Table of Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**FORM 10-Q**

 

**x****                             ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934.**

 

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

 

**OR**

 

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934.**

 

**For the transition period from                                 to                                      **

 

**CommissionFile Number: 1-11388**

 

**PLC SYSTEMS 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 November 12, 2008** |
|-----------------------------|------------|-------------------------------------------|
| Common Stock, no  par value |       | 30,331,935                                |

 

 

 

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**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                                                                                | 23     |
|          |                   |                                                                                        |   |
|          | Item 6.                | Exhibits                                                                                    | 34     |
|               |                        |                                                                                             |        |  |

 

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**Part I.         Financial Information**

 

**Item 1.        FinancialStatements**

 

**PLCSYSTEMS INC.**

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

| ** **                                                                                                                                                                         | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                         | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                    |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                         |       | $                            | 5,537      |                        | $          | 8,060 |   |
| Accounts  receivable, net of allowance of $36 and $23 at September 30, 2008 and  December 31, 2007, respectively                                                         |       | 874                          |       | 998                         |       |
| Inventories, net                                                                                                                                                                   |       | 1,144                        |       | 852                         |       |
| Prepaid expenses  and other current assets                                                                                                                                         |       | 567                          |       | 823                         |       |
| Total current  assets                                                                                                                                                              |       | 8,122                        |       | 10,733                      |       |
| Equipment,  furniture and leasehold improvements, net                                                                                                                              |       | 187                          |       | 269                         |       |
| Other assets                                                                                                                                                                       |       | 193                          |       | 198                         |       |
| Total assets                                                                                                                                                                       |       | $                            | 8,502      |                        | $          | 11,200 |   |
| ** **                                                                                                                                                                         |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                      |       |                         |       |                        |       |
| Current  liabilities:                                                                                                                                                              |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                   |       | $                            | 323        |                        | $          | 623 |   |
| Accrued  compensation                                                                                                                                                              |       | 614                          |       | 766                         |       |
| Accrued other                                                                                                                                                                      |       | 186                          |       | 326                         |       |
| Deferred revenue                                                                                                                                                                   |       | 2,380                        |       | 2,096                       |       |
| Total current  liabilities                                                                                                                                                         |       | 3,503                        |       | 3,811                       |       |
| Deferred revenue                                                                                                                                                                   |       | 1,621                        |       | 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 September 30, 2008 and December 31, 2007,  respectively |       | 93,892                       |       | 93,891                      |       |
| Additional paid  in capital                                                                                                                                                        |       | 421                          |       | 270                         |       |
| Accumulated  deficit                                                                                                                                                               |       | (90,616                      | )          | (88,898                     | )          |
| Accumulated  other comprehensive loss                                                                                                                                              |       | (319                         | )          | (313                        | )          |
| Total  stockholders’ equity                                                                                                                                                   |       | 3,378                        |       | 4,950                       |       |
| Total  liabilities and stockholders’ equity                                                                                                                                   |       | $                            | 8,502      |                        | $          | 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  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues:                             |       |                                                 |       |                                                |       |   |   |   |   |
| Product sales                         |       | $                                                    | 1,203      |                                                | $          | 975 |   | $ | 3,041 |   | $ | 3,629 |   |
| Service fees                          |       | 395                                                  |       | 356                                                 |       | 1,035 |   | 1,127 |   |
| Total revenues                        |       | 1,598                                                |       | 1,331                                               |       | 4,076 |   | 4,756 |   |
| Cost of  revenues:                    |       |                                                 |       |                                                |       |   |   |   |   |
| Product sales                         |       | 647                                                  |       | 258                                                 |       | 1,290 |   | 1,406 |   |
| Service fees                          |       | 182                                                  |       | 210                                                 |       | 517 |   | 631 |   |
| Total cost of  revenues               |       | 829                                                  |       | 468                                                 |       | 1,807 |   | 2,037 |   |
| Gross profit                          |       | 769                                                  |       | 863                                                 |       | 2,269 |   | 2,719 |   |
| Operating  expenses:                  |       |                                                 |       |                                                |       |   |   |   |   |
| Selling, general  and administrative  |       | 619                                                  |       | 830                                                 |       | 2,420 |   | 2,919 |   |
| Research and  development             |       | 516                                                  |       | 637                                                 |       | 1,726 |   | 1,684 |   |
| Total operating  expenses             |       | 1,135                                                |       | 1,467                                               |       | 4,146 |   | 4,603 |   |
| Loss from  operations                 |       | (366                                                 | )          | (604                                                | )          | (1,877 | ) | (1,884 | ) |
| Other income,  net                    |       | 11                                                   |       | 105                                                 |       | 89 |   | 336 |   |
| Loss before  taxes                    |       | (355                                                 | )          | (499                                                | )          | (1,788 | ) | (1,548 | ) |
| Benefit from  income taxes            |       | (70                                                  | )          | —                                              |       | (70 | ) | — |   |
| Net loss                              |       | $                                                    | (285       | )                                                   | $          | (499 | ) | $ | (1,718 | ) | $ | (1,548 | ) |
| Basic and  diluted loss per share     |       | $                                                    | (0.01      | )                                                   | $          | (0.02 | ) | $ | (0.06 | ) | $ | (0.05 | ) |
| Weighted average  shares outstanding: |       |                                                 |       |                                                |       |   |   |   |   |
| Basic and  diluted                    |       | 30,332                                               |       | 30,323                                              |       | 30,331 |   | 30,315 |   |

 

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

 

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**PLC SYSTEMS INC.**

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 
| ** **                                                                                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Operating  activities:                                                                      |       |                                                |       |   |   |
| Net loss                                                                                    |       | $                                                   | (1,718     | ) | $ | (1,548 | ) |
|                                                                                        |       |                                                |       |   |   |
| Adjustments to  reconcile net loss to net cash provided by (used for) operating activities: |       |                                                |       |   |   |
| Depreciation and  amortization                                                              |       | 79                                                  |       | 75 |   |
| Compensation  expense from stock options                                                    |       | 151                                                 |       | 119 |   |
| Loss on retirement  of equipment                                                            |       | 35                                                  |       | — |   |
| Change in assets  and liabilities:                                                          |       |                                                |       |   |   |
| Accounts  receivable                                                                        |       | 124                                                 |       | (300 | ) |
| Inventory                                                                                   |       | (292                                                | )          | 400 |   |
| Prepaid expenses  and other assets                                                          |       | 256                                                 |       | (123 | ) |
| Accounts payable                                                                            |       | (300                                                | )          | 15 |   |
| Deferred revenue                                                                            |       | (533                                                | )          | (172 | ) |
| Accrued  liabilities                                                                        |       | (292                                                | )          | 343 |   |
| Net cash used  for operating activities                                                     |       | (2,490                                              | )          | (1,191 | ) |
|                                                                                        |       |                                                |       |   |   |
| Investing  activities:                                                                      |       |                                                |       |   |   |
| Maturity of  investments                                                                    |       | —                                              |       | 4,000 |   |
| Purchase of  equipment                                                                      |       | (27                                                 | )          | (153 | ) |
| Net cash  provided by (used for) investing activities                                       |       | (27                                                 | )          | 3,847 |   |
|                                                                                        |       |                                                |       |   |   |
| Financing  Activities:                                                                      |       |                                                |       |   |   |
| Net proceeds  from issuance of common stock                                                 |       | 1                                                   |       | 1 |   |
| Net proceeds  from exercise of stock options                                                |       | —                                              |       | 6 |   |
|                                                                                        |       | 1                                                   |       | 7 |   |
|                                                                                        |       |                                                |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                               |       | (7                                                  | )          | 15 |   |
| Net increase  (decrease) in cash and cash equivalents                                       |       | (2,523                                              | )          | 2,678 |   |
| Cash and cash  equivalents at beginning of period                                           |       | 8,060                                               |       | 6,034 |   |
| Cash and cash  equivalents at end of period                                                 |       | $                                                   | 5,537      |   | $ | 8,712 |   |

 

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

 

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**PLCSYSTEMS INC.**

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30,2008

 

***1.******            ******Business***

 

PLC Systems Inc. (“PLC” or the “Company”) isa medical device company specializing in innovative technologies for thecardiac and vascular markets.  TheCompany pioneered and manufactures the *CO**2** HeartLaser System* (the “Heart Laser System”) that cardiacsurgeons use to perform carbon dioxide (CO2)transmyocardial revascularization, or TMR, to alleviate symptoms of severeangina.  The Company also manufactures *CO**2* surgical laser tubes and provides contractassembly services on general purpose *CO**2*lasers, which it sells to a singlecustomer on an original equipment manufacturer (“OEM”) basis.

