of its TMR distribution agreement with Novadaq, the Company is ableto bill Novadaq for actual warranty costs, including preventative maintenanceservices, up to a specified amount during the warranty period.

 

The Company evaluates theestimated future unrecoverable costs of warranty and preventative maintenanceservices for its installed base of lasers on a quarterly basis and adjusts itswarranty reserve accordingly.  TheCompany considers all available evidence, including historical experience andinformation obtained from supplier audits.

 

Changes in the warrantyaccrual were as follows (in thousands):

 

| ** **                                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                              | ** ** | **2007**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Balance,  beginning of period                                |       | $                                     | 60         |                                | $          | 60 |   | $ | 60 |   | $ | 60 |   |
| Change in  liability for warranties issued during the period |       | —                                |       | —                              |       | — |   | — |   |
| Change in  liability for pre-existing warranties             |       | (50                                   | )          | —                              |       | (50 | ) | — |   |
| Balance, end of  period                                      |       | $                                     | 10         |                                | $          | 60 |   | $ | 10 |   | $ | 60 |   |

 

**Item 2.****                      ****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

This quarterly report(including certain information incorporated herein by reference) containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”). Statements containingterms such as “believes”, “plans”, “expects”, “anticipates”, “intends”, “estimates”and similar expressions reflect uncertainty and are forward-looking statements.Forward-looking statements are based upon current plans and expectations andinvolve known and unknown important risks and uncertainties that could causeactual results to differ materially from those described in the forward-lookingstatements. Such important factors and uncertainties include, but are notlimited to, those set forth below in Part II, Item 1A. Risk Factors, andelsewhere in this quarterly report.

 

# **Overview**

# ** **

We are a medical devicecompany specializing in innovative technologies for the cardiac and vascularmarkets.  We pioneered and manufacturethe Heart Laser System that cardiac surgeons use to perform TMR to alleviatesymptoms of severe angina. We also manufacture *CO**2* surgical lasertubes and provide contract assembly services on general purpose *CO**2** *lasers.

 

In addition, in 2007 weinitiated our pilot clinical safety trial for RenalGuard. RenalGuard is designedto reduce the potentially toxic effects that contrast media can have on thekidneys when it is administered to patients undergoing image-guided procedures,such as those performed when placing drug-eluting stents. It is believed thatallowing contrast media to dwell in the kidneys can lead to CIN. By inducingand maintaining a high urine flow rate before, during and after theseimage-guided procedures, it is believed the incidence rates of CIN in at-riskpatients can be reduced. RenalGuard facilitates this increased urine clearanceenabling the body to more rapidly void the contrast media, thereby reducing itsoverall resident time and toxic effects in the kidney.

 

 

13

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Weenrolled a total of 23 patients in our initial pilot safety study. Based uponthe positive safety data collected in the study and discussions we had with theFDA, we elected to stop enrolling new patients in the pilot study in November 2007.  We submitted an IDE supplement to the FDA in February 2008seeking approval to move from our pilot study to a pivotal clinical trial tostudy the safety and effectiveness of RenalGuard in the prevention of CIN. In March 2008,the FDA granted us conditional approval to begin our pivotal study. We have receivedapproval to study RenalGuard on 246 patients at up to 30 U.S. clinical sites.In July 2008 we announced that we would delay the start of this pivotaltrial until such time as we can obtain data from the clinical trial beingconducted in Milan, Italy that we hope will enable us to raise sufficientadditional capital necessary to complete the U.S. study.

 

OurU.S. distributor for the Heart Laser System (Novadaq currently and Edwardsprior to March 20, 2007) is our largest customer, accounting for 83% ofour total revenues in both the three and six months ended June 30, 2008and 85% in the year ended December 31, 2007, respectively.  We expect a high level of sales concentrationto continue in the near future with Novadaq as our largest customer because itholds the exclusive U.S. distribution rights for our TMR products.

 

Approximately 89% of ourrevenues in both the three and six months ended June 30, 2008 and 87% inthe year ended December 31, 2007, respectively, came from the sale andservice of TMR lasers and related disposable kits. We believe that the numberof opportunities for new TMR laser sales to hospital customers, andspecifically sales of our HL2 laser, is likely to continue to decline in futurequarters as a result of (1) a diminishing number of available hospitalsthat have not already implemented a TMR program that are still likely to do soin the future and (2) continuing financial pressures that hospitals face,in particular for the funding of new capital equipment purchases, in light ofongoing cutbacks in both Medicare and private insurance reimbursement rates forall medical procedures. In addition, we have seen a recent downward trend inthe price at which new TMR lasers are being sold in the market as competitionfor the remaining available customers increases. As such, we expect to continueto see a decline in revenue generated from the sale of HL2 lasers in futurequarters and TMR revenues in future quarters will be more dependent on the saleof TMR kits and service revenues.

 

Aggregate TMR kitshipments to U.S. hospitals decreased approximately 19% and 18% in the threeand six months ended June 30, 2008 as compared to the three and six monthsended June 30, 2007.  We believe itis likely that our TMR revenues in the second half of 2008 will be lower thanthe corresponding 2007 periods due to an expected decline in new TMR lasershipments.

 

Ourmanagement reviews anumber of key performance indicators to assist in determining how to allocateresources and run our day to day operations. These indicators include (1) actualprior quarterly sales trends, (2) projected TMR laser and kit sales forthe next four quarters, as provided by Novadaq in a rolling 12 month salesforecast, (3) projected future sales of RenalGuard consoles and single-usesets, (4) research and development progress as measured against internalproject plan objectives, (5) budget to actual financial expenditureresults, (6) inventory levels (both our own and Novadaq’s) and (7) shortterm and long term projected cash flows of the business.

 

 

14

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# ** **

# **Critical Accounting Policies and Estimates**

# ** **

                Ourfinancial statements are based on the application of significant accountingpolicies, many of which require us to make significant estimates andassumptions (see Note 2 to the Consolidated Financial Statements).  We believe that the following are some of themore material judgment areas in the application of our accounting policies thatcurrently affect our financial condition and results of operations.

 

# ***                Inventories***

# ** **

                Inventories are stated at thelower of cost (computed on a first-in, first-out method) or market value andinclude allocations of labor and overhead. A specific obsolescence allowance is provided for slow moving, excess andobsolete inventory based on our best estimate of the net realizable value ofinventory on hand taking into consideration factors such as (1) actualtrailing 12 month sales, (2) expected future product line demand, based inpart on sales forecast input received from Novadaq, and (3) service partstocking levels which, in management’s best judgment, are advisable to maintainin order to meet warranty, service contract and time and material spare partdemands.  Historically, we have found ourreserves to be adequate.

 

# ***                AccountsReceivable***

# ** **

                Accounts receivable is stated atthe amount we expect to collect from the outstanding balance.  We continuously monitor collections fromcustomers, and we maintain a provision for estimated credit losses based upon historicalexperience and any specific customer collection issues that we haveidentified.  Historically, we have notexperienced significant losses related to our accounts receivable. Collateralis not generally required. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required.

 

                ***Researchand Development***

 

                Research and development costsare expensed as incurred.

 

# ***                Warrantyand Preventative Maintenance Costs***

# ** **

Wewarranty our products against manufacturing defects under normal use andservice during the warranty period.  Weobtain similar warranties from a majority of our suppliers, including those whosupply critical Heart Laser System components. In addition, under the terms of our TMR distribution agreement withNovadaq, we are able to bill Novadaq for actual warranty costs, includingpreventative maintenance services, up to a specified amount during the warrantyperiod.

 

Weevaluate the estimated future unrecoverable costs of warranty and preventativemaintenance services for our installed base of lasers on a quarterly basis andadjust our warranty reserve accordingly. We consider all available evidence, including historical experience andinformation obtained from supplier audits.

