**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

**FORM 10-Q**

**x****                             ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**

**For thequarterly period ended September 30, 2006.**

**OR**

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**

**For thetransition period from                                         to**

**CommissionFile Number: 1-11388**

**PLCSYSTEMS INC.**(Exact Name of Registrant 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 markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  x   No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

| Large accelerated  filer o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act)  Yes  o     No  x

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

| **Class**                   | ** ** | **Outstanding  at November 6, 2006** |
|-----------------------------|------------|--------------------------------------|
| Common Stock, no  par value |       | 30,237,436                           |

 

 

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**PLC SYSTEMS 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 |   | 14 |
|     |   |                    |                                                                                        |   |   |
|     |   | Item 3.                 | Quantitative  and Qualitative Disclosures about Market Risk                                 |   | 24 |
|     |   |                    |                                                                                        |   |   |
|     |   | Item 4.                 | Controls and  Procedures                                                                    |   | 25 |
|     |   |                    |                                                                                        |   |   |
|     |   |                    |                                                                                        |   |   |
| Part II. |   | Other Information:      |                                                                                        |   |
|     |   |                    |                                                                                        |   |
|     |   | Item  1A.               | Risk  Factors                                                                               |   | 25 |
|     |   |                    |                                                                                        |   |   |
|     |   | Item  6.                | Exhibits                                                                                    |   | 37 |

 

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**Part I.         FinancialInformation**

**Item 1.        Financial Statements**

**PLCSYSTEMS INC.**CONDENSED CONSOLIDATED BALANCE SHEETS(In thousands)(Unaudited)
| ** **                                                                                                                                                                         | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                         |       |                         |       |                        |       |
| Current assets:                                                                                                                                                                    |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                         |       | $                            | 4,744      |                        | $          | 2,560 |   |
| Short-term  investments                                                                                                                                                            |       | 5,500                        |       | 6,900                       |       |
| Accounts  receivable — Edwards                                                                                                                                                |       | 945                          |       | 634                         |       |
| Accounts  receivable — other, net of allowance of $121 and $96 as of September 30,  2006 and December 31, 2005, respectively                                        |       | 90                           |       | 153                         |       |
| Inventories, net                                                                                                                                                                   |       | 1,164                        |       | 963                         |       |
| Prepaid expenses  and other current assets                                                                                                                                         |       | 714                          |       | 798                         |       |
| Total current  assets                                                                                                                                                              |       | 13,157                       |       | 12,008                      |       |
|                                                                                                                                                                               |       |                         |       |                        |       |
| Equipment, furniture  and leasehold improvements, net                                                                                                                              |       | 152                          |       | 235                         |       |
| Other assets                                                                                                                                                                       |       | 212                          |       | 224                         |       |
| Total assets                                                                                                                                                                       |       | $                            | 13,521     |                        | $          | 12,467 |   |
|                                                                                                                                                                               |       |                         |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                     |       |                         |       |                        |       |
| Current liabilities:                                                                                                                                                               |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                   |       | $                            | 403        |                        | $          | 352 |   |
| Accrued  compensation                                                                                                                                                              |       | 664                          |       | 677                         |       |
| Accrued other                                                                                                                                                                      |       | 286                          |       | 334                         |       |
| Deferred revenue  — Edwards                                                                                                                                                   |       | 1,784                        |       | 1,621                       |       |
| Deferred revenue  — other                                                                                                                                                     |       | 73                           |       | 60                          |       |
| Total current  liabilities                                                                                                                                                         |       | 3,210                        |       | 3,044                       |       |
| Deferred revenue  — Edwards                                                                                                                                                   |       | 3,108                        |       | 3,692                       |       |
| Deferred revenue  — other                                                                                                                                                     |       | 188                          |       | 188                         |       |
| Total long-term  liabilities                                                                                                                                                       |       | 3,296                        |       | 3,880                       |       |
|                                                                                                                                                                               |       |                         |       |                        |       |
| 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, 30,237 and 30,080 shares issued and  outstanding as of September 30, 2006 and December 31, 2005,  respectively |       | 93,845                       |       | 93,737                      |       |
| Additional paid in  capital                                                                                                                                                        |       | 68                           |       | —                      |       |
| Accumulated deficit                                                                                                                                                                |       | (86,567                      | )          | (87,850                     | )          |
| Accumulated other  comprehensive loss                                                                                                                                              |       | (331                         | )          | (344                        | )          |
| Total  stockholders’ equity                                                                                                                                                   |       | 7,015                        |       | 5,543                       |       |
| Total liabilities and  stockholders’ equity                                                                                                                                   |       | $                            | 13,521     |                        | $          | 12,467 |   |

 

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

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**PLC SYSTEMS INC.**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)(Unaudited)
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Product sales — Edwards              |       | $                                                    | 1,115      |                                                | $          | 1,352 |   | $ | 3,717 |   | $ | 4,198 |   |
| Product sales — other                |       | 90                                                   |       | 183                                                 |       | 545 |   | 462 |   |
| Service fees — Edwards               |       | 337                                                  |       | 313                                                 |       | 1,034 |   | 984 |   |
| Service fees — other                 |       | 25                                                   |       | 52                                                  |       | 103 |   | 181 |   |
| Total revenues                            |       | 1,567                                                |       | 1,900                                               |       | 5,399 |   | 5,825 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of  revenues:                        |       |                                                 |       |                                                |       |   |   |   |   |
| Product sales — Edwards              |       | 344                                                  |       | 564                                                 |       | 1,172 |   | 1,580 |   |
| Product sales — other                |       | 78                                                   |       | 68                                                  |       | 315 |   | 204 |   |
| Service fees — Edwards               |       | 133                                                  |       | 153                                                 |       | 405 |   | 435 |   |
| Service fees — other                 |       | 35                                                   |       | 30                                                  |       | 111 |   | 114 |   |
| Total cost of revenues                    |       | 590                                                  |       | 815                                                 |       | 2,003 |   | 2,333 |   |
| Gross profit                              |       | 977                                                  |       | 1,085                                               |       | 3,396 |   | 3,492 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Operating  expenses:                      |       |                                                 |       |                                                |       |   |   |   |   |
| Selling, general and administrative       |       | 786                                                  |       | 739                                                 |       | 2,470 |   | 2,516 |   |
| Research and development                  |       | 394                                                  |       | 810                                                 |       | 1,385 |   | 2,030 |   |
| Total operating expenses                  |       | 1,180                                                |       | 1,549                                               |       | 3,855 |   | 4,546 |   |
| Gain on the sale  of manufacturing rights |       | —                                               |       | —                                              |       | 1,432 |   | — |   |
| Income (loss)  from operations            |       | (203                                                 | )          | (464                                                | )          | 973 |   | (1,054 | ) |
| Other income,  net                        |       | 123                                                  |       | 67                                                  |       | 310 |   | 183 |   |
| Net income  (loss)                        |       | $                                                    | (80        | )                                                   | $          | (397 | ) | $ | 1,283 |   | $ | (871 | ) |
| Basic income  (loss) per share            |       | $                                                    | (0.00      | )                                                   | $          | (0.01 | ) | $ | 0.04 |   | $ | (0.03 | ) |
| Diluted income  (loss) per share          |       | $                                                    | (0.00      | )                                                   | $          | (0.01 | ) | $ | 0.04 |   | $ | (0.03 | ) |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Average shares  outstanding:              |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                     |       | 30,237                                               |       | 30,079                                              |       | 30,080 |   | 30,073 |   |
| Diluted                                   |       | 30,237                                               |       | 30,079                                              |       | 30,518 |   | 30,073 |   |

 

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

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**PLC SYSTEMS INC.**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)(Unaudited)
| ** **                                                                                | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Operating  activities:                                                                    |       |                                                |       |   |   |
| Net income (loss)                                                                         |       | $                                                   | 1,283      |   | $ | (871 | ) |
|                                                                                      |       |                                                |       |   |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                                |       |   |   |
| Depreciation and amortization                                                             |       | 87                                                  |       | 96 |   |
| Loss on retirement of equipment                                                           |       | 77                                                  |       | — |   |
| Compensation expense from stock options                                                   |       | 68                                                  |       | — |   |
|                                                                                      |       |                                                |       |   |   |
| Change in assets and liabilities:                                                         |       |                                                |       |   |   |
| Accounts receivable — Edwards                                                        |       | (311                                                | )          | 227 |   |
| Accounts receivable — other                                                          |       | 63                                                  |       | 117 |   |
| Inventories                                                                               |       | (201                                                | )          | 126 |   |
| Prepaid expenses and other assets                                                         |       | 84                                                  |       | (147 | ) |
| Accounts payable                                                                          |       | 51                                                  |       | 33 |   |
| Deferred revenue — Edwards                                                           |       | (421                                                | )          | 263 |   |
| Deferred revenue — other                                                             |       | 11                                                  |       | 2 |   |
| Accrued liabilities                                                                       |       | (61                                                 | )          | 267 |   |
| Net cash  provided by operating activities                                                |       | 730                                                 |       | 113 |   |
|                                                                                      |       |                                                |       |   |   |
| Investing  activities:                                                                    |       |                                                |       |   |   |
| Purchase of investments                                                                   |       | (4,000                                              | )          | (8,400 | ) |
| Maturity of investments                                                                   |       | 5,400                                               |       | 1,500 |   |
| Purchase of equipment                                                                     |       | (69                                                 | )          | (32 | ) |
| Net cash  provided by (used for) investing activities                                     |       | 1,331                                               |       | (6,932 | ) |
|                                                                                      |       |                                                |       |   |   |
| Financing  activities:                                                                    |       |                                                |       |   |   |
| Net proceeds from sales of common shares                                                  |       | 108                                                 |       | 6 |   |
| Net cash  provided by financing activities                                                |       | 108                                                 |       | 6 |   |
|                                                                                      |       |                                                |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                             |       | 15                                                  |       | (48 | ) |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 2,184                                               |       | (6,861 | ) |
|                                                                                      |       |                                                |       |   |   |
| Cash and cash  equivalents at beginning of period                                         |       | 2,560                                               |       | 9,678 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                                   | 4,744      |   | $ | 2,817 |   |