 

In addition, the Company has begun initialcommercialization in the European Union (“EU”) of its newest product,RenalGuardTM. RenalGuardis designed to reduce the potentially toxic effects that contrast media canhave on the kidneys when it is administered to patients during certain medicalimaging procedures. It is believed that allowing contrast media to dwell in thekidneys can lead to contrast-induced nephropathy (“CIN”), a potentially deadlyform of acute kidney injury. By inducing and maintaining a high urine flow ratebefore, during and after these medical imaging procedures, the Company believesthe incidence rates of CIN in at-risk patients can be reduced. RenalGuardfacilitates this increased urine clearance, enabling the body to more rapidlyvoid the contrast media, thereby reducing its overall resident time and toxiceffects in the kidney.

 

The Company received full U.S. Food and DrugAdministration (“FDA”) approval to conduct its first human clinical trialutilizing RenalGuard under an investigational device exemption (“IDE”). Thispilot clinical trial was designed to evaluate the safety of RenalGuard and itsability to accurately measure and balance fluid inputs and outputs on patientsundergoing a catheterization imaging procedure where contrast media would beadministered.  In February 2008, theCompany submitted an IDE supplement to the FDA seeking approval to move from itspilot study to a pivotal clinical trial to study the safety and effectivenessof RenalGuard in the prevention of CIN. In March 2008, the FDA granted theCompany conditional approval to begin this pivotal study. The Company is alsosupporting an investigator-sponsored randomized controlled trial utilizingRenalGuard that is being conducted in Milan, Italy; it is designed to determinethe effectiveness of RenalGuard in preventing CIN in at-risk patients. TheCompany announced in July 2008 that it will delay the start of the U.S.pivotal trial until such time as it can obtain data from the clinical trial inItaly that it hopes will enable it to raise sufficient additional capitalnecessary to both start and complete the U.S. study.

 

RenalGuard is currently approved for sale inthe EU as a general fluid balancing device. The RenalGuard System consists of aproprietary, closed loop, software-controlled console and accompanyingsingle-use sets that can be used by physicians and nurses to manage patientfluid levels. RenalGuard operates by first collecting and measuring patienturine outputs and then in real-time precisely matches these urine outputs witha prescribed replacement fluid by means of intravenous infusion. With itsautomated matched fluid replacement capability, RenalGuard is intended tominimize the risk to patients of over- or under-hydration while alsoeliminating to a large degree what can otherwise be an intensive and timeconsuming manual fluid balancing task for physicians and nurses.

 

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The Company is establishing a distributionnetwork in the EU with the intent to market RenalGuard for general balancing applicationsutilizing the device.

 

On March 20, 2007, the Company enteredinto a distribution agreement with Novadaq Corp. (“Novadaq”), a subsidiary ofNovadaq Technologies Inc., pursuant to which the Company appointed Novadaq asits exclusive distributor in the United States for its TMR business.  The agreement amended and restated theexclusive distribution agreement between the Company and Edwards LifesciencesLLC (“Edwards”), which had been assigned by Edwards to Novadaq on the samedate.  The agreement with Novadaqreflects substantially the same roles, responsibilities and financial terms asthe 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 nine months ended September 30, 2008 are not necessarily indicative of the results that maybe expected for the year ending December 31, 2008.  These financial statements should be read inconjunction with the consolidated financial statements and footnotes theretoincluded in the Company’s Annual Report on Form 10-K for the year ended December 31,2007.

 

Thepreparation of financial statements in accordance with generally acceptedaccounting principles requires the Company to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements, andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

***3.            New Accounting Pronouncements***

 

InSeptember 2006, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 157, “Fair ValueMeasurements” (“SFAS No. 157”), which defines fair value, establishesguidelines for measuring fair value and expands disclosures regarding fairvalue measurements. SFAS No. 157 does not require any new fair valuemeasurements but rather eliminates inconsistencies in guidance found in variousprior accounting pronouncements. SFAS No. 157 is effective for fiscalyears beginning after November 15, 2007. Earlier adoption is permitted,provided the company has not yet issued financial statements, including forinterim periods, for that fiscal year. The FASB has agreed to defer the effective date of SFAS No. 157 forall nonfinancial assets and liabilities, except those that are recognized ordisclosed at fair value in the financial statements on a recurring basis, foroneyear.

 

On October 3, 2008 theFASB proposed FASB Staff Position (“FSP”) 157-d which would amend SFAS No. 157,to clarify its application in an inactive market by providing an illustrativeexample to demonstrate how the fair value of a financial asset is determinedwhen the market for that financial asset is inactive.  This FSP shall be effective upon issuance,including prior periods

 

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for which financialstatements have not been issued.

 

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value 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 the lower of cost (computed on a first-in,first-out method) or market value and include allocations of labor andoverhead.  As of September 30, 2008and December 31, 2007, inventories consisted of the following (inthousands):

 
| ** **       | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials    |       | $                            | 715        |                        | $          | 560 |   |
| Work in progress |       | 210                          |       | 151                         |       |
| Finished goods   |       | 219                          |       | 141                         |       |
|             |       | $                            | 1,144      |                        | $          | 852 |   |

 

At September 30, 2008 and December 31, 2007, inventories arestated net of a specific obsolescence allowance of $791,000 and $524,000,respectively.

 

***5.******             Stock-BasedCompensation***

 

*StockOption Plans*

 

InMay 2005, the Company’s shareholders approved the 2005 Stock IncentivePlan (the “2005 Plan”).  The 2005 Planhas replaced the 1997 Executive Stock Option Plan, 2000 Equity Incentive Plan,2000 Non-Statutory Stock Option Plan and 2000 Non-Qualified Performance andRetention Equity Plan (collectively, the “Previous Plans”), under which nofurther awards can be granted.

 

OnJune 18, 2008, the Company’s shareholders approved an amendment increasingthe number of shares of common stock authorized for issuance under the 2005Plan by an additional 2,000,000 shares. The number of stock options that may be granted under the 2005 Plan isequal to 4,156,175 shares of common stock (subject to adjustment in the eventof stock splits and other similar events), plus such number of shares as maybecome available under the Previous Plans after the date of the adoption of the2005 Plan because any award previously granted under any such plan expires oris terminated, surrendered or cancelled without having been fully exercised or isforfeited 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 upon

 

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grant,or ratably over one to four years from the date of grant, and expire ten yearsfrom the date of grant.  Under the 2005Plan, the per share exercise price of incentive stock options may not be lessthan the fair market value of the common stock on the date the option isgranted.  The 2005 Plan provides that theCompany may not grant non-qualified stock options at an exercise price lessthan 85% of the fair market value of the Company’s common stock.

 

TheCompany grants stock options to its non-employee directors. Generally, newnon-employee directors receive an initial grant of an option to purchase 30,000shares of the Company’s common stock that vests in installments over threeyears.  Once the initial grant has fullyvested, non-employee directors (other than the Chairman of the Board) receivean annual grant of an option to purchase 15,000 shares of the Company’s commonstock that generally vests in four equal quarterly installments. The Chairmanof the Board receives an annual grant of an option to purchase 30,000 shares ofthe Company’s common stock that generally vests in four equal quarterlyinstallments. All such options have an exercise price equal to the fair marketvalue of the Company’s common stock on the date of grant.

 

Optionsgranted during 2008 and 2007 vest ratably annually over a three year period foremployees and ratably quarterly over a one year period for non-employeedirectors.

 

The following is a summary of option activity underall plans (in thousands, except per 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                             |       | (68                     | )          | 0.58                                   |       |                                                   |       |
| Expired                               |       | (278                    | )          | 5.22                                   |       |                                                   |       |
| Outstanding,  September 30, 2008 |       | 5,501                   |       | $                                      | 0.71       |                                                   | 5.90       |   |
| Exercisable,  September 30, 2008 |       | 4,494                   |       | $                                      | 0.73       |                                                   | 4.93       |   |

 

The following table summarizes unvested optionactivity during the nine months ended September 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                             |       | (386                                             | )          | 0.45                                                    |       |
| Forfeited                          |       | (51                                              | )          | 0.40                                                    |       |
| Unvested,  September 30, 2008 |       | 1,007                                            |       | $                                                       | 0.36       |   |

 

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*SFAS No. 123(R)*

 

TheCompany records share-based compensation pursuant to SFAS No. 123 (revised2004), “Share-based Payment”.  TheCompany recorded compensation expense of $54,000 and $151,000 in the three andnine months ended September 30, 2008, respectively, as compared to $49,000and $119,000 in the three and nine months ended September 30, 2007,respectively.  As of September 30,2008, the Company had $289,000 of total unrecognized compensation cost relatedto its unvested options, which is expected to be recognized over a weightedaverage period of 1.7 years.