 

 

15

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## ***RevenueRecognition***

## ** **

Werecord revenue from the sale of TMR kits at the time of shipment toNovadaq.  TMR kit revenues include theamount invoiced to Novadaq for kits shipped pursuant to purchase ordersreceived, as well as an amortized portion of deferred revenue related to apayment of $4,533,333 received in February 2004.  This payment was made in exchange for areduction in the prospective purchase price we receive upon a sale of thekits.  We are amortizing this paymentinto our Consolidated Statements of Operations as revenue over a seven yearperiod (culminating in 2010) under the units-of-revenue method as prescribed byEmerging Issues Task Force 88-18, “Sales of Future Revenue”.  We determined that a seven year timeframe wasthe most appropriate amortization period based on a valuation model we used toassess the economic fairness of the payment. Factors we considered indeveloping this valuation model included the estimated foregone revenues over aseven year period resulting from the reduction in the prospective purchaseprice payable to us, a discount rate deemed appropriate to this transaction andan estimate of the remaining economic useful life of the current TMR kitdesign, without any benefit being given to potential future productimprovements we may make. We review annually, and adjust if necessary, theprospective revenue amortization rate for kits based on our best estimate ofthe total number of kits likely remaining to be shipped to hospital customersby Novadaq through 2010. We recorded amortization of $167,000 and $347,000 inthe three and six months ended June 30, 2008, respectively, as compared to$181,000 and $371,000 in the three and six months ended June 30, 2007,respectively, which is included in revenues in our Consolidated Statements ofOperations.

 

TMRlasers are billed to Novadaq in accordance with purchase orders that wereceive.  Invoiced TMR lasers arerecorded as other current assets and deferred revenue on our ConsolidatedBalance Sheet until such time as the laser is shipped to a hospital, at whichtime we record revenue and cost of revenue.

 

Underthe terms of the TMR distribution agreement, once Novadaq has recovered aprescribed amount of revenue from a hospital for the use or purchase of a TMRlaser, any additional revenues earned by Novadaq are shared with us pursuant toa formula established in the distribution agreement. We only record our shareof such additional revenue, if any, at the time the revenue is earned.

 

We record all other product revenue, including sales ofTMR lasers and kits to international customers, sales of RenalGuard consolesand single-use sets and OEM sales of surgical tubes and general purpose CO2lasers, at the time of shipment.

 

                Revenuesfrom service and maintenance contracts are recognized ratably over the life ofthe contract.

 

                Installationrevenues related to a TMR laser transaction are recorded as a component ofservice fees when the laser is installed.

 

 

16

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## **Results of Operations**

## ** **

Results for thethree and six months ended June 30, 2008 and 2007 and the related percentof revenues were as follows:

 
| ** **                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                  | ** ** | **2008**                              | ** ** | **2007**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                        | ** ** | **$**                                 | ** ** | **%**                               | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
|                                        | ** ** | **(dollars  in thousands)**           | ** ** |
|                                        |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                              |       | $                                     | 1,310      |                                | 100        | % | $ | 1,932 |   | 100 | % | $ | 2,478 |   | 100 | % | $ | 3,425 |   | 100 | % |
| Total cost of  revenues                     |       | 573                                   |       | 44                                  |       | 775 |   | 40 |   | 978 |   | 39 |   | 1,569 |   | 46 |   |
| Gross profit                                |       | 737                                   |       | 56                                  |       | 1,157 |   | 60 |   | 1,500 |   | 61 |   | 1,856 |   | 54 |   |
| Selling, general &  administrative |       | 831                                   |       | 63                                  |       | 1,076 |   | 56 |   | 1,801 |   | 73 |   | 2,089 |   | 61 |   |
| Research &  development            |       | 602                                   |       | 46                                  |       | 556 |   | 29 |   | 1,210 |   | 49 |   | 1,047 |   | 31 |   |
| Total operating  expenses                   |       | 1,433                                 |       | 109                                 |       | 1,632 |   | 85 |   | 3,011 |   | 122 |   | 3,136 |   | 92 |   |
| Loss from  operations                       |       | (696                                  | )          | (53                                 | )          | (475 | ) | (25 | ) | (1,511 | ) | (61 | ) | (1,280 | ) | (37 | ) |
| Other income                                |       | 25                                    |       | 2                                   |       | 112 |   | 6 |   | 78 |   | 3 |   | 231 |   | 6 |   |
| Net loss                                    |       | $                                     | (671       | )                                   | (51        | )% | $ | (363 | ) | (19 | )% | $ | (1,433 | ) | (58 | )% | $ | (1,049 | ) | (31 | )% |
|                                             |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 
| ** **                                           | ** ** | **Three Months Ended  June 30,** | ** ** | ** ** | ** ** | ** **                          | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** | ** **                          | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|------------|------------|-------------------------------------|------------|-------------------------------------|------------|------------|------------|-------------------------------------|------------|
| ** **                                           | ** ** | **2008**                              | ** ** | **2007**   | ** ** | **Increase  (decrease)  over 2007** | ** ** | **2008**                            | ** ** | **2007**   | ** ** | **Increase  (decrease)  over 2007** | ** ** |
| ** **                                           | ** ** | **$**                                 | ** ** | **$**      | ** ** | **$**                               | ** ** | **%**                               | ** ** | **$**      | ** ** | **$**                               | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**            | ** ** |
|                                                 |       |                                  |       |       |       |                                |       |                                |       |       |       |                                |       |   |   |   |   |
| Product sales                                        |       | $                                     | 1,032      |       | $          | 1,520                               |       | $                                   | (488       | )          | (32        | )%                                  | $          | 1,838 |   | $ | 2,654 |   | $ | (816 | ) | (31 | )% |
| Service fees                                         |       | 278                                   |       | 412        |       | (134                                | )          | (33                                 | )          | 640        |       | 771                                 |       | (131 | ) | (17 | ) |
| Total revenues                                       |       | 1,310                                 |       | 1,932      |       | (622                                | )          | (32                                 | )          | 2,478      |       | 3,425                               |       | (947 | ) | (28 | ) |
| Product cost of  sales                               |       | 423                                   |       | 562        |       | (139                                | )          | (25                                 | )          | 643        |       | 1,148                               |       | (505 | ) | (44 | ) |
| Service fees  cost of sales                          |       | 150                                   |       | 213        |       | (63                                 | )          | (30                                 | )          | 335        |       | 421                                 |       | (86 | ) | (20 | ) |
| Total cost of  revenues                              |       | 573                                   |       | 775        |       | (202                                | )          | (26                                 | )          | 978        |       | 1,569                               |       | (591 | ) | (38 | ) |
| Gross profit                                         |       | 737                                   |       | 1,157      |       | (420                                | )          | (36                                 | )          | 1,500      |       | 1,856                               |       | (356 | ) | (19 | ) |
| Selling,  general & administrative expenses |       | 831                                   |       | 1,076      |       | (245                                | )          | (23                                 | )          | 1,801      |       | 2,089                               |       | (288 | ) | 14 |   |
| Research &  development expenses            |       | 602                                   |       | 556        |       | 46                                  |       | 8                                   |       | 1,210      |       | 1,047                               |       | 163 |   | 16 |   |
| Total operating  expenses                            |       | 1,433                                 |       | 1,632      |       | (199                                | )          | (12                                 | )          | 3,011      |       | 3,136                               |       | (125 | ) | (4 | ) |
| Income (loss)  from operations                       |       | (696                                  | )          | (475       | )          | (221                                | )          | (47                                 | )          | (1,511     | )          | (1,280                              | )          | (231 | ) | (18 | ) |
| Other income                                         |       | 25                                    |       | 112        |       | (87                                 | )          | (78                                 | )          | 78         |       | 231                                 |       | (153 | ) | (66 | ) |
| Net income  (loss)                                   |       | $                                     | (671       | )          | $          | (363                                | )          | $                                   | (308       | )          | (85        | )%                                  | $          | (1,433 | ) | $ | (1,049 | ) | $ | (384 | ) | (37 | )% |

 

 

17

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***Product Sales***

 

DisposableTMR kit revenues, the largest component of product sales in the three months endedJune 30, 2008, decreased by $34,000, or 5%, as compared to the threemonths ended June 30, 2007.  Thisdecrease is primarily related to a lower volume of kit shipments to Novadaq inthe three months ended June 30, 2008 as compared to the three months endedJune 30, 2007.