 

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

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**PLCSYSTEMS INC.**

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2006

***1.             Nature of Business***

PLC Systems Inc. (“PLC” or the “Company”) is a medical device companyspecializing in innovative technologies for the cardiac and vascular markets.  The Company currently manufactures two lasersthat are used in the treatment of cardiovascular disease.  PLC pioneered the *CO**2** Heart Laser System* (“The Heart Laser System”) that cardiacsurgeons use to perform carbon dioxide (CO2)transmyocardial revascularization (“TMR”) to alleviate symptoms of severeangina.  The Company’s exclusivedistributor for TMR products in the United States is Edwards Lifesciences LLC (“Edwards”).  In addition, the Company manufactures theOptiwave 980 laser (“Optiwave 980”) under a supply agreement with Edwards.  The Optiwave 980 is expected to be utilizedby surgeons to ablate cardiac tissue as a means to treat certain heartarrhythmias.  As a result of theseexclusive distributor and supply arrangements, Edwards is the Company’s largestcustomer, accounting for 93% and 88% of the Company’s total sales in the threeand nine months ended September 30, 2006, respectively. Edwards is also theCompany’s largest shareholder, owning approximately 18% of its outstandingstock as of September 30, 2006.

Ina move to broaden its market beyond its current products, the Company recentlyannounced its intention to initiate clinical studies for its RenalGuardÔ Therapy andRenalGuardÔ System(collectively, “RenalGuard”). RenalGuard Therapy is designed to reduce thetoxic effects that contrast media can have on the kidneys.  This therapyis based on the theory that creating and maintaining a high urine output isbeneficial to patients undergoing imaging procedures where contrast agents areused.  The real-time measurement and matched fluid replacement design ofthe RenalGuard System is intended to ensure that a high urine flow ismaintained before, during and after these procedures, thus allowing the body torapidly eliminate contrast, reducing its toxic effects. The RenalGuard System,with its matched fluid replacement capability, is intended to minimize the riskof over or under hydration.

The Companyinitiated its first human clinical trial utilizing its RenalGuard System andTherapy in November 2006 after receiving a conditional investigational deviceexemption from the FDA in October 2006. This 40 patient pilot clinical trial isdesigned to evaluate the safety of the RenalGuard System and its ability toaccurately measure and balance fluid inputs and outputs on patients undergoinga catheterization imaging procedure where contrast media will be administered.

TheCompany hopes to be able to demonstrate through future clinical trials that itsRenalGuard System and Therapy are also safe and effective in preventingcontrast-induced nephropathy, a form of acute renal failure caused by exposureto contrast media for patients undergoing imaging procedures.

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

Theaccompanying unaudited condensed consolidated financial statements of theCompany have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally 

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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, 2006are not necessarily indicative of the results that may be expected for the yearending December 31, 2006.  Thesefinancial statements should be read in conjunction with the consolidatedfinancial statements and footnotes thereto included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2005.

***3.             Edwards Transaction***

In February 2004, the Company signed an agreementwith Edwards to assume development and manufacturing of the Optiwave 980 andrelated system disposables. In March 2006, the Company and Edwards terminatedthis agreement and entered into a new agreement. The Company received$1,500,000 in consideration for selling its Optiwave 980 system relateddisposable manufacturing and development rights to Edwards.  The Company will continue to be the exclusivemanufacturer of the current generation of Optiwave 980 laser console forEdwards and will have certain rights of first refusal related to the developmentand manufacture of any next generation laser. Separately, Edwards pays the Company a royalty on all future Optiwave980 system related disposable sales until such time that cumulative royaltypayments from Edwards reach $1,700,000. For each of the three and nine months ended September 30, 2006, theCompany recorded $4,000 and $12,000, respectively, of royalty revenue, which isincluded in the accompanying Condensed Consolidated Statements of Operations.

In conjunctionwith the sale of the Optiwave 980 disposable manufacturing rights, the Companywrote off certain inventory and capital assets acquired to manufacture theOptiwave 980 disposables.  The Companyrecorded a gain of $1,432,000 on the sale of its manufacturing rights in itsstatement of operations during the first quarter of 2006.  A summary of the components of this gain areas follows:

| Proceeds from sale of  manufacturing rights |   | $       | 1,500,000 |   |
|---------------------------------------------|--------|---------|-----------|--------|
| Net book value  of production equipment     |   | (52,000 | )         |
| Inventory                                   |   | (16,000 | )         |
| Gain on sale of  manufacturing rights       |   | $       | 1,432,000 |   |

 

***4.             Earnings (Loss) per Share***

For the threemonths ended September 30, 2006 and for the three and nine months endedSeptember 30, 2005, basic and diluted loss per share have been computed usingonly the weighted average number of common shares outstanding during the periodwithout giving effect toany potential future issuances of common stock related to stock option programsor warrants, since their inclusion would be antidilutive.

For the ninemonths ended September 30, 2006, basic earnings per share have been computedusing only the weighted average number of common shares outstanding during theperiod, while diluted earnings per share have been computed using the weightedaverage number of common shares outstanding during the period plus the effectof outstanding dilutive stock options using the treasury stock method.

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In calculatingdiluted earnings per share, the dilutive effect of stock options is computedusing the average market price for the respective period.  For the three months ended September 30, 2006and 2005, 5,036,410 and 4,718,422 shares, respectively, and for the nine monthsended September 30, 2006 and 2005, 5,036,410 and 4,718,422 shares, respectively,attributable to outstanding stock options were excluded from the calculation ofdiluted earnings (loss) per share because the effect was antidilutive.  For each of the three and nine months endedSeptember 30, 2005, 1,100,000 shares attributable to outstanding common stockwarrants were also excluded from the calculation of diluted loss per sharebecause the effect was antidilutive.  Thefollowing table sets forth the computation of basic and diluted earnings (loss)per share.
| ** **                                                                                             | ** ** | **Three Months Ended  September 30,**               | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2006**                                                           | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                             | ** ** | **(In thousands, except per share data)** | ** ** |
| Basic:                                                                                                 |       |                                                               |       |                                                |       |   |   |   |   |
| Net income (loss)                                                                                      |       | $                                                                  | (80        | )                                                   | $          | (397 | ) | $ | 1,283 |   | $ | (871 | ) |
| Weighted average  shares outstanding                                                                   |       | 30,237                                                             |       | 30,079                                              |       | 30,080 |   | 30,073 |   |
| Earnings (loss)  per share                                                                             |       | $                                                                  | (0.00      | )                                                   | $          | (0.01 | ) | $ | 0.04 |   | $ | (0.03 | ) |
| Diluted:                                                                                               |       |                                                               |       |                                                |       |   |   |   |   |
| Net income (loss)                                                                                      |       | $                                                                  | (80        | )                                                   | $          | (397 | ) | $ | 1,283 |   | $ | (871 | ) |
| Weighted average  shares outstanding                                                                   |       | 30,237                                                             |       | 30,079                                              |       | 30,080 |   | 30,073 |   |
| Assumed impact  of the exercise of outstanding dilutive stock options using the treasury  stock method |       | —                                                             |       | —                                              |       | 438 |   | — |   |
| Weighted average  common and common equivalent shares                                                  |       | 30,237                                                             |       | 30,079                                              |       | 30,518 |   | 30,073 |   |
| Earnings (loss) per  share                                                                             |       | $                                                                  | (0.00      | )                                                   | $          | (0.01 | ) | $ | 0.04 |   | $ | (0.03 | ) |

 

***5.             Stock-Based Compensation***

*StockOption and Stock Purchase Plans*

In May 2005, the Company adopted the 2005Stock Incentive Plan (the “2005 Plan”). The 2005 Plan has replaced the 1997 Executive Stock Option Plan, 2000Equity Incentive Plan, 2000 Non-Statutory Stock Option Plan and 2000Non-Qualified Performance and Retention Equity Plan (the “Previous Plans”),under which no further awards can be granted.

The number of stock options that may be granted under the 2005 Plan isequal to 2,156,175 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 oris forfeited in whole or in part or results in any common stock not beingissued, 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 options may beissued to non-employee directors, consultants, and others, as well as toemployees. The options granted under the 

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PreviousPlans and the 2005 Plan become exercisable either immediately, or ratably overone to four years from the date of grant, and expire ten years from the date ofgrant.