 

Theweighted average fair value of options issued during the nine months ended September 30,2008 was estimated using the Black-Scholes model.

 
| ** **               | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **September 30, 2008** | ** ** | **September 30, 2007** | ** ** |
| Expected life  (years)   |       | 5.50-6.00                        |       | 5.50-6.00 |   |
| Interest rate            |       | 2.92%-3.55%                      |       | 4.62%-5.20% |   |
| Volatility               |       | 63.9%-73.6%                      |       | 74.7%-77.4% |   |
| Expected  dividend yield |       | None                             |       | None |   |
| Value of option  granted |       | $0.22-$0.27                      |       | $0.43-$0.45 |   |

 

There were no options granted in the three months ended September 30,2008 or 2007.

 

The expected life was calculated in 2008 and 2007 using the simplifiedmethod. The risk-free interest rate is based on the U.S. Treasury yield curvein effect at the time of the grant for the expected term period.  Expected volatility is based exclusively onhistorical volatility data of the Company’s common stock.  The Company estimates an expected forfeiturerate based on its historical forfeiture activity.  Actual results, and future changes inestimates, may differ substantially from the Company’s current estimates.

 

*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 10% of their gross compensation during an offering period,subject to certain additional limitations. Under the Purchase Plan, employees of the Company purchased 2,455 sharesof common stock in the nine months ended September 30, 2008 at an averageprice of $0.37 per share and 5,179 shares of common stock in the year ended December 31,2007 at an average price of $0.47. At September 30, 2008, 313,618 shareswere reserved for future issuance under the Purchase Plan.

 

***6.******             RevenueRecognition***

 

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 a 

 

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paymentof $4,533,333 from Edwards, the Company’s previous exclusive U.S. TMRdistributor, received in February 2004. This payment was made in exchange for a reduction in the prospective purchaseprice the Company receives upon a sale of the kits.  The Company is amortizing this payment intoits Consolidated Statements of Operations as revenue over a seven year period(culminating in 2010) under the units-of-revenue method as prescribed by EmergingIssues 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 the Companyconsidered in developing this valuation model included the estimated foregonerevenues 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$191,000 and $539,000 in the three and nine months ended September 30,2008, respectively, as compared to $132,000 and $503,000 in the three and ninemonths ended September 30, 2007, respectively, which is included inrevenues in the Consolidated 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.

 

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

 

***7.******             Lossper Share***

 

Inthe three and nine months ended September 30, 2008 and 2007, basic anddiluted loss per share have been computed using only the weighted averagenumber of common shares outstanding during the period without giving effect toany potential future issuances of common stock related to stock optionprograms, since their inclusion would be antidilutive.

 

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Forthe three months ended September 30, 2008 and 2007, 5,501,000 and5,298,000 shares, respectively, and for the nine months ended September 30,2008 and 2007, 5,501,000 and 5,298,000 shares, respectively, attributable tooutstanding stock options were excluded from the calculation of dilutedearnings per share because the effect would have been antidilutive.  The following table sets forth thecomputation of basic and diluted loss per share:

 
| ** **                                                                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                             | ** ** | **(In  thousands, except per share data)**           | ** ** |
| Basic:                                                                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss                                                                                               |       | $                                                    | (285       | )                                                   | $          | (499 | ) | $ | (1,718 | ) | $ | (1,548 | ) |
| Weighted average  shares outstanding                                                                   |       | 30,332                                               |       | 30,323                                              |       | 30,331 |   | 30,315 |   |
| Basic loss per  share                                                                                  |       | $                                                    | (0.01      | )                                                   | $          | (0.02 | ) | $ | (0.06 | ) | $ | (0.05 | ) |
| Diluted:                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss                                                                                               |       | $                                                    | (285       | )                                                   | $          | (499 | ) | $ | (1,718 | ) | $ | (1,548 | ) |
| Weighted average  shares outstanding                                                                   |       | 30,332                                               |       | 30,323                                              |       | 30,331 |   | 30,315 |   |
| Assumed impact  of the exercise of outstanding dilutive stock options using the treasury  stock method |       | —                                               |       | —                                              |       | — |   | — |   |
| Weighted average  common and common equivalent shares                                                  |       | 30,332                                               |       | 30,323                                              |       | 30,331 |   | 30,315 |   |
| Diluted loss per  share                                                                                |       | $                                                    | (0.01      | )                                                   | $          | (0.02 | ) | $ | (0.06 | ) | $ | (0.05 | ) |

 

***8.******             ComprehensiveLoss***

 

Total comprehensive lossfor the three and nine months ended September 30, 2008 amounted to$293,000 and $1,724,000, respectively, as compared to $492,000 and $1,536,000in the three and nine months ended September 30, 2007, respectively.  Comprehensive loss is comprised of net lossplus the increase/decrease in currency translation adjustment.

 

# ***9.****            **Warranty and PreventativeMaintenance 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, under the terms of its TMRdistribution agreement with Novadaq, the Company is able to bill Novadaq foractual warranty costs, including preventative maintenance services, up to aspecified 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.

 

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

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

 

**Item 2.****                       Management’sDiscussion and Analysis ofFinancial 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**

# ** **

On November 7, 2008, our common stockwas delisted from the NYSE Alternext Market (formerly the American StockExchange).  Accordingly, as of November10, 2008 our stock is quoted on the Pink Sheets. We expect that our stock willbe quoted on the OTC Bulletin Board in the near future.

 

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 laser tubes and provide contractassembly services on general purpose *CO**2*lasers.

 

In addition, in 2007 we initiated our pilot clinicalsafety trial for RenalGuard. RenalGuard is designed to reduce the potentiallytoxic effects that contrast media can have on the kidneys when it isadministered to patients undergoing certain image-guided procedures, such asthose performed when placing drug-eluting stents. It is believed that allowingcontrast media to dwell in the kidneys can lead to CIN. By inducing andmaintaining a high urine flow rate before, during and after these image-guidedprocedures, it is believed the incidence rates of CIN in at-risk patients canbe reduced. RenalGuard facilitates this increased urine clearance enabling thebody to more rapidly void the contrast media, thereby reducing its overallresident time and toxic effects in the kidney.

 

We enrolled a total of 23 patients in our initial pilotsafety study. Based upon the positive safety data collected in the study anddiscussions we had with the FDA, we elected to stop 

 

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enrolling new patients in thepilot study in November 2007.  Wesubmitted an IDE supplement to the FDA in February 2008 seeking approvalto move from our pilot study to a pivotal clinical trial to study the safetyand effectiveness of RenalGuard in the prevention of CIN. In March 2008,the FDA granted us conditional approval to begin our pivotal study. We havereceived approval to study RenalGuard on 246 patients at up to 30 U.S. clinicalsites. In July 2008, we announced that we would delay the start of thispivotal trial until such time as we can obtain data from the clinical trialbeing conducted in Milan, Italy that we hope will enable us to raise sufficientadditional capital necessary to conduct 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 61% and74% of our total revenues in the three and nine months ended September 30,2008 and 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.

 

Approximately85% and 88% of our revenues in the three and nine months ended September 30,2008, respectively, and 87% in the year ended December 31, 2007,respectively, came from the sale and service of TMR lasers and relateddisposable kits. We believe that the number of opportunities for new TMR lasersales to U.S. 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 do so 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 at which new TMR lasers arebeing sold in the U.S. market as competition for the remaining availablecustomer’s increases. As such, we expect our U.S. TMR revenues in futurequarters will be more dependent on the sale of TMR kits and service revenues,both of which we believe in the near term will continue at levels similar tothat which we realized in the current third quarter of 2008.

 

Ourmanagement reviews a number of key performance indicators to assist indetermining how to allocate resources and run our day to day operations. Theseindicators include (1) actual prior quarterly sales trends, (2) projectedTMR laser and kit sales for the next four quarters, as provided by Novadaq in arolling 12 month sales forecast, (3) projected future sales of RenalGuardconsoles and single-use sets, (4) research and development progress asmeasured against internal project plan objectives, (5) budget to actualfinancial expenditure results, (6) inventory levels (both our own andNovadaq’s), and (7) short term and long term projected cash flows of thebusiness.

 

# **Critical Accounting Policiesand Estimates**

# ** **

Our financial statements are based on theapplication of significant accounting policies, many of which require us tomake significant estimates and assumptions (see Note 2 to the ConsolidatedFinancial Statements).  We believe thatthe following are some of the more material judgment areas in the applicationof our accounting policies that currently affect our financial condition andresults of operations.

 

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# ***Inventories***

# ** **

Inventoriesare stated at the lower of cost (computed on a first-in, first-out method) ormarket value and include allocations of labor and overhead.  A specific obsolescence allowance is providedfor slow moving, excess and obsolete inventory based on our best estimate ofthe net realizable value of inventory on hand taking into consideration factorssuch as (1) actual trailing 12 month sales, (2) expected futureproduct line demand, based in part on sales forecast input received fromNovadaq, and (3) service part stocking levels which, in management’s bestjudgment, are advisable to maintain in order to meet warranty, service contractand time and material spare part demands. Historically, we have found our reserves to be adequate.