 

In the six months ended June 30,2008, disposable TMR kit revenues increased by $125,000, or 11%, as compared tothe six months ended June 30, 2007. This increase is primarilyrelated to a higher volume of kit shipments to Novadaq in the six months ended June 30,2008 as compared to the six months ended June 30, 2007. We expect that kit shipments to Novadaqduring the remaining half of 2008 will be somewhat lower than the number ofkits shipped in the first half of 2008 as Novadaq attempts to reduce itson-hand stocking level of kits in inventory by yearend.

 

TMRlaser revenues decreased $413,000, or 67%, and $701,000, or 68%, respectively,in the three and six months ended June 30, 2008, as compared to the threeand six months ended June 30, 2007. These decreases are a result of (1) a decrease in the number of newTMR lasers sold and (2) a lower average selling price on the new TMRlasers sold.  We expect to see acontinuation of the recent trend whereby TMR revenues in future quarters willbe more dependent on the sale of TMR kits and service revenues than on sales ofTMR lasers.

 

Otherproduct sales decreased $41,000, or 22%, in the three months ended June 30,2008 as compared to the three months ended June 30, 2007.  This overall decrease is a result of adecrease in manufacturing contract assembly product revenues, which resultedfrom a delay in incoming work product from our sole supplier of general purposelasers. We expect normal incoming supply patterns to resume during the thirdand fourth quarters of 2008 and consequently we anticipate our revenues fromother product sales will increase over the second half of 2008 as compared tothe first half of 2008.

 

Otherproduct sales decreased $240,000, or 47%, in the six months ended June 30,2008 as compared to the six months ended June 30, 2007.  This overall decrease is a result of (1) adecrease in manufacturing contract assembly product revenues and (2) decreasedrevenues from Edwards related to the discontinued Optiwave 980 product line.  These decreases were offset in part by newinternational RenalGuard revenues.

 

***Service FeeRevenues***

 

Servicefees decreased $134,000, or 33%, and $131,000, or 17%, in the three and sixmonths ended June 30, 2008, respectively, as compared to the three and sixmonths ended June 30, 2007. Domestic service fees related to billableservice calls and spare part sales decreased $100,000 and $89,000, respectivelyin the three and six months ended June 30, 2008 as compared to the 2007periods. International service fees decreased $34,000 and $42,000,respectively, in the three and six months ended June 30, 2008 as comparedto the 2007 periods.

 

 

18

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***Gross Profit***

 

                Gross profit was $737,000, or56% of total revenues, in the three months ended June 30, 2008 as comparedwith gross profit of $1,157,000, or 60% of total revenues, in the three monthsended June 30, 2007.  The decreasein gross profit is due to (1) a decrease in both the number and theaverage selling prices of new TMR lasers sold, (2) lower revenues fromservice, (3) lower revenues from contract assembly services, (4) highercost of sales related to both higher period manufacturing expenses and anincrease in our inventory reserve and (5) lower disposable TMR kitrevenue.  These decreases were partiallyoffset by a reduction in our warranty accrual.

 

Grossprofit was $1,500,000, or 61% of total revenues, in the six months ended June 30,2008 as compared with gross profit of $1,856,000, or 54% of total revenues, inthe six months ended June 30, 2007. The decrease in gross profit is due to (1) a decrease in both thenumber and the average selling prices of new TMR lasers sold, (2) lowerrevenues from contract assembly services and (3) lower revenues from service.  These decreases were offset in part by higherdisposable TMR kit revenues and new international RenalGuard revenues.

 

                ***Selling, General and Administrative Expenses***

 

Selling,general and administrative expenditures decreased 23% and 14% in the three andsix months ended June 30, 2008 as compared to the three and six monthsended June 30, 2007.  In the threemonths ended June 30, 2008, there were decreases in (1) compensationrelated costs, (2) overall spending on sales and marketing activities relatedto RenalGuard, (3) bad debt expense, and (4) international expensesas compared to the three months ended June 30, 2007.  In the six months ended June 30, 2008,there were decreases in (1) compensation related costs, (2) overallspending on sales and marketing activities related to RenalGuard, and (3) corporateand legal expenditures incurred in connection with the transfer of the U.S. TMRdistribution agreement and the origination of RenalGuard clinical trialcontracts as compared to the six months ended June 30, 2007.

 

                ***Researchand Development Expenses***

 

Researchand development expenditures increased 8% and 16% in the three and six monthsended June 30, 2008 as compared to the three and six months ended June 30,2007.  In the three months ended June 30,2008, the increase was primarily related to a write-off of certain capitalizeddevelopment equipment. In the six months ended June 30, 2008, the increasewas due to increased RenalGuard related clinical costs and the write-off ofcertain capitalized development equipment offset in part by a decrease in TMRrelated clinical costs as compared to the six months ended June 30, 2007.

 

InJuly 2008, we announced that we would defer the commencement of the U.S.pivotal trial of RenalGuard. We expect therefore that our research anddevelopment expenditures for the second half of 2008 will remain at a similarlevel as the first half of 2008.

 

                ***Other Income***

 

Thelargest component of other income consists of interest income earned on ourcash and cash equivalents. Interest income decreased $87,000 and $153,000 inthe three and six months ended June 30, 2008, respectively, due to loweraverage investable balances and lower 

 

 

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interestrates on those investable balances in the three and six months ended June 30,2008 periods as compared to the three and six months ended June 30, 2007.

 

                ***Net Loss***

 

In the three and sixmonths ended June 30, 2008 and 2007, we recorded a net loss of $671,000and $1,433,000, respectively.  In the three and six months ended June 30,2008, the increased loss was due to lower sales generating lower gross margindollars, and lower interest income, offset in part by lower operating expensesas compared to the three and six months ended June 30, 2007.

 

***Kit Shipments***

 

                We generally view disposable kitshipments to end users as an important metric in evaluating our business,although we believe that specific short-term factors not indicative oflong-term trends can sometimes affect shipments of disposable kits in any givenquarter.

 

Disposablekit shipments to end users were as follows:

 
| ** **                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                      | ** ** | **2008**                             | ** ** | **2007**                           | ** ** | **%  Increase  (Decrease)  Over  2007** | ** ** | **2008** | ** ** | **2007** | ** ** | **%  Increase  (Decrease)  Over  2007** | ** ** |
|                            |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Domestic (by  U.S. Distributor) |       | 347                                  |       | 429                                |       | (19 | ) | 722 |   | 881 |   | (18 | ) |
| International                   |       | 35                                   |       | 25                                 |       | 40 |   | 50 |   | 30 |   | 67 |   |
| Total                           |       | 382                                  |       | 454                                |       | (16 | ) | 772 |   | 911 |   | (15 | ) |

 

                Because asignificant number of the total TMR procedures performed each year by cardiacsurgeons are done in combination with open-heart bypass surgery, we believe anyfuture growth in the number of TMR procedures will be partly dependent on thenumber of bypass surgeries performed in the future, which we believe have thepotential to grow modestly over the next few years.