The Company grantsstock options to its non-employee directors. Generally, new non-employeedirectors receive an initial grant of an option to purchase 30,000 shares ofthe Company’s common stock that vests in installments over three years.  Once the initial grant has fully vested,non-employee directors other than the Chairman of the Board receive an annualgrant of an option to purchase 15,000 shares of the Company’s common stock thatgenerally vests either immediately or in four equal quarterly installments. TheChairman of the Board receives an annual grant of an option to purchase 30,000shares of the Company’s common stock that vests either immediately or in fourequal quarterly installments in the same manner as the options granted annuallyto the other non-employee directors. All such options have an exercise priceequal to the fair market value of the common stock on the date of grant.

The per share exercise price of an incentive stock option may not beless than the fair market value of the common stock on the date the option isgranted. The Company must grant non-qualified options at an exercise price ofat least 85% of the fair market value of the common stock.

The Company has a 2000 Employee Stock Purchase Plan (the “Purchase Plan”)for all eligible employees.  Prior toDecember 1, 2005, shares of the Company’s common stock could be purchased atsix-month intervals at 85% of the lower of the fair market value on the firstor the last day of each six-month period. On November 30, 2005, the Company adopted an amendment to thePurchase Plan which provides that the purchase price for each share of theCompany’s common stock purchased under the Plan will be 95% of the closingprice of the Company’s common stock on the last business day of the relevantplan period.  The change in the purchaseprice was effective beginning with the plan period commencing on December 1,2005. Employees may purchase shares having a value not exceeding 10% of theirgross compensation during an offering period, subject to certain additionallimitations. Under the Purchase Plan, employees of the Company purchased 631shares of common stock in 2006, 12,044 shares of common stock in 2005, and13,390 shares of common stock in 2004 at average prices of $0.62, $0.51 and$0.70 per share, respectively.  AtSeptember 30, 2006, 321,856 shares were reserved for future issuance under thePurchase Plan.

*Adoption of SFAS 123(R)*

Effective January 1, 2006, the Company adopted the fair valuerecognition provisions of Statement of Financial Accounting StandardsNo. 123(R), *Share-Based Payment*(“SFAS123(R)”)*,* using themodified-prospective transition method, which did not require restatement ofprior period results. Under this transition method, compensation expensetotaling $35,000 and $68,000, respectively, was recognized in the accompanyingstatement of operations for the three and nine months ended September 30, 2006.The compensation expense recorded includes (a) $22,000 of compensationcost in the nine months ended September 30, 2006 for all share-based paymentsgranted prior to, but not yet vested as of January 1, 2006, based on thegrant date fair value calculated in accordance with the original provisions ofStatement of Financial Accounting Standards No. 123, *Accountingfor Stock-based Compensation* (“SFAS 123”), and (b) $46,000 ofcompensation cost in the nine months ended September 30, 2006 for allshare-based payments granted subsequent to December 31, 2005, based on thegrant-date fair value estimated in accordance with the provisions of SFAS123(R). The Company estimates an 

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expectedforfeiture rate based on its historical forfeiture activity.  Actual results, and future changes inestimates, may differ substantially from the Company’s current estimates.  As of September 30, 2006, the Company had$246,000 of total unrecognized compensation cost related to its unvestedoptions, which is expected to be recognized over a weighted average period of 2.3years.

The weightedaverage fair value of options issued during the three and nine months endedSeptember 30, 2006 were estimated using the Black-Scholes model.

|                          | ** ** | **Three Months Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2006** | ** ** |
|--------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Expected life  (years)   |       | 6.00                                                           |       | 5.50-6.00                                                     |       |
| Interest rate            |       | 4.77                                                           | %          | 4.07-5.05                                                     | %          |
| Volatility               |       | 93.9                                                           | %          | 91.2-93.9                                                     | %          |
| Expected  dividend yield |       | None                                                           |       | None                                                          |       |
| Value of option granted  |       | $                                                              | 0.68       |                                                          | $          | 0.48-0.68 |   |
|                          |            |                                                                |            |                                                               |            |  |  |

 

The expected life is calculated 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.

*OptionsOutstanding*

The followingtable summarizes stock option activity during the nine months ended September30, 2006:
| ** **                                             | ** ** | **Number  of Options**                                              | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **(in thousands, except per option data)** | ** ** |
| Outstanding,  December 31, 2005                        |       | 4,688                                                               |       | $                                      | 1.19       |                                                             |       |                            |       |   |
| Granted                                                |       | 596                                                                 |       | 0.69                                   |       |                                                             |       |                            |       |
| Exercised                                              |       | (157                                                                | )          | 0.68                                   |       |                                                             |       |                            |       |
| Canceled                                               |       | (40                                                                 | )          | 0.88                                   |       |                                                             |       |                            |       |
| Cancellation upon termination of expired option  plans |       | (51                                                                 | )          | 4.90                                   |       |                                                             |       |                            |       |
| Outstanding,  September 30, 2006                       |       | 5,036                                                               |       | 1.11                                   |       | 6.35                                                             |       | $                               | 1,139      |   |
| Exercisable, September  30, 2006                       |       | 4,483                                                               |       | 1.16                                   |       | 5.95                                                             |       | 1,032                           |       |
|                                                        |            |                                                                     |            |                                        |            |                                                                  |            |                                 |            |  |  |

 

The aggregateintrinsic value amounts in the table above represent the difference between theclosing price of the Company’s common stock on September 30, 2006 and theexercise price, multiplied by the in-the-money stock options as of the samedate.  There were no stock optionsexercised during the three months ended September 30, 2006.

10

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Options grantedduring 2006 will vest ratably annually over a three year period for employeesand ratably quarterly over a one year period for non-employee directors.Options granted during 2005 to both employees and non-employee directors vestedimmediately upon granting.

The following table summarizes unvested shareactivity during the nine months ended September 30, 2006:

|                                | ** ** | **Number  of Options**                                               | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|--------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                     | ** ** | **(in thousands, except weighted average data)** | ** ** |
| Nonvested,  December 31, 2005  |       | 101                                                                       |       | $                                                       | 0.82       |   |
| Granted                        |       | 596                                                                       |       | 0.69                                                    |       |
| Vested                         |       | (117                                                                      | )          | 0.76                                                    |       |
| Canceled                       |       | (27                                                                       | )          | 0.86                                                    |       |
| Nonvested, September  30, 2006 |       | 553                                                                       |       | 0.69                                                    |       |
|                                |            |                                                                           |            |                                                         |            |  |

 

*Pro Forma Information for PeriodPrior to SFAS 123(R) Adoption*

The Company has historically granted stock optionsfor a fixed number of shares to employees and certain other individuals withexercise prices equal to the fair value of the shares at the dates of grant.Through December 31, 2005, the Company adopted the disclosure only provisionsof SFAS 123, and accounted for its stock option plans in accordance with theprovisions of Accounting Principles Board Opinion 25, *Accountingfor Stock Issued to Employees*(“APB Opinion No. 25”).  Under APB Opinion No. 25, compensationexpense with respect to such awards is not recognized if on the date the awardswere granted the exercise price was equal to or greater than the fair marketvalue of the underlying common shares.

The followingtable illustrates the effect on net loss and basic loss per share if theCompany had applied the fair value recognition provisions of SFAS 123 to stock-basedemployee compensation during the three and nine month periods ended September30, 2005.  For purposes of this pro formadisclosure, the value of the options is estimated using the Black-Scholesoption-pricing model and is being amortized to expense over the options’ vesting periods.

11

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| ** **                                                                                                           | ** ** | **Three Months Ended   September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **(In thousands, except per share data)**   | ** ** |
| Net loss  attributable to common stockholders—As reported                                                       |       | $                                                                    | (397       | )                                                             | $          | (871 | ) |
| Deduct total  stock-based compensation expense determined under fair value based method for  all stock option awards |       | (10                                                                  | )          | (176                                                          | )          |
| Net loss  attributable to common stockholders—Pro forma                                                         |       | $                                                                    | (407       | )                                                             | $          | (1,047 | ) |
| Loss per basic  and diluted share attributable to common stockholders—As reported                               |       | $                                                                    | (0.01      | )                                                             | $          | (0.03 | ) |
| Loss per basic and  diluted share attributable to common stockholders—Pro forma                                 |       | $                                                                    | (0.01      | )                                                             | $          | (0.03 | ) |

 

Thefair value of issued options at the date of grant was estimated using theBlack-Scholes model with the following weighted average assumptions:

|                         | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
|                    |       |                                                          |       |
| Expected life  (years)  |       | 3                                                             |       |
| Interest rate           |       | 3.68                                                          | %          |
| Volatility              |       | 40.7                                                          | %          |
| Expected dividend yield |       | None                                                          |       |

 

***6.             Comprehensive Income (Loss)***

Total comprehensive loss for the three months ended September 30, 2006was $78,000 and total comprehensive income for the nine months ended September30, 2006 was $1,296,000.  Totalcomprehensive loss for the three and nine months ended September 30, 2005 was$400,000 and $905,000, respectively. Comprehensive income (loss) is comprisedof net income (loss) plus the increase/decrease in currency translationadjustment.

***7.             Inventories***

Inventories are stated at the lowerof cost (computed on a first-in, first-out method) or market value and includeallocations of labor and overhead.  As ofSeptember 30, 2006 and December 31, 2005, inventories consisted of thefollowing (in thousands):

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|                  | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials    |       | $                            | 911        |                        | $          | 701 |   |
| Work in progress |       | 140                          |       | 67                          |       |
| Finished goods   |       | 113                          |       | 195                         |       |
|             |       | $                            | 1,164      |                        | $          | 963 |   |

 

At September 30, 2006 and December31, 2005, inventories are stated net of a reserve of $528,000 and $533,000,respectively, for potentially excess and obsolete inventory.