 

# ***Accounts Receivable***

# ** **

Accountsreceivable is stated at the amount we expect to collect from the outstandingbalance.  We continuously monitorcollections from customers, and we maintain a provision for estimated creditlosses based upon historical experience and any specific customer collectionissues that we have identified. Historically, we have not experienced significant losses related to ouraccounts receivable. Collateral is not generally required. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may be required.

 

***Research and Development***

 

Researchand development costs are expensed as incurred.

 

# ***Warranty and 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.

 

## ***Revenue Recognition***

## ** **

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 from Edwards, our previous exclusive U.S. TMR distributor,received in February 2004.  Thispayment was made in exchange for a reduction in the prospective purchase pricewe receive upon a sale of the kits.  Weare amortizing this payment into our Consolidated Statements of Operations asrevenue over a seven year period (culminating in 2010) under theunits-of-revenue method as prescribed by Emerging Issues Task Force 88-18, “Salesof Future Revenue”.

 

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Wedetermined that a seven year timeframe was the most appropriate amortizationperiod based on a valuation model we used to assess the economic fairness ofthe payment. Factors we considered in developing this valuation model includedthe estimated foregone revenues over a seven year period resulting from thereduction in the prospective purchase price payable to us, a discount ratedeemed appropriate to this transaction and an estimate of the remainingeconomic useful life of the current TMR kit design, without any benefit beinggiven to potential future product improvements we may make. We review annually,and adjust if necessary, the prospective revenue amortization rate for kitsbased on our best estimate of the total number of kits likely remaining to beshipped to hospital customers by Novadaq through 2010. We recorded amortizationof $191,000 and $539,000 in the three and nine months ended September 30,2008, respectively, as compared to $132,000 and $503,000 in the three and ninemonths ended September 30, 2007, respectively, which is included inrevenues in our Consolidated Statements of Operations.

 

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 otherproduct revenue, including sales of TMR lasers and kits to internationalcustomers, sales of RenalGuard consoles and single-use sets and OEM sales ofsurgical tubes and general purpose CO2 lasers, 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.

 

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## **Results of Operations**

## ** **

Results for the three andnine months ended September 30, 2008 and 2007 and the related percent ofrevenues were as follows:

 
| ** **                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                  | ** ** | **$**                                                | ** ** | **%**                                               | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                  | ** ** | **(dollars in thousands)**                 | ** ** |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                              |       | $                                                    | 1,598      |                                                | 100        | % | $ | 1,331 |   | 100 | % | $ | 4,076 |   | 100 | % | $ | 4,756 |   | 100 | % |
| Total cost of  revenues                     |       | 829                                                  |       | 52                                                  |       | 468 |   | 35 |   | 1,807 |   | 44 |   | 2,037 |   | 43 |   |
| Gross profit                                |       | 769                                                  |       | 48                                                  |       | 863 |   | 65 |   | 2,269 |   | 56 |   | 2,719 |   | 57 |   |
| Selling,  general & administrative |       | 619                                                  |       | 39                                                  |       | 830 |   | 62 |   | 2,420 |   | 59 |   | 2,919 |   | 62 |   |
| Research &  development            |       | 516                                                  |       | 32                                                  |       | 637 |   | 48 |   | 1,726 |   | 42 |   | 1,684 |   | 35 |   |
| Total operating  expenses                   |       | 1,135                                                |       | 71                                                  |       | 1,467 |   | 110 |   | 4,146 |   | 102 |   | 4,603 |   | 97 |   |
| Loss from  operations                       |       | (366                                                 | )          | (23                                                 | )          | (604 | ) | (45 | ) | (1,877 | ) | (46 | ) | (1,884 | ) | (40 | ) |
| Other income                                |       | 11                                                   |       | 1                                                   |       | 105 |   | 8 |   | 89 |   | 2 |   | 336 |   | 7 |   |
| Loss before taxes                           |       | (355                                                 | )          | (22                                                 | )          | (499 | ) | (37 | ) | (1,788 | ) | (44 | ) | (1,548 | ) | (33 | ) |
| Benefit from  income taxes                  |       | (70                                                  | )          | (4                                                  | )          | — |   | — |   | (70 | ) | (2 | ) | — |   | — |   |
| Net loss                                    |       | $                                                    | (285       | )                                                   | (18        | )% | $ | (499 | ) | (37 | )% | $ | (1,718 | ) | (42 | )% | $ | (1,548 | ) | (33 | )% |

 
|                                                 |   | ** **                                           | ** ** | ** **                   |       | ** **                                          |       | ** **                   |       |
|------------------------------------------------------|--------|------------------------------------------------------|------------|------------------------------|------------|-----------------------------------------------------|------------|------------------------------|------------|
|                                                 |   | **Three Months Ended  September 30,** | ** ** | **Increase (decrease)** |       | **Nine Months Ended  September 30,** |       | **Increase (decrease)** |       |
|                                                 |   | **2008**                                             | ** ** | **2007**                     | ** ** | **over 2007**                                  | ** ** | **2008**                     | ** ** | **2007** |   | **over 2007** |   |
|                                                 |   | **$**                                                | ** ** | **$**                        | ** ** | **$**                                               | ** ** | **%**                        | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **%** |   |
|                                                 |   | **(dollars in thousands)**                 |       |
|                                                 |   |                                                 |       |                         |       |                                                |       |                         |       |   |   |   |   |   |   |   |   |
| Product sales                                        |   | $                                                    | 1,203      |                         | $          | 975                                                 |       | $                            | 228        |   | 23 | % | $ | 3,041 |   | $ | 3,629 |   | $ | (588 | ) | (16 | )% |
| Service fees                                         |   | 395                                                  |       | 356                          |       | 39                                                  |       | 11                           |       | 1,035 |   | 1,127 |   | (92 | ) | (8 | ) |
| Total revenues                                       |   | 1,598                                                |       | 1,331                        |       | 267                                                 |       | 20                           |       | 4,076 |   | 4,756 |   | (680 | ) | (14 | ) |
| Product cost of sales                                |   | 647                                                  |       | 258                          |       | 389                                                 |       | 151                          |       | 1,290 |   | 1,406 |   | (116 | ) | (8 | ) |
| Service fees cost  of sales                          |   | 182                                                  |       | 210                          |       | (28                                                 | )          | (13                          | )          | 517 |   | 631 |   | (114 | ) | (18 | ) |
| Total cost of  revenues                              |   | 829                                                  |       | 468                          |       | 361                                                 |       | 77                           |       | 1,807 |   | 2,037 |   | (230 | ) | (11 | ) |
| Gross profit                                         |   | 769                                                  |       | 863                          |       | (94                                                 | )          | (11                          | )          | 2,269 |   | 2,719 |   | (450 | ) | (17 | ) |
| Selling,  general & administrative expenses |   | 619                                                  |       | 830                          |       | (211                                                | )          | (25                          | )          | 2,420 |   | 2,919 |   | (499 | ) | (17 | ) |
| Research &  development expenses            |   | 516                                                  |       | 637                          |       | (121                                                | )          | (19                          | )          | 1,726 |   | 1,684 |   | 42 |   | 2 |   |
| Total operating  expenses                            |   | 1,135                                                |       | 1,467                        |       | (332                                                | )          | (23                          | )          | 4,146 |   | 4,603 |   | (457 | ) | (10 | ) |
| Loss from  operations                                |   | (366                                                 | )          | (604                         | )          | 238                                                 |       | (39                          | )          | (1,877 | ) | (1,884 | ) | 7 |   | — |   |
| Other income                                         |   | 11                                                   |       | 105                          |       | (94                                                 | )          | (90                          | )          | 89 |   | 336 |   | (247 | ) | (74 | ) |
| Loss before taxes                                    |   | (355                                                 | )          | (499                         | )          | 144                                                 |       | (29                          | )          | (1,788 | ) | (1,548 | ) | (240 | ) | (16 | ) |
| Benefit from  income taxes                           |   | (70                                                  | )          | —                       |       | (70                                                 | )          | 100                          |       | (70 | ) | — |   | 70 |   | (5 | ) |
| Net loss                                             |   | $                                                    | (285       | )                            | $          | (499                                                | )          | $                            | 214        |   | (43 | )% | $ | (1,718 | ) | $ | (1,548 | ) | $ | (170 | ) | (11 | )% |

 

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***Product Sales***

 

DisposableTMR kit revenues, the largest component of product sales in the three monthsended September 30, 2008, decreased by $49,000, or 8%, as compared to thethree months ended September 30, 2007. Domestic TMR kit revenues decreased $77,000 related to a lower volume ofkit shipments to Novadaq offset in part by (1) an increase in the averageselling price of TMR kits, and (2) increased disposable revenueamortization of $59,000.  InternationalTMR kit revenues increased $28,000 in the three months ended September 30,2008 as compared to the three months ended September 30, 2007.