 

**Liquidity and Capital Resources**

 

Cashand cash equivalents totaled $5,506,000 as of June 30, 2008, a decrease of$2,554,000 from $8,060,000 as of December 31, 2007.  We have no debt obligations. We believe thatour existing cash resources will meet our working capital requirements throughat least the next 12 months.

 

Cashused for operating activities in the six months ended June 30, 2008 was$2,535,000 due to our net loss and unfavorable working capital changes, offsetin part by non-cash depreciation and amortization, compensation related tostock options and a loss on retirement of equipment.  We received $1,000 from the issuance ofcommon stock related to proceeds from our employee stock purchase plan. We used$27,000 for the purchase of equipment. The effect of exchange rate changes provided an additional $7,000.

 

 

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Inthe near term we will be largely dependent on the future success of Novadaq’ssales and marketing efforts in the U.S. to continue to increase the installedbase of HL2 lasers and to substantially increase TMR procedural volumes andrevenues. Should the installed base of HL2 lasers or TMR procedural volume notincrease sufficiently, our liquidity and capital resources will be negativelyimpacted.  Additionally, otherunanticipated decreases in operating revenues or increases in expenses orchanges or delays in third-party reimbursement to healthcare providers usingour products would adversely impact our cash position and require further costreductions or the need to obtain additional capital.  It is not certain that we, working withNovadaq and our international distributors, will be successful in achievingbroad commercial acceptance of the Heart Laser Systems, or that we will be ableto operate profitably in the future.

 

Somehospital customers prefer to acquire the Heart Laser Systems on a usage basisrather than as a capital equipment purchase. We believe this is the result of current limitations at many hospitalsregarding acquiring expensive capital equipment as well as competitivepressures in the marketplace.  A usagebusiness model will result in a longer recovery period for Novadaq to recoupits investment in lasers it may purchase from us in the future.  This results in (1) a delay in ourability to receive additional shared revenue, if any, that we otherwise areentitled to receive under the terms of our new distribution agreement withNovadaq and (2) a potential delay in the purchase of new lasers by Novadaqif the installed base of lasers placed under usage contracts isunder-performing and Novadaq chooses to re-deploy these lasers to otherhospital sites in lieu of purchasing a new laser from us.

 

Webelieve we will incur losses at least through 2010.  We cannot be certain that we will be able toraise the additional capital necessary to complete the pivotal clinical trialin the U.S. that is necessary to obtain regulatory approval to marketRenalGuard in the U.S., or that future sales, if any, of RenalGuard will justifythe investments we plan to make.  Therecan be no assurance that the future capital we will need to implement ourbusiness plan will be available on terms and conditions acceptable to us,especially considering the current uncertainty in the global creditmarkets.  As a result of the currentmarket conditions, we have deferred the commencement of the U.S. pivotal trial,and should additional financing not be available on terms and conditionsacceptable to us, we will need to further curtail our RenalGuard program andtake additional actions that will adversely impact our ability to continue torealize assets and satisfy liabilities in the normal course of business.  The consolidated financial statements set forthin this report do not include any adjustments to reflect the possible futureeffects of these uncertainties.

 

**Off-Balance Sheet Arrangements**

 

**               **None.

 

**Item 3.        Quantitativeand Qualitative Disclosures about Market Risk**

 

                Aportion of our operations consists of sales activities in foreign jurisdictions.  We manufacture our products exclusively inthe U.S. and sell our products in the U.S. and abroad. As a result, ourfinancial results could be affected by factors such as changes in foreigncurrency exchange rates or weak economic conditions in the foreign markets inwhich we distribute our products.  Ouroperating results are exposed to changes in exchange rates between the U.S.dollar and foreign currencies, especially the Euro. When the U.S. dollarstrengthens against the Euro, the value of foreign sales decreases. When theU.S. dollar weakens, the functional currency amount of sales increases. Noassurance can be given that foreign currency fluctuations in the future willnot 

 

 

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adversely affect our business, financial condition andresults of operations, although at present we do not believe that our exposureis significant, as international sales represented 9% and 3% of ourconsolidated sales in the six months ended June 30, 2008 and the yearended December 31, 2007, respectively. We do not hedge any balance sheetexposures and intercompany balances against future movements in foreignexchange rates.

 

Ourinterest income and expense are sensitive to changes in the general level ofU.S. and foreign interest rates. In this regard, changes in U.S. and foreigninterest rates affect the interest earned on our cash and cashequivalents.  We do not believe that a10% change to the applicable interest rates would have a material impact on ourfuture results of operations or cash flows.

 

## **Item 4.        Controlsand Procedures**

## ** **

***Evaluation of Disclosure Controlsand Procedures***

 

                Ourmanagement, with the participation of our chief executive officer and chieffinancial officer, evaluated the effectiveness of our disclosure controls andprocedures as of June 30, 2008.  Theterm “disclosure controls and procedures”, as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and other procedures of acompany that are designed to ensure that information required to be disclosedby a company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure.  Management recognizes that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving their objectives and management necessarilyapplies its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.  Based on theevaluation of our disclosure controls and procedures as of June 30, 2008,our chief executive officer and chief financial officer concluded that, as ofsuch date, our disclosure controls and procedures were effective at thereasonable assurance level.

 

***Changesin Internal Control over Financial Reporting***

 

                Nochange in our internal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) occurred during the fiscal quarter endedJune 30, 2008 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**Part II.  Other Information**

 

**Item 1A.       RiskFactors**

 

                The risks and uncertaintiesdescribed below are not the only risks we face. Additional risks and uncertainties not presently known to us orcurrently deemed immaterial may also impair our business operations.  If any of the following risks actually occur,our financial condition and operating results could be materially adverselyaffected.

 

 

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***We expect our common stock to bedelisted from AMEX.***

 

***               ***Our stockholders’equity was $3,617,000 as of June 30, 2008. Under the AMEX listing requirements, because we have sustained lossesfrom continuing operations and/or net losses in three of our four most recentfiscal years and our stockholders’ equity has fallen below $4,000,000 as of June 30,2008 we expect that AMEX will notify us by a deficiency letter within tenbusiness days after we file this quarterly report that we are not in compliancewith the continued listing standards.  Wedo not anticipate being able to provide a plan to AMEX that will enable us toavoid our common stock from being delisted. When our common stock becomesdelisted from AMEX and begins to trade on an over-the-counter basis, we couldface a number of negative implications, including reduced liquidity in ourcommon stock as a result of the loss of market efficiencies associated withAMEX and the loss of federal preemption of state securities laws, as well asthe potential loss of confidence by investors, suppliers, customers andemployees, fewer business development opportunities and greater difficulty inobtaining financing or credit.

 

***We expect toincur significant operating losses in the near future.***

 

                We expect to incur net losses infuture quarters, at least through 2010. We cannot provide any assurance that we will be successful with ourbusiness strategy, that we will be able to raise sufficient capital to completeour pivotal clinical trial of RenalGuard in the U.S. or that if such a clinicaltrial is completed that RenalGuard will receive FDA approval or commercialacceptance, or that we will ever return to profitability.

 

***                Our company may be unable toraise needed capital.***

 

                As of June 30, 2008, we hadcash and cash equivalents totaling $5,506,000. Based upon our current operatingplan, we anticipate that our existing capital resources should be sufficient tomeet our working capital requirements for at least the next 12 months; however,we will need to raise additional capital for the future in order to implementour business plan.  As a result ofcurrent capital market conditions, we have deferred the commencement of theU.S. pivotal trial for RenalGuard, and should additional financing not beavailable on terms and conditions acceptable to us, we will need to furthercurtail our RenalGuard program and take additional actions that will adverselyimpact our ability to continue to realize assets and satisfy liabilities in thenormal course of business.  To the extentthat we raise additional capital by issuing equity or convertible securities,ownership dilution to our shareholders will result.  To the extent that we raise additionalcapital through the incurrence of debt, our activities may be restricted by therepayment obligations and other restrictive covenants related to the debt.