***8.             Revenue Recognition***

The Company records revenue from the sale of TMR kits and the Optiwave980 at the time of shipment to Edwards. TMR kit revenues include the amount invoiced to Edwards for kits shippedpursuant to purchase orders received, as well as an amortized portion ofdeferred revenue related to a payment of $4,533,333 received from Edwards inFebruary 2004.  This payment was made byEdwards in exchange for a reduction in the prospective purchase price theCompany receives from Edwards upon a sale of the kits.  The Company is amortizing this payment fromEdwards into its Consolidated Statement of Operations as revenue over a sevenyear period (culminating in 2010) under the units-of-revenue method asprescribed by Emerging Issues Task Force (EITF) 88-18, *Sales ofFuture Revenue*.  Managementdetermined that a seven year timeframe was the most appropriate amortizationperiod based on a valuation model they used to assess the economic fairness ofthe payment. Factors management considered in developing this valuation modelincluded the estimated foregone revenues over a seven year period resultingfrom the reduction in the prospective purchase price payable to the Company byEdwards, a discount rate deemed appropriate to this transaction and an estimateof the remaining economic useful life of the current TMR kit design, withoutany benefit being given to potential future product improvements the Companymay make.  Management reviews annually,and adjusts if necessary, the prospective revenue amortization rate for kitsbased on its best estimate of the total number of kits likely remaining to beshipped to hospital customers by Edwards through 2010.  Based on this, for the three and nine monthsended September 30, 2006 the Company recorded amortization of $158,000 and$483,000, respectively, as compared to $89,000 and $263,000, respectively, forthe three and nine months ended September 30, 2005.  These amounts are included in revenues in theConsolidated Statements of Operations for the respective periods.

TMR lasers are billed to Edwards in accordance with purchase ordersthat the Company receives.  Invoiced TMRlasers are 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.

Under the terms of the Edwards TMR distribution agreement, once Edwardshas recovered a prescribed amount of revenue from a hospital for the use orpurchase of a TMR laser, any additional revenues earned by Edwards are sharedwith the Company pursuant to a formula established in the distributionagreement. The Company only records its share of such additional revenue, ifany, at the time the revenue is earned.

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The Company records revenue from the sale of TMRkits and TMR lasers to international distributors or hospitals at the time ofshipment.

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

Installation revenuesrelated to a TMR laser transaction are recorded as a component of service feeswhen the laser is installed.

# ***9.             Warranty and PreventativeMaintenance Costs***

The Company warranties its products against manufacturing defects undernormal use and service during the warranty period.  The Company obtains similar warranties from amajority of its suppliers, including those who supply critical Heart LaserSystem components.  In addition, underthe terms of its TMR distribution agreement with Edwards, the Company is ableto bill Edwards for actual warranty costs, including preventative maintenanceservices, up to a specified amount during the warranty period.

The Company evaluates the estimated future unrecoverable costs ofwarranty and preventative maintenance services for its installed base of laserson a quarterly basis and adjusts its warranty reserve accordingly.  The Company considers all available evidence,including historical experience and information obtained from supplier audits.

Changes in thewarranty accrual were as follows (in thousands):

|                                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Balance, beginning of  period                              |       | $                                                   | 60         |   | $ | 60 |   |
| Payments made                                              |       | —                                              |       | — |   |
| Change in liability for  warranties issued during the year |       | —                                              |       | 10 |   |
| Change in liability for  preexisting warranties            |       | —                                              |       | (10 | ) |
| Balance, end of period                                     |       | $                                                   | 60         |   | $ | 60 |   |

 

**Item 2.        Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

This quarterlyreport (including certain information incorporated herein by reference)contains forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended (the “Exchange Act”). Statements containing terms suchas “believes”, “plans”, “expects”, “anticipates”, “intends”, “estimates” andsimilar expressions reflect uncertainty and are forward-looking statements.Forward-looking statements are based on 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.

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# **Overview**

We are amedical device company specializing in innovative technologies for the cardiacand vascular markets.  We currentlymanufacture two lasers that are used in the treatment of cardiovasculardisease.  Our Heart Laser Systems areused to treat patients with severe angina and the Optiwave 980 is used toablate cardiac tissue as a means to treat certain heart arrhythmias.

Ina move to broaden our market beyond our current products, we recently announcedour intention to initiate clinical studies for our RenalGuardÔ Therapy andRenalGuardÔ System.RenalGuard Therapy is designed to reduce the toxic effects that contrast mediacan have on the kidneys.  This therapy is based on the theory that creatingand maintaining a high urine output is beneficial to patients undergoingimaging procedures where contrast agents are used.  The real-time measurement and matched fluidreplacement design of our RenalGuard System is intended to ensure that a highurine flow is maintained before, during and after these procedures, thusallowing the body to rapidly eliminate contrast, reducing its toxic effects.The RenalGuard System, with its matched fluid replacement capability, isintended to minimize the risk of over or under hydration.

We initiated ourfirst human clinical trial utilizing our RenalGuard System and Therapy inNovember 2006 after receiving a conditional investigational device exemptionfrom the FDA in October 2006. This 40 patient pilot clinical trial is designedto evaluate the safety of the RenalGuard System and its ability to accuratelymeasure and balance fluid inputs and outputs on patients undergoing acatheterization imaging procedure where contrast media will be administered.

We hope to be ableto demonstrate through future clinical trials that our RenalGuard System andTherapy are also safe and effective in preventing contrast-induced nephropathy,a form of acute renal failure caused by exposure to contrast media for patientsundergoing imaging procedures.

Edwards is our exclusive distributor for TMR products in the UnitedStates and our largest customer. In addition, we manufacture the Optiwave 980for Edwards under a supply agreement. As a result of these exclusivedistributor and supply arrangements, Edwards accounted for approximately 93%and 88%, respectively, of our total sales in the three and nine months endedSeptember 30, 2006 and 89% in the year ended December 31, 2005.  We expect this sales trend to continue forthe near future.  We do not expect in thefuture to market RenalGuard through Edwards.

Approximately 95% and 96%, respectively, of ourrevenues in the three and nine months ended September 30, 2006 and 89% in theyear ended December 31, 2005 came from the sale and service of TMR lasers andrelated disposable kits. Although not a direct measure, we believe a leadingindicator of the adoption rate of TMR as a treatment for severe angina is TMRkit shipments to U.S. hospitals. TMR kit shipments to U.S. hospitals throughEdwards decreased approximately 2% and increased approximately 1%,respectively, in the three and nine months ended September 30, 2006 compared tothe three and nine months ended September 30, 2005. We remain largely dependenton the success of Edwards’ sales and marketing efforts to increase ourinstalled base of TMR lasers and increase TMR procedure volumes and revenues.

15

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Our management reviews a number of key performance indicators to assistthem in determining how to allocate resources and run our day to dayoperations. These indicators include (1) actual prior quarterly sales trends,(2) projected TMR laser and kit sales for the next four quarters, as providedby Edwards in a rolling twelve month sales forecast, (3) research anddevelopment progress as measured against internal project plan objectives, (4)budget to actual financial expenditure results, (5) inventory levels (both ourown and Edwards’) and (6) short term and long term projected cash flows of thebusiness.

# **Critical AccountingPolicies and Estimates**

Our financial statementsare based on the application of significant accounting policies, many of whichrequire us to make significant estimates and assumptions (see Note 2 to theConsolidated Financial Statements).  Webelieve that the following are some of the more material judgment areas in theapplication of our accounting policies that currently affect our financialcondition and results of operations.

# ***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.  A specific obsolescenceallowance is provided for slow moving, excess and obsolete inventory based onour best estimate of the net realizable value of inventory on hand taking into considerationfactors such as (1) actual trailing twelve month sales, (2) expected futureproduct line demand, based in part on sales forecast input received fromEdwards, 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.

# ***Allowance for Doubtful Accounts***

For our accounts receivable, we continuously monitor collections fromcustomers, our principal customer being Edwards, and we maintain a provisionfor estimated credit losses based upon historical experience and any specificcustomer collection issues that we have identified.  Historically, we have not experienced significantlosses related to our accounts receivable. Collateral is not generally required. If the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required.

# ***Warranty and Preventative Maintenance Costs***

We warranty our products against manufacturing defects under normal useand service during the warranty period. We obtain similar warranties from a majority of our suppliers, includingthose who supply critical Heart Laser System and Optiwave 980 components.  In addition, under the terms of our TMRdistribution agreement with Edwards, we are able to bill Edwards for actualwarranty costs, including preventative maintenance services, up to a specifiedamount during the warranty period.

We evaluate the estimated future unrecoverable costs of warranty andpreventative maintenance services for our installed base of lasers on aquarterly basis and adjust our warranty reserve accordingly.  We consider all available evidence, includinghistorical experience and 

16

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informationobtained from supplier audits.