 

In the nine months ended September 30,2008, disposable TMR kit revenues increased by $76,000, or 4%, as compared tothe nine months ended September 30, 2007. Domestic TMR kit revenues increased $22,000related to (1) an increase in the average selling price of TMR kits, and (2) increaseddisposable revenue amortization of $36,000. These increases were offset in part by a decrease in the number of TMRkits sold to Novadaq.  International TMRkit revenues increased $54,000 in the nine months ended September 30, 2008as compared to the nine months ended September 30, 2007. We expectthat our kit shipments to Novadaq in the fourth quarter of 2008 and insubsequent quarters during 2009 will be similar to that which we shipped in thethree months ended September 30, 2008.

 

TMRlaser revenues increased $186,000, or 83%, in the three months ended September 30,2008, as compared to the three months ended September 30, 2007.  International TMR laser revenues increased$305,000 due to the sale of two lasers to new customers.  Domestic TMR laser revenues decreased$119,000 as a result of (1) a decrease in the number of new TMR laserssold, and (2) a lower average selling price on the new TMR lasers sold.

 

TMRlaser revenues decreased $515,000, or 41%, in the nine months ended September 30,2008 as compared to the nine months ended September 30, 2007. Domestic TMRlaser revenues decreased $844,000 as a result of a (1) a decrease in thenumber of new TMR lasers sold, and (2) a lower average selling price onthe new TMR lasers sold.  InternationalTMR laser revenues increased $329,000 due to the sale of two lasers to newcustomers and the sale to a hospital of a previously installed laser system.

 

Otherproduct sales increased $91,000, or 62%, in the three months ended September 30,2008 as compared to the three months ended September 30, 2007.  This overall increase is a result of (1) $71,000of new international RenalGuard revenues, and (2) an increase of $20,000in manufacturing contract assembly product revenues.

 

Otherproduct sales decreased $149,000, or 23%, in the nine months ended September 30,2008 as compared to the nine months ended September 30, 2007.  This overall decrease is a result of (1) adecrease of $191,000 in manufacturing contract assembly product revenues, and (2) adecrease of $100,000 of revenues from Edwards related to the discontinuedOptiwave 980 product line.  These decreaseswere offset in part by $142,000 of new international RenalGuard revenues.

 

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***Service Fee Revenues***

 

Servicefees increased $39,000, or 11%, in the three months ended September 30,2008 as compared to the three months ended September 30, 2007. Domesticservice fees increased $12,000 due to increased service spare part billingsoffset in part by a decrease in billable service calls in the three monthsended September 30, 2008 as compared to the 2007 period. Internationalservice fees increased $27,000 in the three months ended September 30,2008 as compared to the 2007 period.

 

Servicefees decreased $92,000, or 8%, in the nine months ended September 30, 2008as compared to the nine months ended September 30, 2007. Domestic servicefees decreased $77,000 due to decreases in billable service calls and servicecontract billings offset in part by increased service spare part billings inthe nine months ended September 30, 2008 as compared to the 2007 period.International service fees decreased $15,000 in the nine months ended September 30,2008 as compared to the 2007 period.

 

***Gross Profit***

 

Grossprofit was $769,000, or 48% of total revenues, in the three months ended September 30,2008 as compared with gross profit of $863,000, or 65% of total revenues, inthe three months ended September 30, 2007. The decrease in gross profit is due to (1) higher cost of salesrelated to both higher period manufacturing expenses and a $182,000 increase inour inventory reserve, (2) a decrease in both the number and the averageselling prices of new domestic TMR lasers sold, and (3) a decrease in thenumber of domestic TMR kits sold.  Thesedecreases were offset in part by (1) an increase in international TMRlasers sold, (2) an increase in the average selling price of domestic TMRkits, (3) higher revenues from service, (4) new internationalRenalGuard revenue, and (5) higher disposable revenue amortization.

 

Grossprofit was $2,269,000, or 56% of total revenues, in the nine months ended September 30,2008 as compared with gross profit of $2,719,000, or 57% of total revenues, inthe nine months ended September 30, 2007. The decrease in gross profit isdue to (1) higher cost of sales related to both higher periodmanufacturing expenses and a $244,000 increase in our inventory reserve, (2) adecrease in both the number and the average selling prices of new domestic TMRlasers sold, (3) a decrease in the number of domestic TMR kits sold, and (4) lowerrevenues from contract assembly services. These decreases were offset in part by (1) an increase in theaverage selling price of domestic TMR kits, (2) an increase ininternational TMR lasers sold, (3) new international RenalGuard revenues, (4) areduction in our warranty accrual, and (5) higher disposable revenueamortization.

 

***Selling, General and AdministrativeExpenses***

 

Selling,general and administrative expenditures decreased 25% and 17% in the three andnine months ended September 30, 2008, respectively, as compared to thethree and nine months ended September 30, 2007.  In the three months ended September 30,2008, there were decreases in (1) compensation related costs, (2) overallspending on sales and marketing activities related to RenalGuard, and (3) internationalexpenses as compared to the three months ended September 30, 2007. Thesedecreases were partially offset by an increase in bad debt expense.  In the nine months ended September 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, which had included fees incurred in connection with thetransfer of the U.S. 

 

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TMRdistribution agreement and the origination of RenalGuard clinical trialcontracts in the nine months ended September 30, 2007.

 

***Research and Development Expenses***

 

Researchand development expenditures decreased 19% and increased 2% in the three andnine months ended September 30, 2008, respectively, as compared to thethree and nine months ended September 30, 2007.  In the three months ended September 30,2008, the decrease was primarily related to decreases in TMR-related clinicalcosts and RenalGuard product development, offset in part by increasedRenalGuard clinical costs and the write-off of certain capitalized developmentequipment as compared to the three months ended September 30, 2007.

 

Inthe nine months ended September 30, 2008, the increase was due toincreased RenalGuard-related clinical costs and the write-off of certaincapitalized development equipment offset in part by decreases both inTMR-related clinical costs and RenalGuard product development as compared tothe nine months ended September 30, 2007.

 

***Other Income***

 

Otherincome decreased $94,000 and $247,000 in the three and nine months ended September 30,2008, respectively.  Interest incomedecreased $84,000 and $237,000 in the three and nine months ended September 30,2008, respectively, due to lower average investable balances and lower interestrates on those investable balances in the three and nine months ended September 30,2008 as compared to the three and nine months ended September 30,2007.  In the three and nine months endedSeptember 30, 2008, we recorded a $10,000 unrealized loss from foreigncurrency transactions.

 

***Benefit from Income Taxes***

 

Inthe three and nine months ended September 30, 2008, we recorded a $70,000benefit from income taxes due to the reversal of an income tax reserve that wasno longer required to be utilized for its potential tax exposure.

 

***Net Loss***

 

In the three months endedSeptember 30, 2008 and 2007, we recorded a net loss of $285,000 and$499,000, respectively. In the three months ended September 30, 2008, thedecreased loss was due to lower operating expenses and a benefit from incometaxes, offset in part by lower gross margin dollars and lower interest income,as compared to the three months ended September 30, 2007.

 

In the nine months ended September 30,2008 and 2007, we recorded a net loss of $1,718,000 and $1,548,000,respectively.  In the nine months ended September 30, 2008, theincreased loss was due to lower gross margin dollars and lower interest income,offset in part by lower operating expenses and a benefit from income taxes, ascompared to the nine months ended September 30, 2007.

 

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***Kit Shipments***

 

Wegenerally view disposable kit shipments to end users as an important metric inevaluating our business, although we believe that specific short-term factorsnot indicative of long-term trends can sometimes affect shipments of disposablekits in any given quarter.  Domestic kitshipments referenced in the table below relate to sales by Novadaq to hospitalend users.  International kit shipmentsrelate to sales by us directly to our international distributors or hospitalend users.

 

Disposablekit shipments to end users were as follows:

 
| ** **                      | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                      | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **%  Increase  (Decrease)  Over  2007** | ** ** | **2008** | ** ** | **2007** | ** ** | **%  Increase  (Decrease)  Over  2007** | ** ** |
|                            |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Domestic (by  U.S. Distributor) |       | 398                                                      |       | 313                                                     |       | 27 |   | 1,120 |   | 1,194 |   | (6 | ) |
| International                   |       | 36                                                       |       | 2                                                       |       | 1,700 |   | 86 |   | 32 |   | 169 |   |
| Total                           |       | 434                                                      |       | 315                                                     |       | 38 |   | 1,206 |   | 1,226 |   | (2 | ) |

 

Because a significant number of the total TMRprocedures performed each year by cardiac surgeons are done in combination withopen-heart bypass surgery, we believe any future growth in the number of TMRprocedures will be partly dependent on the number of bypass surgeries performedin the future, which we believe have the potential to grow modestly over thenext few years.

 

**Liquidity and Capital Resources**

 

Cashand cash equivalents totaled $5,537,000 as of September 30, 2008, adecrease of $2,523,000 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 nine months ended September 30, 2008was $2,490,000 due to our net loss and unfavorable working capital changes,offset in part by non-cash depreciation and amortization, compensation relatedto stock 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 used an additional $7,000.