 

***Our ability tocommence our planned future U.S. pivotal clinical trial to study the safety andeffectiveness of RenalGuard in preventing contrast-induced nephropathy isdependent on our ability to raise sufficient additional capital in the futureto fund the completion of the study.***

 

***               ***Although we have received conditional FDAapproval to commence our pivotal clinical trial in the U.S. to study the safetyand effectiveness of RenalGuard in preventing contrast-induced nephropathy, wewill need to raise additional capital in the future to fund the cost ofcompleting the study. We can provide no assurance that we will be able to raisethe necessary capital to complete this trial or that such capital will beavailable on terms and conditions acceptable to us, especially considering thecurrent uncertainty in the global credit markets.

 

 

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***Our company iscurrently dependent on one principal customer.***

 

                Pursuant to the terms of our TMRdistribution agreement with Novadaq, Novadaq is our exclusive distributor forour HL2 laser and TMR kits in the U.S. As a result of this exclusive arrangement, our U.S. distributor (Novadaqcurrently and Edwards prior to March 20, 2007) accounted for 83% of totalrevenues in both the three and six months ended June 30, 2008,respectively, and 85% in the year ended December 31, 2007, and we expectNovadaq to account for the significant majority of our revenue in the nearfuture.  As a result of this expectedconcentration of sales with Novadaq, we bear an increased financial risk oftimely sales collection if, for any reason, Novadaq’s business condition shouldsuffer.

 

***We are dependenton Novadaq in the U.S. to attempt to increase our TMR revenues.***

 

Novadaq’ssales organization is responsible for selling a number of different products,including our TMR products.  We arelargely dependent on the future success of Novadaq’s sales and marketingefforts in the U.S. to increase the installed base of HL2 lasers and TMRprocedural volumes and revenues.  If ourrelationship with Novadaq does not progress, or if Novadaq’s sales andmarketing strategies fail to generate sales of our products in the future,******our revenue will decreasesignificantly and our business, financial condition and results of operationswill be seriously harmed.

 

***                Ourcompany is currently dependent upon one principal product line to generaterevenues.***

 

                We currently sell one principalproduct line, the Heart Laser Systems, which accounts for the majority of ourtotal revenues.  Approximately 89% of ourrevenues in both the three and six months ended June 30, 2008,respectively, and 87% in the year ended December 31, 2007, were derivedfrom the sales and service of our Heart Laser Systems.  This absence of a diversified product linemeans that we are directly and materially impacted by changes in the market forHeart Laser Systems. We believe that the number of opportunities for new TMRlaser sales to hospital customers, and specifically sales of our HL2 laser, islikely to continue to decline in future quarters as a result of (1) adiminishing number of available hospitals that have not already implemented aTMR program that are still likely to in the future and (2) continuingfinancial pressures that hospitals face, in particular for the funding of newcapital equipment purchases, in light of ongoing cutbacks in both Medicare andprivate insurance reimbursement rates for all medical procedures. In addition,we have seen a recent downward trend in the price for new TMR lasers in themarket, as competition for the remaining available customers increases. Thesemarket factors and our dependency on revenues related to sales of the HeartLaser System pose a serious risk to our ongoing ability to generate sufficientcash to fund our operations, which may seriously harm our business, financialcondition and results of operations in future quarters.

 

***                Ourcompany is dependent upon certain suppliers.***

 

                Someof the components for our Heart Laser Systems, most notably the power supplyand certain optics and fabricated parts for the HL2, are only available fromone supplier, and we have no assurance that we will be able to source any ofour sole-sourced components from additional suppliers.  We are dependent upon our sole suppliers toperform their obligations in a timely manner. In the past, we have experienced delays in product delivery from oursole suppliers and, because we do not have an alternative supplier to producethese products for us, we have little 

 

 

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leverage to enforce timely delivery. Any delay in productdelivery or other interruption in supply from these suppliers could prevent usfrom meeting our commercial demands for our products, which could have amaterial adverse effect on our business, financial condition and results ofoperations.  Furthermore, we do notrequire significant quantities of any components because we produce a limitednumber of our products each year.  Ourlow-quantity needs may not generate substantial revenue for our suppliers.  Therefore, it may be difficult for us tocontinue our relationships with our current suppliers or establishrelationships with additional suppliers on commercially reasonable terms, if atall, and such difficulties may seriously harm our business, financial conditionand results of operations.

 

***We are dependent upon our key personnel andmay need to hire additional key personnel in the future.***

 

Our ability to operate ourbusiness successfully depends in significant part upon the retention andmotivation of certain key technical, regulatory, production and managerialpersonnel and consultants and our ongoing ability to hire and retain additionalqualified personnel in these areas. Competition for such personnel is intense,particularly in the Greater Boston area. We cannot be certain that we will beable to attract such personnel and the loss of any of our current key employeesor consultants could have a significant adverse impact on our business.

 

***                Inorder to compete effectively, our current and future products need to gaincommercial acceptance.***

 

                Our current TMR products maynever achieve widespread commercial acceptance. To be successful, we and Novadaq need to:

 

·                  demonstrate to the medical community ingeneral, and to heart surgeons and cardiologists in particular, that TMRprocedures are effective, relatively safe and cost effective;

 

·                  support third-party efforts to document themedical processes by which TMR procedures relieve angina;

 

·                  train more heart surgeons toperform TMR procedures using the Heart Laser Systems; and

 

·                  maintain and expand third-party reimbursementfor the TMR procedure.

 

                To date, only a limited numberof heart surgeons have been trained in the use of TMR using the Heart LaserSystems.  We are dependent on Novadaq toexpand related marketing and training efforts in the U.S. for the use of ourproducts.

 

                The Heart Laser Systems have notyet received widespread commercial acceptance. We believe that concerns over the lack of a consensus view about thereason or reasons why a TMR procedure relieves angina in patients who undergothe procedure has limited demand for and use of the Heart Laser Systems. Untilthere is consensus, if ever, on the medical processes by which TMR proceduresrelieve angina, we believe some hospitals will delay the implementation of aTMR program.

 

 

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                If we are unable to achievewidespread commercial acceptance of the Heart Laser Systems, our business,financial condition and results of operations will be materially and adverselyaffected.

 

***Our newestproduct, RenalGuard, has only had limited testing in a clinical setting and wemay need to modify it in the future to be commercially acceptable.***

 

***               ***We have onlycompleted the first generation product design for RenalGuard and we have onlybeen able to perform a limited amount of testing of this device in a clinicalhospital setting as part of our recently completed initial pilot human clinicalstudy. We may need to make substantial modifications to the design, features orfunctions of our device in order for it to eventually obtain FDA approval orotherwise to meet customer expectations in the EU where we are currentlymarketing it. These changes may not be able to be completed in a timelyfashion, if at all. Should any such modifications prove to be significantlymore costly or time consuming to engineer than we estimate, our ability tobring this product to market may be severely and negatively impacted.

 

***                Ourpotential future success in marketing RenalGuard in the EU as a CIN preventiondevice and our ability to raise additional capital in the future will belargely dependent on the timely outcome of the current investigator-sponsoredclinical trial of RenalGuard being conducted at the Centro Cardiologico Monzino(CCM) in Milan Italy.***

 

***               ***We currently are supporting aninvestigator-sponsored clinical trial at the CCM where RenalGuard is beingcompared in an equivalency study to that of an overnight hydration protocol interms of its safety and effectiveness in preventing CIN in at-risk patients. Webelieve our ability to raise additional capital to fund our U.S. pivotal studyof RenalGuard, as well as our ability to successfully market RenalGuard in theEU and gain widespread market adoption for our system as a CIN preventiondevice, is largely dependent on the CCM study results, specifically a favorablefinding that RenalGuard is equivalent to overnight hydration in terms of safelypreventing CIN in the at-risk patients studied.