## ***Revenue Recognition***

We record revenue from the sale of TMR kits and the Optiwave 980 at thetime of shipment to Edwards.  TMR kitrevenues include the amount invoiced to Edwards for kits shipped pursuant topurchase orders received, as well as an amortized portion of deferred revenuerelated to Edwards’ payment to us of $4,533,333 in February 2004. This paymentwas made by Edwards in exchange for a reduction in the prospective purchaseprice we receive from Edwards upon a sale of the kits. We are amortizing thispayment from Edwards into our Consolidated Statement of Operations as revenueover a seven year period (culminating in 2010) under the units-of-revenuemethod as prescribed by Emerging Issues Task Force (EITF) 88-18, *Sales of Future Revenue*. We determined that a seven yeartimeframe was the most appropriate amortization period based on a valuationmodel we used to assess the economic fairness of the payment. Factors weconsidered in developing this valuation model included the estimated foregonerevenues over a seven year period resulting from the reduction in theprospective purchase price payable to us by Edwards, 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 we may make.  Management 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 Edwards through 2010.  Basedon this, for the three and nine months ended September 30, 2006, we recordedamortization of $158,000 and $483,000, respectively, as compared to $89,000 and$263,000, respectively, for the three and nine months ended September 30, 2005.These amounts are included in revenues in our Consolidated Statements ofOperations for the respective periods.

TMR lasers are billed to Edwards in accordance with purchase ordersthat we receive.  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.

Under the terms of the Edwards TMR distribution agreement, once Edwardshas recovered a prescribed amount of revenue from a hospital for the use orpurchase of a TMR laser, any additional revenues earned by Edwards are sharedwith us pursuant to a formula established in the distribution agreement. Weonly record our share of such additional revenue, if any, at the time therevenue is earned.

We record revenue from thesale of TMR kits and TMR lasers to international distributors or hospitals atthe time of shipment.

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

Installation revenuesrelated to a TMR laser transaction are recorded as a component of service feeswhen the laser is installed.

17

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**Stock Based Compensation**

Effective January 1, 2006, we adopted the fair valuerecognition provisions of SFAS 123(R) using the modified-prospective transitionmethod, which did not require restatement of prior period results. Under thistransition method, compensation expense totaling $35,000 and $68,000,respectively, was recognized in our statement of operations for the three andnine months ended September 30, 2006. The compensation expense recordedincludes (a) $22,000 of compensation cost in the nine months ended September30, 2006 for all share-based payments granted prior to, but not yet vested asof January 1, 2006, based on the grant date fair value calculated in accordancewith the original provisions SFAS 123, and (b) $46,000 of compensation cost inthe nine months ended September 30, 2006 for all share-based payments grantedsubsequent to December 31, 2005, based on the grant-date fair value estimatedin accordance with the provisions of SFAS 123(R). As of September 30, 2006, wehad $246,000 of total unrecognized compensation cost related to our unvestedoptions, which is expected to be recognized over a weighted average period of2.3 years.

The valuation of employee stock options is aninherently subjective process, since market values are generally not availablefor long-term, non-transferable employee stock options. Accordingly, an optionpricing model is utilized to derive an estimated fair value. In calculating theestimated fair value of our stock options, we used the Black-Scholes pricingmodel which requires the consideration of six variables for purposes ofestimating fair value which include the stock option exercise price, the grantdate price of our common stock, the expected life of the option, the risk freeinterest rate for the expected option life, the expected volatility of ourcommon stock and****the expecteddividends on our common stock.  Theexpected life is calculated using the simplified method.  The risk-free interest rate is based on the U.S.Treasury yield curve in effect at the time of the grant for the expected termperiod.  Expected volatility is basedexclusively on historical volatility data on our common stock. The dividendyield percentage is zero because we do not currently pay dividends nor intendto do so during the expected option life.

## **Results of Operations**

Results for thethree and nine months ended September 30, 2006 and 2005 and the related percentof revenues were as follows:
| ** **                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **$**                                                | ** ** | **%**                                               | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**                 | ** ** |
|                                   |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                         |       | 1,567                                                |       | 100                                                 |       | 1,900 |   | 100 |   | 5,399 |   | 100 |   | 5,825 |   | 100 |   |
| Total cost of revenues                 |       | 590                                                  |       | 38                                                  |       | 815 |   | 43 |   | 2,003 |   | 37 |   | 2,333 |   | 40 |   |
| Gross profit                           |       | 977                                                  |       | 62                                                  |       | 1,085 |   | 57 |   | 3,396 |   | 63 |   | 3,492 |   | 60 |   |
| Selling, general &  administrative |       | 786                                                  |       | 50                                                  |       | 739 |   | 39 |   | 2,470 |   | 46 |   | 2,516 |   | 43 |   |
| Research &  development            |       | 394                                                  |       | 25                                                  |       | 810 |   | 43 |   | 1,385 |   | 26 |   | 2,030 |   | 35 |   |
| Total operating  expenses              |       | 1,180                                                |       | 75                                                  |       | 1,549 |   | 82 |   | 3,855 |   | 71 |   | 4,546 |   | 78 |   |
| Gain on sale of  manufacturing assets  |       | —                                               |       | —                                              |       | — |   | — |   | 1,432 |   | 27 |   | — |   | — |   |
| Income (loss) from  operations         |       | (203                                                 | )          | (13                                                 | )          | (464 | ) | (24 | ) | 973 |   | 18 |   | (1,054 | ) | (18 | ) |
| Other income                           |       | 123                                                  |       | 8                                                   |       | 67 |   | 4 |   | 310 |   | 6 |   | 183 |   | 3 |   |
| Net income (loss)                      |       | (80                                                  | )          | (5                                                  | )          | (397 | ) | (21 | ) | 1,283 |   | 24 |   | (871 | ) | (15 | ) |

 

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| ** **                                      | ** ** | **Three Months Ended  September 30,** | ** ** | ** ** | ** ** | **Nine Months Ended  September 30,** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|-----------------------------------------------------|------------|------------|------------|
| ** **                                      | ** ** | **2006**                                             | ** ** | **2005**   | ** ** | **Increase (decrease)  over 2005**        | ** ** | **2006**   | ** ** | **2005** | ** ** | **Increase (decrease)  over 2005** | ** ** |
| ** **                                      | ** ** | **$**                                                | ** ** | **$**      | ** ** | **$**                                               | ** ** | **%**      | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                      | ** ** | **(dollars in thousands)**                 | ** ** |
|                                            |       |                                                 |       |       |       |                                                |       |       |       |   |   |   |   |   |   |   |   |
| Product sales                                   |       | 1,205                                                |       | 1,535      |       | (330                                                | )          | (21        | )          | 4,262 |   | 4,660 |   | (398 | ) | (9 | ) |
| Service fees                                    |       | 362                                                  |       | 365        |       | (3                                                  | )          | (1         | )          | 1,137 |   | 1,165 |   | (28 | ) | (2 | ) |
| Total revenues                                  |       | 1,567                                                |       | 1,900      |       | (333                                                | )          | (18        | )          | 5,399 |   | 5,825 |   | (426 | ) | (7 | ) |
| Product cost of sales                           |       | 422                                                  |       | 632        |       | (210                                                | )          | (33        | )          | 1,487 |   | 1,784 |   | (297 | ) | (17 | ) |
| Service fees cost of  sales                     |       | 168                                                  |       | 183        |       | (15                                                 | )          | (8         | )          | 516 |   | 549 |   | (33 | ) | (6 | ) |
| Total cost of revenues                          |       | 590                                                  |       | 815        |       | (225                                                | )          | (28        | )          | 2,003 |   | 2,333 |   | (330 | ) | (14 | ) |
| Gross profit                                    |       | 977                                                  |       | 1,085      |       | (108                                                | )          | (10        | )          | 3,396 |   | 3,492 |   | (96 | ) | (3 | ) |
| Selling, general &  administrative expenses |       | 786                                                  |       | 739        |       | 47                                                  |       | 6          |       | 2,470 |   | 2,516 |   | (46 | ) | (2 | ) |
| Research &  development expenses            |       | 394                                                  |       | 810        |       | (416                                                | )          | (51        | )          | 1,385 |   | 2,030 |   | (645 | ) | (32 | ) |
| Total operating  expenses                       |       | 1,180                                                |       | 1,549      |       | (369                                                | )          | (24        | )          | 3,855 |   | 4,546 |   | (691 | ) | (15 | ) |
| Gain on sale of  manufacturing assets           |       | —                                               |       | —     |       | —                                              |       | —     |       | 1,432 |   | — |   | 1,432 |   | 100 |   |
| Income (loss) from  operations                  |       | (203                                                 | )          | (464       | )          | 261                                                 |       | 56         |       | 973 |   | (1,054 | ) | 2,027 |   | 192 |   |
| Other income                                    |       | 123                                                  |       | 67         |       | 56                                                  |       | 84         |       | 310 |   | 183 |   | 127 |   | 69 |   |
| Net income (loss)                               |       | (80                                                  | )          | (397       | )          | 317                                                 |       | 80         |       | 1,283 |   | (871 | ) | 2,154 |   | 247 |   |

 

***Product Sales***

TMR laser revenues, the largest component of product sales in the threemonths ended September 30, 2006, decreased by $438,000, or 52%, as compared tothe three months ended September 30, 2005. Domestic TMR laser revenues decreased $388,000, or 49%, as a result of adecrease in the number of new TMR lasers sold by Edwards, as well as decreasedrevenue sharing earned under the TMR distribution agreement with Edwards.  International TMR laser revenues decreased$50,000, from $50,000 to $0, due to the sale of a single used laser to aninternational customer in the three months ended September 30, 2005.