 

In thenear term we do not expect that our TMR product sales to Novadaq will changesignificantly. Therefore we will be largely dependent on our ability toincrease our revenues through the sale of our RenalGuard product intointernational markets. Should sales of RenalGuard not increase sufficiently,our liquidity and capital resources will be negatively impacted.

 

Additionally,unanticipated decreases in operating revenues or increases in expenses orchanges or delays in third-party reimbursement to healthcare providers usingour TMR products

 

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would adversely impact our cash position and requirefurther cost reductions or the need to obtain additional capital.

 

Webelieve we will incur losses at least through 2010.  We cannot be certain that we will be able toraise the additional capital necessary to start and conduct the pivotalclinical trial in the U.S. that is necessary to obtain regulatory approval tomarket RenalGuard in the U.S., or that future sales, if any, of RenalGuard willjustify these investments.  There can beno assurance that the future capital we will need to implement our businessplan will be available on terms and conditions acceptable to us, especiallyconsidering the current uncertainty in the global credit markets.  As a result of the current financial marketconditions, we have deferred the commencement of the U.S. pivotal trial, andshould additional financing not be available on terms and conditions acceptableto us, or if we are unable to sufficiently increase sales of our products, wewill need to further curtail our RenalGuard program and take additional actionsthat will adversely impact our ability to continue to realize assets andsatisfy liabilities in the normal course of business.  The consolidated financial statements setforth in this report do not include any adjustments to reflect the possiblefuture effects of these uncertainties.

 

**Off-BalanceSheet Arrangements**

 

None.

 

**Item 3.        Quantitativeand Qualitative Disclosuresabout Market Risk**

 

A portion of our operations consists of salesactivities in foreign jurisdictions.  Wemanufacture our products exclusively in the U.S. and sell our products in theU.S. and abroad. As a result, our financial results could be affected byfactors such as changes in foreign currency exchange rates or weak economicconditions in the foreign markets in which we distribute our products.  Our operating results are exposed to changesin exchange rates between the U.S. dollar and foreign currencies, especiallythe Euro. When the U.S. dollar strengthens against the Euro, the value offoreign sales decreases. When the U.S. dollar weakens, the functional currencyamount of sales increases. No assurance can be given that foreign currencyfluctuations in the future will not adversely affect our business, financialcondition and results of operations, although at present we do not believe thatour exposure is significant, as international sales represented 17% and 3% ofour consolidated sales in the nine months ended September 30, 2008 and theyear ended December 31, 2007, respectively. We do not hedge any balancesheet exposures 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 Controls andProcedures***

 

Our management, with the participation of ourchief executive officer and chief financial officer, evaluated theeffectiveness of our disclosure controls and procedures as of September 30,2008.  The term “disclosure controls andprocedures”, as defined in Rules 13a-15(e) and 15d-15(e)

 

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under the Exchange Act, means controls andother procedures of a company that are designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rules andforms.  Disclosure controls andprocedures include, without limitation, controls and procedures designed toensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure.  Management recognizes thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving their objectives and managementnecessarily applies its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.  Basedupon the evaluation of our disclosure controls and procedures as of September 30,2008, our chief executive officer and chief financial officer concluded that,as of such date, our disclosure controls and procedures were effective at thereasonable assurance level.

 

***Changes in Internal Controlover Financial Reporting***

 

No change in our internal control over financialreporting (as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) occurred during the fiscal quarter ended September 30, 2008that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**Part II.  Other Information**

 

**Item 1A.       RiskFactors**

 

Therisks and uncertainties described below are not the only risks we face.  Additional risks and uncertainties notpresently known to us or currently deemed immaterial may also impair ourbusiness operations.  If any of thefollowing risks actually occur, our financial condition and operating resultscould be materially adversely affected.

 

***We expect to incur significantoperating losses in the near future.***

 

Weexpect to incur net losses in future quarters, at least through 2010.  We cannot provide any assurance that we willbe successful with our business strategy, that we will be able to raisesufficient capital to conduct our pivotal clinical trial of RenalGuard in the U.S.or that if such a clinical trial is completed, that RenalGuard will receive FDAapproval or commercial acceptance, or that we will ever return toprofitability.

 

***Our company may be unable to raiseneeded capital.***

 

Asof September 30, 2008, we had cash and cash equivalents totaling$5,537,000. Based upon our current operating plan, we anticipate that ourexisting capital resources should be sufficient to meet our working capitalrequirements for at least the next 12 months; however, we will need to raiseadditional capital for the future in order to implement our business plan.  As a result of current capital marketconditions, we have deferred the commencement of the U.S. pivotal trial forRenalGuard, and should additional financing not be available on terms andconditions acceptable to us, or if we are unable to sufficiently increase salesof our products, we

 

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willneed to further curtail our RenalGuard program and take additional actions thatwill adversely 

impactour ability to continue to realize assets and satisfy liabilities in the normalcourse of business.  To the extent thatwe 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.

 

***The commencement of our planned U.S.pivotal clinical trial to study the safety and effectiveness of RenalGuard inpreventing contrast-induced nephropathy is dependent upon our ability to raisesufficient additional capital to fund the completion of the study.***

 

Although we have receivedconditional FDA approval to commence our pivotal clinical trial in the U.S. tostudy the safety and effectiveness of RenalGuard in preventing contrast-inducednephropathy, we will need to raise additional capital 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 andconditions acceptable to us, especially considering the current uncertainty inthe global credit markets.

 

***Our company is currently dependentupon one principal customer.***

 

Pursuantto the terms of our TMR distribution agreement with Novadaq, Novadaq is ourexclusive distributor for our HL2 laser and TMR kits in the U.S.  As a result of this exclusive arrangement,our U.S. distributor (Novadaq currently and Edwards prior to March 20,2007) accounted for 61% and 74% of total revenues in the three and nine monthsended September 30, 2008, respectively, and 85% in the year ended December 31,2007, and we expect Novadaq to account for the significant majority of ourrevenue in the near future.  As a resultof this expected concentration of sales with Novadaq, we bear an increasedfinancial risk of timely sales collection if, for any reason, Novadaq’sbusiness condition should suffer.

 

***We are dependent upon Novadaq in theU.S. to increase our TMR revenues.***

 

Novadaq’ssales organization is responsible for selling a number of different products,including our TMR products.  We arelargely dependent upon the success of Novadaq’s sales and marketing efforts inthe U.S. to increase the installed base of HL2 lasers and TMR proceduralvolumes and thus kit revenues.  If ourrelationship with Novadaq does not progress, or if Novadaq’s sales andmarketing strategies fail to generate increased sales of our products in thefuture,******ourbusiness, financial condition and results of operations will be seriouslyharmed.

 

***Our company is currently dependentupon one principal product line to generate revenues.***

 

Wecurrently sell one principal product line, the Heart Laser Systems, whichaccounts for the majority of our total revenues.  Approximately 85% and 88% of our revenues inthe three and nine months ended September 30, 2008, respectively, and 87%in the year ended December 31, 2007, were derived from the sales andservice of our Heart Laser Systems.  Thisabsence of a diversified product line means that we are directly and materiallyimpacted by changes in the market for Heart Laser Systems. We believe that thenumber of opportunities for new TMR laser sales to U.S. 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

 

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notalready implemented a TMR program that are still likely to do so in the future,and (2) continuing financial pressures that hospitals face, in particularfor the funding of new capital equipment purchases, in light of ongoingcutbacks in both Medicare and private insurance reimbursement rates for allmedical procedures. In addition, we have seen a recent downward trend in theprice for new TMR lasers in the market, as competition for the remainingavailable customers increases. These market factors and our dependency onrevenues related to sales of the Heart Laser System pose a serious risk to ourongoing ability to generate sufficient cash to fund our operations, which mayseriously harm our business, financial condition and results of operations infuture quarters.

 

***Our company is dependent upon certain suppliers.***

 

Some of the components for our Heart Laser Systems,most notably the power supply and certain optics and fabricated parts for theHL2, are only available from one supplier, and we have no assurance that wewill be able to secure any of our sole-sourced components from additionalsuppliers.  We are dependent upon oursole suppliers to perform their obligations in a timely manner.  In the past, we have experienced delays inproduct delivery from our sole suppliers and, because we do not have analternative supplier to produce these products for us, we have little leverageto enforce timely delivery. Any delay in product delivery or other interruptionin supply from these suppliers could prevent us from meeting our commercialdemands for our products, which could have a material adverse effect on ourbusiness, financial condition and results of operations.  Furthermore, we do not require significantquantities of any components because we produce a limited number of ourproducts each year.  Our low-quantityneeds 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.