 

                We can provide no assurance that the CCM study willbe completed in a timely fashion, if at all, or that should it be completedthat it will produce the desired result of showing that RenalGuard isequivalent to overnight hydration in the study population. If the study showsthat RenalGuard is not at least equivalent to overnight hydration in terms ofits safety or effectiveness in preventing CIN, then our ability to raiseadditional capital in the future to complete our U.S. pivotal trial, fund ouroperations and implement our business plan will be materially and adverselyaffected.

 

                ***Ourplanned U.S. pivotal clinical trial of RenalGuard will, if we can successfullyraise the necessary capital to commence and complete it, take us a significantamount of time to complete, if we can complete it at all, and the results ofthis clinical trial may not show sufficient safety and efficacy for us toeither obtain FDA approval or otherwise be able to successfully market and sellthe product.***

 

***               ***Our business strategy to grow our revenues andprofitability is largely dependent upon our success in the timely completion ofour U.S. pivotal clinical trial of RenalGuard. We hope to be able todemonstrate through this clinical trial that RenalGuard is safe and effectivein preventing CIN.

 

 

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                We can provide no assurance thatwhen studied in humans, RenalGuard will be shown to be safe or effective inpreventing CIN, or that the degree of any positive safety and efficacy resultswill be sufficient to either obtain FDA approval or otherwise successfullymarket our product. Furthermore, the completion of our planned clinical trialis dependent upon many factors, some of which are not entirely within ourcontrol, including, but not limited to, our ability to successfully recruitinvestigators, the availability of patients meeting the inclusion criteria ofour clinical study, the competition for these particular study patients amongstother clinical trials being conducted by other companies at these same studysites, the ability of the sites participating in our study to successfullyenroll patients in our trial, and proper data gathering on the part of theinvestigating sites.

 

                Should our U.S. pivotal clinicaltrial take longer than we expect to complete, our competitive position relativeto existing preventative measures, or relative to new devices, drugs ortherapies that may be developed, could be seriously harmed and our ability tosuccessfully fund the completion of the trial and bring RenalGuard to marketmay be adversely affected.

 

***                We will need to build a directsales and marketing organization or otherwise enter into distributionarrangements in order to market RenalGuard in the U.S, if and when it isapproved for sale, and in the EU, as we prepare for a sales launch in thismarket in 2009.***

 

***               ***We currently donot have a direct sales force. Instead, we market our TMR products throughNovadaq in the U.S. and through independent distributors outside the U.S.  We do not plan to use Novadaq or our currentinternational TMR distributors to market RenalGuard if and when it becomescommercially available. We will need to either build an internal direct salesand marketing organization or find new distribution partners to successfullymarket RenalGuard.

 

                If we choose to build a directsales force, we may not be able to attract qualified individuals with therequisite training or experience to sell our product. In addition, we wouldneed to devote substantial management time instituting policies, procedures andcontrols to oversee and effectively manage this new part of our organization,which could adversely impact our daily operations and would require us toinvest significant financial resources, the cost of which could be prohibitive.

 

                If we instead choose to pursuean indirect distribution strategy, which is our current plan for the EU market,we may not be able to identify suitable distribution partners with sufficientindustry experience, brand recognition, sales capacity and willingness orability to maximize sales. Further, we may not be able to negotiatedistribution agreements with terms and conditions that are acceptable to us,including ensuring that our product receives adequate sales force focus andattention.

 

***                Rapid technological changes inour industry could make our products obsolete.***

 

                Our industry is characterized byrapid technological change and intense competition.  New technologies and products and newindustry standards will develop at a rapid pace, which could make our currentand future planned products obsolete. The advent of new devices and proceduresand advances in new drugs and genetic engineering are especially concerningcompetitive threats.  Our future successwill depend upon our ability to develop and introduce product enhancements toaddress the needs of our customers.  Material delays in introducing productenhancements may cause customers to forego purchases of our products andpurchase those of our competitors.

 

 

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                Many potential competitors havesubstantially greater financial resources and are in a better financialposition to exploit marketing and research and development opportunities.

 

***We must receiveand maintain government clearances or approvals in order to market ourproducts.***

 

                Our products and our manufacturingactivities are subject to extensive, rigorous and changing federal and stateregulation in the U.S. and to similar regulatory requirements in other majorinternational markets, including the EU and Japan.  These regulations and regulatory requirementsare broad in scope and govern, among other things:

 

·                  product design anddevelopment;

 

·                  product testing;

 

·                  product labeling;

 

·                  product storage;

 

·                  premarket clearance andapproval;

 

·                  advertising and promotion;and

 

·                  product sales anddistribution.

 

                Furthermore, regulatoryauthorities subject a marketed product, its manufacturer and the manufacturingfacilities to continual review and periodic inspections.  We are subject to ongoing FDA requirements,including required submissions of safety and other post-market information andreports, registration requirements, Quality Systems regulations andrecordkeeping requirements. The FDA’s Quality Systems regulations includerequirements relating to quality control and quality assurance, as well as thecorresponding maintenance of records and documentation.  Depending on its activities, Novadaq may alsobe subject to certain requirements under the Federal Food, Drug, and CosmeticAct and the regulations promulgated thereunder, and state laws and registrationrequirements covering the distribution of our products. Regulatory agencies maychange existing requirements or adopt new requirements or policies that couldaffect our regulatory responsibilities or the regulatory responsibilities of adistributor like Novadaq.  We may be slowto adapt or may not be able to adapt to these changes or new requirements.

 

                Later discovery of previouslyunknown problems with our products, manufacturing processes or our failure tocomply with applicable regulatory requirements may result in enforcementactions by the FDA and other international regulatory authorities, including,but not limited to:

 

·                  warning letters;

 

·                  patient or physiciannotification;

 

 

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·                  restrictions on our productsor manufacturing processes;

 

·                  voluntary or mandatoryrecalls;

 

·                  product seizures;

 

·                  refusal to approve pendingapplications or supplements to approved applications that we submit;

 

·                  refusal to permit the importor export of our products;

 

·                  fines;

 

·                  injunctions;

 

·                  suspension or withdrawal ofmarketing approvals or clearances; and

 

·                  civil and criminal penalties.

 

                Should any of these enforcementactions occur, our business, financial condition and results of operationscould be materially and adversely affected.

 

Todate, we have received the following regulatory approvals for our products:

 

***                HeartLaser Systems***

 

*                UnitedStates —*We received FDA approval to market the HL1 HeartLaser System in August 1998 and the HL2 Heart Laser System in January 2001.  However, although we have received FDAapproval, the FDA:

 

·                  has restricted the use ofthe Heart Laser Systems by not allowing us to market these products to treatpatients whose condition is amenable to conventional treatments, such as heartbypass surgery, stenting and angioplasty; and

 

·                  could impose additionalrestrictions or reverse its ruling and prohibit use of the Heart Laser Systemsat any time.

 

Inaddition, as a condition of our original FDA approval for our TMR products, wewere required by the FDA to perform a postmarket surveillance study. The FDArequested that we submit a PMA Postapproval Study report summarizing thispostmarket surveillance study. As part of this report, the FDA requested thatwe analyze and discuss the adverse event and mortality rates seen in thepostmarket study and compare these results to the premarket study which waspresented as part of our initial FDA PMA application. We filed thispostapproval study report with the FDA on February 28, 2007.

 

Becauseof the significant safety information collected in the postapproval study, andas the FDA has indicated it plans to do in other product areas, we believe thatthe FDA plans to present the results at a future meeting of the FDA CirculatorySystem Devices Advisory Panel and thereafter determine what, if any, actionsshould be taken with respect to our current Heart Laser Systems PMA.