In the nine months ended September 30, 2006, TMR laser revenuesdecreased by $302,000, or 14%, as compared to the nine months ended September30, 2005.  Domestic TMR laser revenuesdecreased $510,000, or 24%, as a result of a decrease in the number of new TMRlasers sold by Edwards, as well as decreased revenue sharing earned under theTMR distribution agreement with Edwards. International TMR laser revenues increased $208,000, from $60,000 to$278,000, due to one additional laser sale to international customers in thenine months ended September 30, 2006.

Disposable TMR kit revenues, the second largest component of productsales, increased by $156,000, or 28%, in the three months ended September 30,2006 as compared to the three months ended September 30, 2005.  Domestic TMR kit revenues increased $129,000,or 23%, as 

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aresult of (1) a $69,000 increase in deferred revenue amortization related tothe $4,533,333 payment by Edwards in 2004 and (2) a higher volume of kitshipments to Edwards. International disposable TMR kit revenues increased$27,000 as a result of a sale to one customer in the three months endedSeptember 30, 2006.

In the nine months ended September 30, 2006, disposable TMR kitrevenues increased by $350,000, or 20%, as compared to the nine months endedSeptember 30, 2005.  Domestic TMR kitrevenues increased $368,000, or 22%, as a result of (1) a $220,000 increase indeferred revenue amortization related to the $4,533,333 payment by Edwards and(2) a higher volume of kit shipments to Edwards.  International disposable TMR kit revenuesdecreased $18,000, or 18%, as a result of a lower volume of kit shipments tointernational customers.

Optiwave 980 revenues to Edwards were $20,000 in the three months endedSeptember 30, 2006 as compared to $0 in the three months ended September 30,2005, as no Optiwave 980 units were sold to Edwards in the three months endedSeptember 30, 2005. Optiwave 980 revenues to Edwards decreased $325,000, or94%, in the nine months ended September 30, 2006 as compared to the nine monthsended September 30, 2005, due to a lower volume of Optiwave 980 units shippedto Edwards in the nine months ended September 30, 2006.  Under our new supply agreement withEdwards that we entered into in March 2006, Edwards has agreed to purchaseany additional units of the current generation of Optiwave 980 exclusively fromus.  We believe that our future revenuesfrom sales of this current generation laser will not exceed $980,000 and may beless, depending in part on demand for that product and when, if ever, Edwardschooses to introduce its next generation laser to the market.  We have a right of first refusal to developand manufacture any next generation laser for Edwards; however, at this time wehave not had discussions with Edwards regarding any such successor product.

Other product sales, relating to sales of new and refurbished generalpurpose surgical laser tubes, decreased $68,000, or 54%, and 121,000, or 36%,respectively, in the three and nine months ended September 30, 2006 as comparedto the three and nine months ended September 30, 2005.

***Service Fee Revenues***

Service fee revenues decreased $3,000, or 1%, in the three months endedSeptember 30, 2006 as compared to the three months ended September 30,2005.  Domestic service fees increased$25,000, or 8%, due to increased billings to Edwards for service related callsand increased revenues generated from service contracts. International servicefees decreased $28,000, or 53%, due to a decrease in billings to a singleinternational customer whose HL2 laser was removed.

Service fee revenues decreased $28,000, or 2%, in the nine months endedSeptember 30, 2006 as compared to the nine months ended September 30,2005.  Domestic service fees increased$50,000, or 5%, due to increased billings to Edwards for service related callsand increased revenues generated from service contracts. International servicefees decreased $78,000, or 43%, due to a decrease in billings to a singleinternational customer whose HL2 laser was removed.

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***Gross Profit***

Total gross profit was $977,000, or 62% of total revenues, for thethree months ended September 30, 2006 as compared with gross profit of$1,085,000, or 57% of total revenues, for the three months ended September 30,2005.  The improved gross profitpercentage is the result of a better overall sales mix of our products, mostnotably higher TMR kit revenues.  Thedecrease in gross profit dollars is due to (1) a decrease in additional revenuesharing on lasers earned under the TMR distribution agreement with Edwards, (2)a decrease in the number of new domestic TMR lasers sold, (3) lower revenuesfrom new and refurbished general purpose surgical tubes, (4) an increase in theinventory obsolescence reserve and (5) lower international TMR laserrevenues.  These decreases were offset inpart by (1) higher disposable TMR kit revenues, (2) reduced service costs and(3) an increase in Optiwave 980 revenues.

Total gross profit was $3,396,000, or 63% of total revenues, for thenine months ended September 30, 2006 as compared with gross profit of$3,492,000, or 60% of total revenues, for the nine months ended September 30,2005.  The improved gross profitpercentage is the result of a better overall sales mix of our products, mostnotably higher TMR kit revenues.  Thedecrease in gross profit dollars is due to (1) a decrease in additional revenuesharing earned under the TMR distribution agreement with Edwards, (2) lowerrevenues from new and refurbished general purpose surgical tubes, (3) adecrease in Optiwave 980 revenues, (4) a decrease in the number of new domesticTMR lasers sold and (5) an increase in the inventory obsolescence reserve.  These decreases were offset in part by (1)higher disposable TMR kit revenues, (2) reduced service costs and (3) higherinternational TMR laser sales.

***Selling, General and AdministrativeExpenses***

Selling, generaland administrative expensesincreased 6% and decreased 2%, respectively, in the three and nine months endedSeptember 30, 2006 as compared to the three and nine months ended September 30,2005.  The increase in the three monthsended September 30, 2006 is related to increased incentive compensation and baddebt expense offset in part by lower legal expenses and corporateexpenditures.  The decrease in the ninemonths ended September 30, 2006 is related to lower corporate, legal andincentive compensation offset in part by increased consulting and bad debtexpenses.

***Research and Development Expenses***

Research and development expenditures decreased 51% and 32%,respectively, in the three and nine months ended September 30, 2006 as comparedto the three and nine months ended September 30, 2005.  There was a decrease in expenditures inconnection with both the Optiwave 980 and RenalGuard projects.

We expect to continue to incur significant new research and developmentexpenditures for the remainder of 2006 and future years in pursuit of ourbusiness strategy to broaden and diversify our product portfolio beyond ourcurrent product offerings. Ourcurrent and near term development efforts in pursuit of this business strategyare focused on performing clinical trials of our newest product, RenalGuard,which should result in increased research and development expenditures through2008.

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***Gain on Sale of Manufacturing Rights***

In March 2006, we received $1,500,000 related to the sale of ourOptiwave 980 System disposable manufacturing and development rights to Edwards(See Note 3 to the consolidated financial statements). In conjunction with thistransaction, we wrote off certain inventory and capital assets acquired tomanufacture the Optiwave 980 disposables, and we recorded a gain of $1,432,000on the sale of our manufacturing rights in our statement of operations duringthe first quarter of 2006.  A summary ofthe components of this gain are outlined below:

| Proceeds from sale of  manufacturing rights |   | $       | 1,500,000 |   |
|---------------------------------------------|--------|---------|-----------|--------|
| Net book value of production  equipment     |   | (52,000 | )         |
| Inventory                                   |   | (16,000 | )         |
| Gain on sale of manufacturing rights        |   | $       | 1,432,000 |   |

 

***Other Income***

The largest component of other income is interest income earned on ourcash, cash equivalents and short-term investments. Interest income increased$56,000, or 84%, and $127,000, or 69%, respectively, in the three and ninemonths ended September 30, 2006 as compared to the three and nine months endedSeptember 30, 2005 due to higher interest rates earned on our cash, cashequivalents and short-term investments and higher investable balances.

***Net Income (Loss)***

In the threemonths ended September 30, 2006, we recorded net loss of $80,000 as compared toa net loss of $397,000 in the three months ended September 30, 2005.  This decrease in the net loss is primarily aresult of lower operating expenses and higher other income in the three monthsended September 30, 2006 as compared to the three months ended September 30,2005.

In the firstquarter, we recorded a gain of $1,432,000 from the sale of our Optiwave 980disposable manufacturing rights to Edwards. This non-recurring gain resulted in our recording net income for thenine months ended September 30, 2006 of $1,283,000, as compared to a net lossof $871,000 for the nine months ended September 30, 2005.

***Kit Shipments***

We view disposable kit shipments to end users as an important metric inevaluating our business.  We believe thatkit shipments (particularly kit shipments to U.S. hospitals), although not adirect measure, are a reasonable indicator for the adoption of TMR as a therapyin the marketplace.  Disposable kitshipments to end users are as follows:

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| ** **    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                                 | ** ** | **2005**                                                | ** ** | **% Increase  (Decrease)  over 2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **% Increase  (Decrease)  over 2005** | ** ** |
|          |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Domestic      |       | 502                                                      |       | 513                                                     |       | (2 | ) | 1,530 |   | 1,518 |   | 1 |   |
| International |       | 13                                                       |       | 15                                                      |       | (13 | ) | 38 |   | 70 |   | (46 | ) |
| Total         |       | 515                                                      |       | 528                                                     |       | (2 | ) | 1,568 |   | 1,588 |   | (1 | ) |

 

We believe the overalllimited growth in TMR kit shipments in recent years may be partly attributableto what we believe may be an ongoing downward trend in the number of heartbypass surgeries being performed. We believe the proliferation in the number ofinterventional cardiac procedures being performed, particularly with the recentadvent of drug eluting stents, is causing a delay in the number of patientsbeing referred to cardiac surgeons for treatment of their cardiovasculardisease. Because a significantnumber of the total TMR procedures performed each year by cardiac surgeons aredone in combination with bypass surgery, we believe the growth in the number ofTMR procedures may be being adversely impacted by this reduction in the numberof bypass surgeries being performed.