 

***In order to compete effectively, ourcurrent and future products need to gain commercial acceptance.***

 

Ourcurrent TMR products may never achieve widespread commercial acceptance.  To be successful, we and Novadaq need to:

 

·                  demonstrateto the medical community in general, and to heart surgeons and cardiologists inparticular, that TMR procedures are effective, relatively safe and costeffective;

 

·                  supportthird-party efforts to document the medical processes by which TMR 

 

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                        procedures relieve angina;

 

·                  train more heart surgeons to perform TMRprocedures using the Heart Laser Systems; and

 

·                  maintainand expand third-party reimbursement for the TMR procedure.

 

Todate, only a limited number of heart surgeons have been trained in the use ofTMR using the Heart Laser Systems.  Weare dependent upon Novadaq to expand related marketing and training efforts inthe U.S. for the use of our products.

 

TheHeart Laser Systems have not yet received widespread commercialacceptance.  We believe that concernsover the lack of a consensus view about the reason or reasons why a TMRprocedure relieves angina in patients who undergo the procedure has limiteddemand for and use of the Heart Laser Systems. Until there is consensus, ifever, on the medical processes by which TMR procedures relieve angina, webelieve some hospitals will delay the implementation of a TMR program.

 

Ifwe are unable to achieve widespread commercial acceptance of the Heart LaserSystems, our business, financial condition and results of operations will bematerially and adversely affected.

 

***Our newest product, RenalGuard, has onlyhad limited testing in a clinical setting and we may need to modify it in thefuture to be commercially acceptable.***

 

Wehave only completed the first generation product design for RenalGuard and wehave only been able to perform a limited amount of testing of this device in aclinical hospital setting as part of our recently completed initial pilot humanclinical study. We may need to make substantial modifications to the design,features or functions of our device in order for it to eventually obtain FDAapproval or otherwise to meet customer expectations in the EU where we arecurrently marketing it. These changes may not be able to be completed in atimely fashion, if at all. Should any such modifications prove to besignificantly more costly or time consuming to engineer than we estimate, ourability to bring this product to market may be severely and negativelyimpacted.

 

***Our potential future success inmarketing RenalGuard in the EU as a CIN prevention device and our ability toraise additional capital in the future will be largely dependent on the timelyoutcome of the current investigator-sponsored clinical trial of RenalGuardbeing conducted at the Centro Cardiologico Monzino (CCM) in Milan, Italy.***

 

We currently aresupporting an investigator-sponsored clinical trial at the CCM where RenalGuardis being compared in an equivalency study to that of an overnight hydrationprotocol in terms of its safety and effectiveness in preventing CIN in at-riskpatients. We believe our ability to raise additional capital to fund our U.S.pivotal study of RenalGuard, as well as our ability to successfully marketRenalGuard in the EU and gain widespread market adoption for our system as aCIN prevention device, is largely dependent upon the CCM study results, specificallya favorable finding that RenalGuard is equivalent to overnight hydration interms of safely preventing CIN in the at-risk patients studied.

 

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We can provide noassurance that the CCM study will be completed in a timely fashion, if at all,or that should it be completed, that it will produce the desired result ofshowing that RenalGuard is equivalent to overnight hydration in the studypopulation. If the study shows that RenalGuard is not at least equivalent toovernight hydration in terms of its safety or effectiveness in preventing CIN,then our ability to raise additional capital in the future to complete our U.S.pivotal trial, fund our operations and implement our business plan will bematerially and adversely affected.

 

***Our planned U.S. pivotal clinicaltrial of RenalGuard will, if we can successfully raise the necessary capital tocommence and complete it, take us a significant amount of time to complete, ifwe can complete it at all, and the results of this clinical trial may not showsufficient safety and efficacy for us to either obtain FDA approval orotherwise be able to successfully market and sell the product.***

 

Our business strategy to grow our revenuesand profitability is largely dependent upon our success in the timelycompletion of our U.S. pivotal clinical trial of RenalGuard. We hope to be ableto demonstrate through this clinical trial that RenalGuard is safe andeffective in preventing CIN.

 

We can provide no assurance that when studied in humans, RenalGuardwill be shown to be safe or effective in preventing CIN, or that the degree ofany positive safety and efficacy results will be sufficient to either obtainFDA approval or otherwise successfully market our product. Furthermore, thecompletion of our planned clinical trial is dependent upon many factors, someof which are not entirely within our control, including, but not limited to,our ability to successfully recruit investigators, the availability of patientsmeeting the inclusion criteria of our clinical study, the competition for theseparticular study patients amongst other clinical trials being conducted byother companies at these same study sites, the ability of the sitesparticipating in our study to successfully enroll patients in our trial, andproper data gathering on the part of the investigating sites.

 

Should our U.S. pivotal clinical trial take longer than we expect tocomplete, our competitive position relative to existing preventative measures,or relative to new devices, drugs or therapies that may be developed, could beseriously harmed and our ability to successfully fund the completion of thetrial and bring RenalGuard to market may be adversely affected.

 

***We will need to build a direct salesand marketing organization or otherwise enter into distribution arrangements inorder to market RenalGuard in the U.S, if and when it is approved for sale, andin the EU, as we prepare for a sales launch in this market in 2009.***

 

We currently do not have a direct sales force. Instead, we market ourTMR products through Novadaq in the U.S. and through independent distributorsoutside the U.S.  We do not plan to useNovadaq or our current international TMR distributors to market RenalGuard whenit becomes commercially available. We will need to either build an internaldirect sales and marketing organization or find new distribution partners tosuccessfully market RenalGuard.

 

If we choose to build a direct sales force, we may not be able toattract qualified individuals with the requisite training or experience to sellour product. In addition, we would need to devote substantial management timeinstituting policies, procedures and controls to oversee and effectively managethis new part of our organization, which could adversely impact 

 

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our daily operations and would require us to invest significantfinancial resources, the cost of which could be prohibitive.

 

If we instead choose to pursue an indirect distribution strategy, whichis our current plan for the EU market, we may not be able to identify suitabledistribution partners with sufficient industry experience, brand recognition,sales capacity and willingness or ability to maximize sales. Further, we maynot be able to negotiate distribution agreements with terms and conditions thatare acceptable to us, including ensuring that our product receives adequatesales force focus and attention.

 

***Rapid technological changes in ourindustry could make our products obsolete.***

 

Our industry is characterized by rapid technological change and intensecompetition.  New technologies andproducts and new industry standards will develop at a rapid pace, which couldmake our current and future planned products obsolete. The advent of newdevices and procedures and advances in new drugs and genetic engineering areespecially concerning competitive threats. Our future success will depend upon our ability to develop and introduceproduct enhancements to address the needs of our customers.  Material delays in introducing productenhancements may cause customers to forego purchases of our products andpurchase those of our competitors.

 

Many potential competitors have substantially greater financialresources and are in a better financial position to exploit marketing andresearch and development opportunities.

 

***We must receive and maintaingovernment clearances or approvals in order to market our products.***

 

Ourproducts and our manufacturing activities are subject to extensive, rigorousand changing federal and state regulation in the U.S. and to similar regulatoryrequirements in other major international markets, including the EU andJapan.  These regulations and regulatoryrequirements are broad in scope and govern, among other things:

 

·                  product design and development;

 

·                  product testing;

 

·                  product labeling;

 

·                  product storage;

 

·                  premarket clearance and approval;

 

·                  advertising and promotion; and

 

·                  product sales and distribution.

 

Furthermore,regulatory authorities subject a marketed product, its manufacturer and themanufacturing facilities to continual review and periodic inspections.  We are subject to ongoing FDA requirements,including required submissions of safety and other post-market information

 

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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.

 

Laterdiscovery of previously unknown problems with our products, manufacturingprocesses or our failure to comply with applicable regulatory requirements mayresult in enforcement actions by the FDA and other international regulatoryauthorities, including, but not limited to:

 

·                  warning letters;

 

·                  patient or physician notification;

 

·                  restrictions on our products or manufacturingprocesses;

 

·                  voluntary or mandatory recalls;

 

·                  product seizures;

 

·                  refusal to approve pending applications orsupplements to approved applications that we submit;

 

·                  refusal to permit the import or export of ourproducts;

 

·                  fines;

 

·                  injunctions;

 

·                  suspension or withdrawal of marketingapprovals or clearances; and

 

·                  civil and criminal penalties.

 

Shouldany of these enforcement actions occur, our business, financial condition andresults of operations could be materially and adversely affected.

 

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

 

***Heart Laser Systems***

 

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

 

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·                  has restricted the use of the Heart LaserSystems by not allowing us to market these products to treat patients whosecondition is amenable to conventional treatments, such as heart bypass surgery,stenting and angioplasty; and

 

·                  could impose additional restrictions orreverse its ruling and prohibit use of the Heart Laser Systems at 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.  On August 18, 2008, we received a letterfrom the FDA informing us that we had satisfied our postapproval studyrequirements with the submission of our final report.