 

 

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*                Europe—*We received the CE Mark from the European Union for the HL1 and HL2 in March 1995and February 2001, respectively. However:

 

·                  the European Union could impose additionalrestrictions or reverse its ruling and prohibit use of the Heart Laser Systemsat any time; and

 

·                  France has prohibited, and other EuropeanUnion countries could prohibit or restrict, use of the Heart Laser Systems.

 

*                Japan —*Our HL1 Heart Laser System received marketing approval from theJapanese Ministry of Health, Labor and Welfare (“MHLW”) in May 2006.However, the MHLW could impose restrictions in the future or reverse its rulingand prohibit use of the Heart Laser Systems at any time.

 

                In addition, it is unclear whatimpact the introduction of the HL2 into the U.S. and other internationalmarkets will have on the ability of our Japanese distributor to market ourolder, first generation HL1 in Japan. Although our Japanese distributor hasindicated to us that it plans to seek MHLW approval in the future to market ournewer HL2, we can provide no assurance that the distributor will be successfulin obtaining the necessary approvals or how long it may take to secure the requiredapprovals.

 

***                RenalGuard***

 

***               ***We presentlyhave approval to market RenalGuard only in the EU. We must receive either FDAapproval or clearance before we can market RenalGuard in the United States.Other countries may require their own approvals prior to our being able tomarket RenalGuard in those countries.

 

                The process of obtaining andmaintaining regulatory approvals and clearances to market a medical device canbe costly and time consuming, and we cannot predict when, if ever, suchapprovals or clearances will be granted. Pursuant to FDA regulations, unless anexemption is available, the FDA permits commercial distribution of a newmedical device only after the device has received 510(k) clearance or isthe subject of an approved PMA application. The FDA will clear marketing of amedical device through the 510(k) process only if it is demonstrated thatthe new product is substantially equivalent to other 510(k)-cleared products.

 

                At the present time we are notaware of any clear predicates with substantially the same proposed indicationsfor use that would enable us to conclude that RenalGuard is likely to becleared by the FDA as a 510(k) device. Therefore, we believe RenalGuardmost likely will need to go through the PMA application process.

 

                Because the PMA applicationprocess is more costly, lengthy and uncertain than the 510(k) process andmust be supported by extensive data, including data from preclinical studiesand human clinical trials, we cannot predict when RenalGuard may eventuallycome to market in the U.S. Should we be unable to obtain FDA approval forRenalGuard, or should the approval process take longer than we anticipate, ourfuture revenue growth prospects will be materially and adversely affected.

 

 

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***                Changesin third party reimbursement for TMR procedures or our inability to obtainthird party reimbursement for RenalGuard could materially affect future demandfor our products.***

 

                Demand for medical devices isoften affected by whether third party reimbursement is available for thedevices and related procedures. Currently Medicare coverage is provided for TMR when it is performed asa sole therapy treatment.  In addition,when two or more medical procedures are performed in combination with eachother, Medicare rules generally allow hospitals to bill for whichever ofthe two procedures carries the higher reimbursement amount. Therefore, insituations where sole therapy TMR reimbursement rates exceed that provided forbypass surgery alone, if hospitals perform a combination procedure where bothbypass surgery and adjunctive TMR are performed on a patient, the hospital isable to bill for the higher TMR procedure reimbursement payment. In theseinstances, the doctor also can bill an additional amount for performingmultiple procedures.

 

Certain private insurance companies and healthmaintenance organizations also currently provide reimbursement for TMRprocedures performed with our products and physician reimbursement codes have been established forboth surgical procedures.

 

                No assurance can be given,however, that these payers will continue to reimburse healthcare providers whoperform TMR procedures using our products now or in the future.  Further, no assurance can be given that additionalpayers will reimburse healthcare providers who perform TMR procedures using ourproducts or that reimbursement, if provided, will be timely or adequate.

 

                Should third party insurancereimbursement for TMR procedures be reduced or eliminated in the future, ourbusiness, financial condition and results of operations would be materially andadversely affected.

 

                Furthermore, we know of noexisting Medicare coverage or other third party reimbursement that would beavailable to either hospitals or physicians that would help defray theadditional cost that would result from the future purchase and/or use of ourRenalGuard System. We also can provide no assurance that we will ever be ableto obtain Medicare coverage or other third party reimbursement for the use ofRenalGuard, which could materially and adversely affect the potential futuredemand for this product.

 

                In addition, the market for ourall our products could be adversely affected by future legislation to reformthe nation’s healthcare system or by changes in industry practices regardingreimbursement policies and procedures.

 

***                Securingintellectual property rights for RenalGuard is critical to our future businessplans, but may prove to be difficult or impossible for us to obtain.***

 

***               ***We have filednine patent applications with the U.S. patent office related to RenalGuard andother intellectual property in the general field of preventing contrast-inducednephropathy and acute renal failure. Securing patent protection over ourintellectual property ideas in this field is, we believe, critical to our plansto successfully differentiate and market RenalGuard and grow 

 

 

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ourfuture revenues. We can provide no assurance, however, that we will be successfulin securing any patent protection for our intellectual property ideas in thisfield or that our efforts to obtain patent protection will not prove moredifficult, and therefore more costly, than we are otherwise expecting.Furthermore, even if we are successful in securing patent protection for someor all of our intellectual property ideas in this field, we cannot predict whenin the future any such potential patents may be issued, how strong such patentprotection will prove to be, or whether these patents will be issued in atimely enough fashion to afford us any commercially meaningful advantage inmarketing RenalGuard against other potentially competitive devices.

 

***Asserting anddefending intellectual property rights may impact our results of operations.***

 

                In our industry, competitorsoften assert intellectual property infringement claims against oneanother.  The success of our businessdepends on our ability to successfully defend our intellectual property.  Future litigation may have a material impacton our financial condition even if we are successful in marketing our products.We may not be successful in defending or asserting our intellectual propertyrights.

 

                An adverse outcome in anylitigation or interference proceeding could subject us to significantliabilities to third parties and require us to cease using the technology thatis at issue or to license the technology from third parties.  In addition, a finding that any of ourintellectual property is invalid could allow our competitors to more easily andcost-effectively compete with us.  Thus,an unfavorable outcome in any patent litigation or interference proceedingcould have a material adverse effect on our business, financial condition orresults of operations.

 

                The cost to us of any patentlitigation or interference proceeding could be substantial.  Uncertainties resulting from the initiationand continuation of patent litigation or interference proceedings could have amaterial adverse effect on our ability to compete in the marketplace.  Patent litigation and interferenceproceedings may also absorb significant management time.

 

***                Wemay be subject to product liability lawsuits; our insurance may not besufficient to cover damages.***

 

                We may be subject to productliability claims.  Such claims may absorbsignificant management time and could degrade our reputation and themarketability of our products.  Ifproduct liability claims are made with respect to our products, we may need torecall the implicated product, which could have a material adverse effect onour business, financial condition and results of operations. In addition,although we maintain product liability insurance, we cannot be sure that ourinsurance will be adequate to cover potential product liability lawsuits. Our insuranceis expensive and in the future may not be available on acceptable terms, if atall. If a successful product liability claim or series of claims exceeds ourinsurance coverage, it could have a material adverse effect on our business,financial condition and results of operations.