**Liquidity and Capital Resources**

Cash, cash equivalents and short-term investments totaled $10,244,000as of September 30, 2006, an increase of $784,000 from $9,460,000 as ofDecember 31, 2005.  Our short-terminvestments consist of monies invested in bank certificates of deposit.  We have no debt obligations. We believe thatour existing cash resources will meet our working capital requirements throughat least the next 12 months.

Cash provided by operating activities in the nine months endedSeptember 30, 2006 was $730,000 due to our net income (including from the saleof the Optiwave 980 manufacturing rights) and non-cash depreciation,amortization, loss on retirement of equipment and compensation expense relatedto stock options, partially offset by overall unfavorable working capitalchanges. Additional cash was provided by net proceeds from the sales of commonshares of $108,000 and the effect of foreign exchange rate changes totaling$15,000.  We used $69,000 for thepurchase of equipment.

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

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Some hospital customersprefer to acquire the Heart Laser Systems on a usage basis rather than as acapital equipment purchase.  We believethis is the result of limitations many hospitals currently have on acquiringexpensive capital equipment as well as competitive pressures in themarketplace.  A usage business model willresult in a longer recovery period for Edwards to recoup its investment inlasers it purchases from us.  Thisresults in (1) a delay in our ability to receive additional shared revenue, ifany, that we otherwise are entitled to receive under the terms of ourdistribution agreement with Edwards (see “Critical Accounting Policies andEstimates — Revenue Recognition”) and (2) a delay in the purchase of new lasersby Edwards if its installed base of lasers placed under usage contracts areunder-performing and it chooses to re-deploy these lasers to other hospitalsites in lieu of purchasing a new laser from us.  Our cash position and our need for additionalfinancing to fund operations will be dependent in part upon the number ofhospitals that acquire Heart Laser Systems from Edwards on a usage basis andthe number and frequency of TMR procedures performed by these hospitals.

Furthermore, we haveundertaken a new business strategy that involves broadening and diversifyingour product portfolio beyond our current offerings, by developing or acquiringnew and innovative medical devices to address cardiac and vascular relatedmarkets. Our current and near term development efforts in pursuit of thisbusiness strategy are focused on performing clinical trials of our newestproduct, RenalGuard.  We believe thisstrategy will result in our incurring losses at least through 2008 as weincrease our research and development spending in order to conduct the clinicaltrials we believe are necessary to successfully market RenalGuard.  We cannot be certain that we will besuccessful in implementing our business strategy or that future sales, if any,of RenalGuard or other potential new products will recover the investments weplan to make. If we are unsuccessful in implementing our business strategy, orif the diversification of our product portfolio takes longer or costs more thananticipated, our liquidity and capital resources will be adversely affected andwe may need to obtain additional financing.

There can be no assurance that, should we requireadditional financing, such financing will be available on terms and conditionsacceptable to us, if at all.  Shouldadditional financing not be available on terms and conditions acceptable to us,additional actions may be required that could adversely impact our ability tocontinue to realize assets and satisfy liabilities in the normal course ofbusiness.  The consolidated financialstatements set forth in this report do not include any adjustments to reflectthe possible future effects of these uncertainties.

**Off-BalanceSheet Arrangements**

None.

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

A portion of our operationsconsists of sales activities in foreign jurisdictions.  We manufacture our products exclusively inthe U.S. and sell our products in the U.S. and abroad. As a result, ourfinancial results could be affected by factors such as changes in foreign currencyexchange rates or weak economic conditions in the foreign markets in which wedistribute our products.  Our operatingresults are exposed to changes in exchange rates between the U.S. dollar andforeign currencies, especially the Euro. When the U.S. dollar strengthensagainst the Euro, the value of foreign sales decreases. When the U.S. dollarweakens, the value of foreign sales increases. No assurance can be given thatforeign currency fluctuations in the future will not adversely affect

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our business, financial condition and results ofoperations, although at present we do not believe that our exposure issignificant, as international sales represented only 4% and 9%, respectively,of our consolidated sales in the three and nine months ended September 30, 2006and 6% in the year ended December 31, 2005. We do not hedge any balance sheetexposures and intercompany balances against future movements in foreignexchange rates.

Our interest income and expense are sensitive to changes in the generallevel of U.S. and foreign interest rates. In this regard, changes in U.S. andforeign interest 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.        Controls andProcedures**

Our management, with the participation of our chief executive officerand chief financial officer, evaluated the effectiveness of our disclosurecontrols and procedures as of September 30, 2006. The term “disclosure controlsand procedures”, as defined in Rules 13a-15(e) and 15d-15(e) under the ExchangeAct, means controls and other procedures of a company that are designed toensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms.  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.  Basedon the evaluation of our disclosure controls and procedures as of September 30,2006, 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.

No change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)under the Exchange Act) occurred during the fiscal quarter ended September 30,2006 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**Part II.  Other Information**

**Item 1A.         RiskFactors**

## **CertainFactors that May Affect our Future Results**

The risks and uncertainties described below are not the only risks weface.  Additional risks and uncertaintiesnot presently 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.

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

We incurred a net loss in the quarter endedSeptember 30, 2006 and we expect to continue to incur net losses in futurequarters, at least through 2008, as we increase our research and developmentspending on clinical studies of RenalGuard. We cannot provide any assurancethat we will be successful with our business strategy, that RenalGuard willreceive FDA approval or commercial acceptance, or that we will ever return toprofitability.

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

Pursuant to the terms of our TMR distribution agreement with Edwards,Edwards is our exclusive distributor for our HL2 TMR laser and TMR kits in theUnited States.  In addition, we are theexclusive manufacturer of the current version of the Optiwave 980 laser consolefor Edwards.  As a result of these exclusivearrangements, Edwards accounted for 93% and 88%, respectively, of our totalrevenues in the three and nine months ended September 30, 2006 and 89% in theyear ended December 31, 2005, and we expect Edwards to account for thesignificant majority of our revenue in the near future.  If our relationship with Edwards does notprogress as anticipated, or if Edwards’ sales and marketing strategies fail togenerate sales of our products in the future, our revenue will decreasesignificantly and our business, financial condition and results of operationswill be seriously harmed.

***Our company iscurrently dependent on one principal product line to generate revenues.***

We currently sell one principal product line, whichconsists of two patented high-powered carbon dioxide lasers and related TMRdisposable kits known as the Heart Laser Systems, which account for themajority of our total revenue. Approximately 95% and 96%, respectively, of our revenues in the threeand nine months ended September 30, 2006 and 89% in the year ended December 31,2005, were derived from the sales and service of our Heart Laser Systems.  This absence of a diversified product linemeans that we are directly and materially impacted by changes in the market forHeart Laser Systems.

***Our ability to realize futurerevenues from the Optiwave 980 is dependent upon Edwards successfully launchingthis new product into an existing market with a new sales team.***

Edwards has only recently completed its marketingevaluations of the Optiwave 980 System and, as a result, has a limited amountof experience selling this new product into the U.S. market.  Edwards must effectively train a new salesteam to market the Optiwave 980 System and faces significant competition fromseveral other companies that have been selling competitive non-laser basedtechnologies for several years.  Wecannot assure you that Edwards will successfully commercialize the Optiwave 980System or that we will ever receive any or all of the royalty revenue wenegotiated to receive from the sale of disposable products under our royaltyagreement with Edwards.

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

Some of the components forour Heart Laser Systems, most notably the power supply and certain optics andfabricated parts for the HL2, and certain components for the Optiwave 980

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System, are only available from one supplier, and wehave no assurance that we will be able to source any of our sole-sourcedcomponents from additional suppliers.  Weare dependent upon our sole suppliers to perform their obligations in a timelymanner.  In the past, we have experienceddelays in product delivery from our sole suppliers and, because we do not havean alternative supplier to produce these products for us, we have littleleverage to enforce timely delivery. Any delay in product delivery or otherinterruption in supply from these suppliers could prevent us from meeting ourcommercial demands for our products, which could have a material adverse effecton our business, 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 dependentupon our key personnel and will need to hire additional key personnel in thenear future.***

Our ability to operate our business successfullydepends in significant part upon the retention and motivation of certain keytechnical, regulatory, clinical, marketing, production and managerial personneland consultants and our ongoing ability to hire and retain additional qualifiedpersonnel 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.

***Our company may be unable to raise needed funds.***

As of September 30, 2006, we had cash, cashequivalents and short-term investments totaling $10,244,000. Based on ourcurrent operating plan, we anticipate that our existing capital resourcesshould be sufficient to meet our working capital requirements for at least thenext 12 months.  However, if our businessdoes not progress in accordance with our current business plan, we may need toraise additional funds in the future.  Wemay not be able to raise additional capital upon satisfactory terms, or at all,and our business, financial condition and results of operations could bematerially and adversely affected.  Tothe extent that we raise additional capital by issuing equity or convertiblesecurities, 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.