 

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

 

·                  theEuropean Union could impose additional restrictions or reverse its ruling andprohibit use of the Heart Laser Systems at 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.

 

Inaddition, it is unclear what impact the introduction of the HL2 into the U.S.and other international markets will have on the ability of our Japanesedistributor to market our older, first generation HL1 in Japan. Although ourJapanese distributor has indicated to us that it plans to seek MHLW approval inthe future to market our newer HL2, we can provide no assurance that thedistributor will be successful in obtaining the necessary approvals or how longit may take to secure the required approvals.

 

***RenalGuard***

 

We presently have approval to market RenalGuard only in the EU. We mustreceive either FDA approval or clearance before we can market RenalGuard in theUnited States. Other countries may require their own approvals prior to ourbeing able to market RenalGuard in those countries.

 

The process of obtaining and maintaining regulatory approvals andclearances to market a medical device can be costly and time consuming, and wecannot predict when, if ever, such approvals or clearances will be granted.Pursuant to FDA regulations, unless an exemption is available, the FDA permitscommercial distribution of a new medical device only after the device

 

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hasreceived 510(k) clearance or is the subject of an approved PMAapplication. The FDA will clear marketing of a medical device through the 510(k) processonly if it is demonstrated that the new product is substantially equivalent toother 510(k)-cleared products.

 

At the present time we are not aware of any clear predicates withsubstantially the same proposed indications for use that would enable us toconclude that RenalGuard is likely to be cleared by the FDA as a 510(k) device.Therefore, we believe RenalGuard most likely will need to go through the PMAapplication process.

 

Because the PMA application process is more costly, lengthy anduncertain than the 510(k) process and must be supported by extensive data,including data from preclinical studies and human clinical trials, we cannotpredict when RenalGuard may eventually come to market in the U.S. Should we beunable to obtain FDA approval for RenalGuard, or should the approval processtake longer than we anticipate, our future revenue growth prospects will bematerially and adversely affected.

 

***Changes in third party reimbursement forTMR procedures or our inability to obtain third party reimbursement forRenalGuard could materially affect future demand for our products.***

 

Demand for medicaldevices is often affected by whether third party reimbursement is available forthe devices 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 of thetwo procedures carries the higher reimbursement amount. Therefore, in situationswhere sole therapy TMR reimbursement rates exceed that provided for bypasssurgery alone, if hospitals perform a combination procedure where both bypasssurgery and adjunctive TMR are performed on a patient, the hospital is able tobill for the higher TMR procedure reimbursement payment. In these instances,the doctor also can bill an additional amount for performing multipleprocedures.

 

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

 

Noassurance can be given, however, that these payers will continue to reimbursehealthcare providers who perform TMR procedures using our products now or inthe future.  Further, no assurance can begiven that additional payers will reimburse healthcare providers who performTMR procedures using our products or that reimbursement, if provided, will betimely or adequate.

 

Shouldthird party insurance reimbursement for TMR procedures be reduced or eliminatedin the future, our business, financial condition and results of operationswould be materially and adversely affected.

 

Furthermore,we know of no existing Medicare coverage or other third party reimbursementthat would be available to either hospitals or physicians that would helpdefray the additional cost that would result from the future purchase and/oruse of our RenalGuard System. We also can provide no assurance that we willever be able to obtain Medicare coverage

 

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orother third party reimbursement for the use of RenalGuard, which couldmaterially and adversely affect the potential future demand for this product.

 

Inaddition, the market for our all our products could be adversely affected byfuture legislation to reform the nation’s healthcare system or by changes inindustry practices regarding reimbursement policies and procedures.

 

***Securing intellectual propertyrights for RenalGuard is critical to our future business plans, but may proveto be difficult or impossible for us to obtain.***

 

Wehave filed nine patent applications with the U.S. Patent and Trademark Officerelated to RenalGuard and other intellectual property in the general field ofpreventing contrast-induced nephropathy and acute renal failure. Securingpatent protection over our intellectual property ideas in this field is, webelieve, critical to our plans to successfully differentiate and marketRenalGuard and grow our future revenues. We can provide no assurance, however,that we will be successful in securing any patent protection for ourintellectual property ideas in this field or that our efforts to obtain patentprotection will not prove more difficult, and therefore more costly, than weare otherwise expecting. Furthermore, even if we are successful in securingpatent protection for some or all of our intellectual property ideas in thisfield, we cannot predict when in the future any such potential patents may beissued, how strong such patent protection will prove to be, or whether thesepatents will be issued in a timely enough fashion to afford us any commerciallymeaningful advantage in marketing RenalGuard against other potentiallycompetitive devices.

 

***Asserting and defending intellectualproperty rights may impact our results of operations.***

 

Inour industry, competitors often assert intellectual property infringementclaims against one another.  The successof our business depends upon our ability to successfully defend ourintellectual property.  Future litigationmay have a material impact on our financial condition even if we are successfulin marketing our products. We may not be successful in defending or assertingour intellectual property rights.

 

Anadverse outcome in any litigation or interference proceeding could subject usto significant liabilities to third parties and require us to cease using thetechnology that is at issue or to license the technology from thirdparties.  In addition, a finding that anyof our intellectual property is invalid could allow our competitors to moreeasily and cost-effectively compete with us. Thus, an unfavorable outcome in any patent litigation or interferenceproceeding could have a material adverse effect on our business, financialcondition or results of operations.

 

Thecost to us of any patent litigation or interference proceeding could besubstantial.  Uncertainties resultingfrom the initiation and continuation of patent litigation or interferenceproceedings could have a material adverse effect on our ability to compete inthe marketplace.  Patent litigation andinterference proceedings may also absorb significant management time.

 

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***We may be subject to productliability lawsuits; our insurance may not be sufficient to cover damages.***

 

Wemay be subject to product liability claims. Such claims may absorb significant management time and could degrade ourreputation and the marketability of our products.  If product liability claims are made withrespect to our products, we may need to recall the implicated product, whichcould have a material adverse effect on our business, financial condition andresults of operations. In addition, although we maintain product liabilityinsurance, we cannot be sure that our insurance will be adequate to coverpotential product liability lawsuits. Our insurance is expensive and in thefuture may not be available on acceptable terms, if at all. If a successfulproduct liability claim or series of claims exceeds our insurance coverage, itcould have a material adverse effect on our business, financial condition andresults of operations.

 

***We are subject to risks associatedwith international operations.***

 

Aportion of our product sales is generated from operations outside of theU.S.  Establishing, maintaining andexpanding international sales can be expensive. Managing foreign operations is difficult and products may not receivemarket acceptance.  Risks of doingbusiness outside the U.S. include, but are not limited to, the following:agreements may be difficult to enforce and receivables difficult to collectthrough a foreign country’s legal system; foreign customers may have longerpayment cycles; foreign countries may impose additional withholding taxes orotherwise tax our foreign income, impose tariffs or adopt other restrictions onforeign trade; U.S. export licenses may be difficult to obtain; and theprotection of intellectual property rights in foreign countries may be moredifficult to enforce.  There can be noassurance that our international business will grow or that any of theforegoing risks will not result in a material adverse effect on our business orresults of operations.

 

***Because we are incorporated in Canada, you may not be able to enforcejudgments against us and our Canadian directors.***

 

UnderCanadian law, you may not be able to enforce a judgment issued by courts in theU.S. against us or our Canadian directors. The status of the law in Canada isunclear as to whether a U.S. citizen can enforce a judgment from a U.S. courtin Canada for violations of U.S. securities laws. A separate suit may need tobe brought directly in Canada.

 

***Our stock price has historicallyfluctuated and may continue to fluctuate significantly in the future, which mayresult in losses for our investors. There is limited trading volume in ourcommon stock.***

 

On November 7, 2008,our common stock was delisted from the NYSE Alternext Market (formerly theAmerican Stock Exchange).  Accordingly,as of November 10, 2008 our stock is quoted on the Pink Sheets. We expect thatour stock will be quoted on the OTC Bulletin Board in the near future.  Our stock price has been and may continue to be volatile. Some of thefactors that may affect our stock price are:

 

·                  the limited trading of our common stock oneither the Pink Sheets or the OTC Bulletin Board;

 

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

 

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·                  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, operationsor 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.

 

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

 

Certain current shareholders hold large amounts of our stock, whichthey could seek to sell in the public market from time to time.  Sales of a substantial number of shares ofour common stock within a short period of time would cause our stock price tofall.  In addition, the sale of theseshares could impair our ability to raise capital through the sale of additionalstock.

 

**Item 6.****                   Exhibits**

 
| **Exhibit****Number** |   | **Description of Document**                                                                                                                                                                                               | ** ** |
|-----------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                  |   |                                                                                                                                                                                                                      |       |
| 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**

 

Pursuantto the 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:  November 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**                                                                                                                                                                                               | ** ** |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                |       |                                                                                                                                                                                                                      |       |
| 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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