 

***                Weare subject to risks associated with international operations.***

 

                A portion of our product salesis generated from operations outside of the U.S.  Establishing, maintaining and expandinginternational sales can be expensive. Managing and overseeing foreign operations are difficult and productsmay not receive market acceptance.  Risksof doing business outside the U.S. include, but are not limited to, thefollowing: 

 

 

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agreementsmay be difficult to enforce and receivables difficult to collect through aforeign country’s legal system; foreign customers may have longer paymentcycles; foreign countries may impose additional withholding taxes or otherwisetax our foreign income, impose tariffs or adopt other restrictions on foreigntrade; U.S. export licenses may be difficult to obtain; and the protection ofintellectual property rights in foreign countries may be more difficult toenforce.  There can be no assurance that ourinternational business will grow or that any of the foregoing risks will notresult in a material adverse effect on our business or results of operations.

 

***               ******Because we are incorporated in Canada, you may not beable to enforce judgments against us and our Canadian directors.***

 

                Under Canadian law, you may notbe able to enforce a judgment issued by courts in the U.S. against us or ourCanadian directors. The status of the law in Canada is unclear as to whether aU.S. citizen can enforce a judgment from a U.S. court in Canada for violationsof U.S. securities laws. A separate suit may need to be brought directly inCanada.

 

***                Our stock price has historicallyfluctuated and may continue to fluctuate significantly in the future which mayresult in losses for our investors.***

 

***               ***Our stock pricehas been and may continue to be volatile. Some of the factors that may affectour stock price are:

 

·                  delisting of our common stock from the AMEX;

 

·                  announcements relating to the global creditmarkets or our ability as a company to raise additional capital;

 

·                  the status of our clinical trials forRenalGuard;

 

·                  the announcement of new products, services ortechnological innovations by us or our competitors;

 

·                  actual or anticipated quarterly increases ordecreases in revenue, gross margin or earnings, and changes in our business,operations or prospects;

 

·                  speculation or actual news announcements inthe media or industry trade journals about our company, our products, the TMRor CIN prevention procedures or changes in reimbursement policies by Medicareand/or private insurance companies;

 

·                  announcements relating to strategicrelationships or mergers;

 

·                  conditions or trends in the medical deviceindustry;

 

·                  changes in the economic performance or marketvaluations of other medical device companies; and

 

·                  general market conditions or domestic orinternational macroeconomic and geopolitical factors unrelated to ourperformance.

 

 

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***                The market price of our stockmay fall if shareholders sell their stock.***

 

                Certain current shareholdershold large amounts of our stock, which they could seek to sell in the publicmarket from time to time.  Sales of asubstantial number of shares of our common stock within a short period of time wouldcause our stock price to fall.  Inaddition, the sale of these shares could impair our ability to raise capitalthrough the sale of additional stock.

 

**Item 4.            Submissionof Matters to a Vote of Security Holders**

 

On June 18, 2008,the Company held its 2008 Annual Meeting of Shareholders (the “ShareholdersMeeting”).  At the Shareholders Meeting, the following matters wereapproved by the vote specified below:

 

1.                                       Kevin J. Dunn and Brent Norton wereelected as Class III directors and will hold office until the annualmeeting of shareholders in 2011 or until their successors are duly elected andqualified.  Mr. Dunn received 26,978,988 shares of common stockvoting in favor of his election and 962,517 shares of common stock werewithheld.  Dr. Norton received 26,859,167 shares of common stockvoting in favor of his election and 1,082,338 shares of common stock werewithheld.  The terms of Edward H. Pendergast, Mark R. Tauscher, Robert I.Rudko, Benjamin L. Holmes and Alan H. Magazine continued after the ShareholdersMeeting.

 

2.                                       An amendment was approved increasing thenumber of shares of common stock authorized for issuance under the Company’s2005 Stock Incentive Plan.  The voteswere cast as follows: 12,415,963 shares of common stock were voted for the approval,1,545,434 shares of common stock were voted against the approval, 180,620shares of common stock abstained from the vote, and 13,799,488 shares of commonstock were broker non-votes.

 

3.                                       The selection of Vitale, Caturano &Company, Ltd. as the Company’s registered public accounting firm for the fiscalyear ending December 31, 2008 and the authorization of the Audit Committeeof the Board of Directors to fix the remuneration to be paid to the auditorswere approved.  The votes were cast as follows: 27,592,827 shares ofcommon stock were voted for the approval, 211,969 shares of common stock werevoted against the approval and 136,709 shares of common stock abstained fromthe vote.

 

 

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**Item 6.            Exhibits**

 
| 10.1   | 2005  Stock Incentive Plan, as amended, incorporated by reference to the  Registrant’s current report on Form 8-K filed with the Securities and  Exchange Commission on June 23, 2008.                                                                                                                                        |   |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                                                                                                                                                                                                                                         |   |
| 10.2   | Form of  Stock Option Grant Letter for Employees of the Registrant under the  Registrant’s 2005 Stock Incentive Plan used beginning June 18, 2008,  incorporated by reference to the Registrant’s current report on Form 8-K  filed with the Securities and Exchange Commission on June 23, 2008.              |   |
|   |                                                                                                                                                                                                                                                                                                                                         |   |
| 10.3   | Form of  Stock Option Grant Letter for Non-Employee Directors of the Registrant under  the Registrant’s 2005 Stock Incentive Plan used beginning June 18, 2008,  incorporated by reference to the Registrant’s current report on Form 8-K  filed with the Securities and Exchange Commission on June 23, 2008. |   |
|   |                                                                                                                                                                                                                                                                                                                                         |   |
| 31.1   | Certification  of Principal Executive Officer pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                    |   |
|   |                                                                                                                                                                                                                                                                                                                                         |   |
| 31.2   | Certification  of Principal Financial Officer pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                    |   |
|   |                                                                                                                                                                                                                                                                                                                                         |   |
| 32.1   | Certifications  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                         |   |

 

 

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**SIGNATURES**

 

                Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                             | PLC SYSTEMS INC. |
|----------------------------------|------------------|
|                             |             |
|                             |             |
| Date:  August 14, 2008 | By:              | /s/  James G. Thomasch |
|                             |             | James  G. Thomasch |
|                             |             | Chief  Financial Officer |
|                             |             | (Principal  Financial Officer and Chief |
|                             |             | Accounting  Officer) |
|                             |             |   |
|                             |             |   |

 

 

 

 

 

 

 

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**EXHIBIT INDEX**

 
| **Exhibit**Number | ** ** | ****Description of Document                                                                                                                                                                                                                                                                                                                  | ** ** |
|-------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|              |       |                                                                                                                                                                                                                                                                                                                                         |       |
| 10.1              |       | 2005  Stock Incentive Plan, as amended, incorporated by reference to the Registrant’s  current report on Form 8-K filed with the Securities and Exchange  Commission on June 23, 2008.                                                                                                                                        |       |
|              |       |                                                                                                                                                                                                                                                                                                                                         |       |
| 10.2              |       | Form of  Stock Option Grant Letter for Employees of the Registrant under the  Registrant’s 2005 Stock Incentive Plan used beginning June 18, 2008,  incorporated by reference to the Registrant’s current report on Form 8-K  filed with the Securities and Exchange Commission on June 23, 2008.              |       |
|              |       |                                                                                                                                                                                                                                                                                                                                         |       |
| 10.3              |       | Form of  Stock Option Grant Letter for Non-Employee Directors of the Registrant under  the Registrant’s 2005 Stock Incentive Plan used beginning June 18, 2008,  incorporated by reference to the Registrant’s current report on Form 8-K  filed with the Securities and Exchange Commission on June 23, 2008. |       |
|              |       |                                                                                                                                                                                                                                                                                                                                         |       |
| 31.1              |       | Certification  of Principal Executive Officer pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                    |       |
|              |       |                                                                                                                                                                                                                                                                                                                                         |       |
| 31.2              |       | Certification  of Principal Financial Officer pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                    |       |
|              |       |                                                                                                                                                                                                                                                                                                                                         |       |
| 32.1              |       | Certifications  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                         |       |

 

 

 

 

 

 

 

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