***In order tocompete effectively, our current and future products need to gain commercialacceptance.***

TMR and surgical ablation for cardiac arrhythmiasare still both novel technologies.  Ourcurrent and planned future products may never achieve widespread commercialacceptance.  To be successful, we andEdwards need to:

·                  demonstrate to the medical community ingeneral, and to heart surgeons and cardiologists in particular, that TMR andsurgical tissue ablation for cardiac arrhythmias are procedures that areeffective, relatively safe and cost effective;

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·                  support third-party efforts to document themedical processes by which TMR procedures relieve angina and surgical tissueablation cures cardiac arrhythmias;

·                  have more heart surgeons trained to performTMR procedures using the Heart Laser Systems and surgical tissue ablationprocedures using the Optiwave 980 System; and

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

To date, only a limited number of heart surgeonshave been trained in the use of TMR using the Heart Laser Systems and cardiactissue ablation procedures using the Optiwave 980 System.  We are dependent on Edwards to expand relatedmarketing and training efforts in the U.S. for the use of our products.

The Heart Laser Systems have not yet receivedwidespread commercial acceptance.  Webelieve that concerns over the lack of a consensus view on the reason orreasons why a TMR procedure relieves angina in patients who undergo theprocedure has limited demand for and use of the Heart Laser Systems. Untilthere is consensus, if ever, of the medical processes by which TMR proceduresrelieve angina, we believe some hospitals may delay the implementation of a TMRprogram.

If we are unable to achieve widespread commercialacceptance of the Heart Laser Systems or the Optiwave 980 System, our business,financial condition and results of operations will be materially and adverselyaffected.

***Our newest product, RenalGuard, isstill undergoing development and we have only recently begun to test it in aclinical setting as part of our initial pilot clinical study.***

We have onlyrecently completed the first generation product design for our RenalGuardSystem and we have just begun testing the device in a clinical hospital settingas part of our pilot human clinical study. We may need to make substantialmodifications to the design, features or functions of our device in order forit to obtain FDA approval or meet customer expectations. These changes may notbe able to be completed in a timely fashion, if at all. Should any suchmodifications prove to be significantly more costly or time consuming toengineer than we estimate, our ability to bring this product to market may beseverely and negatively impacted.

***Our planned future clinical trialsto study the safety and effectiveness of RenalGuard in preventing contrast-inducednephropathy will take us a significant amount of time to complete, if we cancomplete them at all, and the results of these clinical trials may not showsufficient safety and efficacy for us to either obtain FDA approval orotherwise be able to successfully market and sell the product.***

Ourbusiness strategy to grow our revenues and profitability is largely dependenton our success in timely completing our planned future clinical trials ofRenalGuard. We hope to be able to demonstrate through clinical trials thatRenalGuard is safe and effective in preventing contrast-induced nephropathy (“CIN”),a form of acute renal failure caused by exposure to contrast media for patientsundergoing imaging procedures.

We can provide no assurance that when studied in humans RenalGuard willbe shown to be safe or effective in preventing CIN, or that the degree of anypositive safety and efficacy

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resultswill be sufficient to either obtain FDA approval or otherwise successfullymarket our product. Furthermore, the completion of our planned clinical trialsis dependent upon many factors, some of which are not entirely within ourcontrol, including, but not limited to, our ability to successfully recruitinvestigators, the availability of patients meeting the inclusion criteria ofour clinical study, the competition for these particular study patients amongstother clinical trials being conducted by other companies at these same studysites, the ability of the sites participating in our study to successfullyenroll patients in our trial, and proper data gathering on the part of theinvestigating sites.

Should our clinical trials take longer than weexpect, our competitive position relative to existing preventative measures, orrelative to new devices, drugs or therapies that may be developed, could beseriously harmed and our ability to successfully fund the completion of thetrials and bring RenalGuard to market may be adversely affected.

***We will need to build a direct salesand marketing organization or otherwise enter into one or more distributionarrangements in order to market our RenalGuard System if and when it isapproved for sale.***

We currently donot have a direct sales force. Instead, we market our existing productsprimarily through Edwards in the United States and through independentdistributors outside the U.S.  We do notplan to use Edwards to market our RenalGuard product if and when it becomescommercially available to customers. We will need to either build an internaldirect sales and marketing organization or find distribution partners in orderto successfully market our RenalGuard System.

If we choose tobuild a direct sales force, we may not be able to attract qualified individualswith the requisite training or experience to sell our product. In addition, wewould need to devote substantial management time instituting policies,procedures and controls to oversee and effectively manage this new part of ourorganization, which could adversely impact our daily operations and wouldrequire us to invest significant financial resources, the cost of which couldbe prohibitive.

If we insteadchoose to pursue an indirect distribution strategy, we may not be able toidentify suitable distribution partners with sufficient industry experience,brand recognition, sales capacity and willingness/ability to maximize sales.Further, we may not be able to negotiate distribution agreements with terms andconditions that are acceptable to us, including ensuring that our productreceives adequate sales force focus and attention.

***Our primary competitor in TMR mayobtain FDA approval to market a new device, the impact of which is uncertain onthe future adoption rate of TMR.***

Our primary TMR competitor, CardioGenesis, is attempting to obtain FDAapproval to market their “percutaneous” method of performing myocardialrevascularization, previously known as PMR, and recently rebranded as PMC(percutaneous myocardial channeling), which would provide a less invasivemethod of creating channels in the heart.  If PMC can be shown to be safeand effective and is approved by the FDA, it would eliminate the need incertain patients to make an incision in the chest, reducing costs and speedingrecovery.  It is unclear what impact, ifany, an approval of a PMC device would have on the future adoption rate for TMRprocedures. If PMC is approved, it could erode the potential TMR market whichwould have a material

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adverseeffect on our business, financial condition and results of operations.

***Rapidtechnological changes in our industry could make our products obsolete.***

Our industry is characterized by rapid technologicalchange and intense competition.  Newtechnologies and products and new industry standards will develop at a rapidpace, which could make our current and future planned products obsolete. Theadvent of new devices and procedures and advances in new drugs and geneticengineering are especially concerning competitive threats.  Our future success will depend upon ourability to develop and introduce product enhancements to address the needs ofour customers.  Material delays inintroducing product enhancements may cause customers to forego purchases of ourproducts and purchase those of our competitors.

Many potential competitors have substantiallygreater financial resources and are in a better financial position to exploitmarketing and research and development opportunities.  In addition, we are aware that othercompanies are developing or already have developed proprietary systems for thetreatment of cardiac arrhythmias, and specifically atrial fibrillation (“AF”),that may be safer, clinically more effective, easier and more cost effective touse and, in the case of percutaneous devices, less invasive than the systems wemarket.

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

Our products and our manufacturing activities aresubject to extensive, rigorous and changing federal and state regulation in theU.S. and to similar regulatory requirements in other major internationalmarkets, including the European Union and Japan.  These regulations and regulatory requirementsare broad in scope and govern, among other things:

·                  productdesign and development;

·                  producttesting;

·                  productlabeling;

·                  productstorage;

·                  premarketclearance and approval;

·                  advertisingand promotion; and

·                  product sales and distribution.

Furthermore, regulatory authorities subject amarketed product, its manufacturer and the manufacturing facilities tocontinual review and periodic inspections. We are subject to ongoing FDA requirements, including requiredsubmissions of safety and other post-market information and reports,registration requirements, Quality Systems regulations, and recordkeepingrequirements. The FDA’s Quality Systems regulations include requirementsrelating to quality control and quality assurance, as well as the correspondingmaintenance of records and documentation. Edwards, our distributor, depending on its activities, is also subjectto certain requirements under the Federal Food, Drug, and Cosmetic Act and theregulations 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 Edwards.  We may be slowto adapt or may not be able to adapt to these changes or new requirements.

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Later discovery of previously unknown problems withour products, manufacturing processes, or our failure to comply with applicableregulatory requirements may result in enforcement actions by the FDA and otherinternational regulatory authorities, including, but not limited to:

·                  warningletters;

·                  patientor physician notification;

·                  restrictionson our products or manufacturing processes;

·                  voluntaryor mandatory recalls;

·                  productseizures;

·                  refusalto approve pending applications or supplements to approved applications that wesubmit;

·                  refusalto permit the import or export of our products;

·                  fines;

·                  injunctions;

·                  suspensionor withdrawal of marketing approvals or clearances; and

·                  civil and criminal penalties.

Should any of these enforcement actions occur, ourbusiness, financial condition and results of operations could be materially andadversely affected.

To date, the following regulatory approvals havebeen obtained for our products:

***Heart LaserSystems***

*UnitedStates —*We receivedFDA approval to market the HL1 Heart Laser System in August 1998 and the HL2Heart Laser System in January 2001. However, although we have received FDA approval, the FDA:

·                  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.

In addition, as a condition of our original FDAapproval for our TMR products, we were required by the FDA to perform apostmarket surveillance study. The FDA has recently requested us to submit aPremarket Approval (“PMA”) Postapproval Study report summarizing thispostmarket surveillance study. As part of this report, the FDA has requestedthat we 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. Because of thesignificant safety information collected in the postapproval study, and as the FDAhas indicated it plans to do in other product areas, the FDA plans to presentthe results at a future meeting of the FDA Circulatory System Devices AdvisoryPanel and thereafter determine what, if any, actions should be taken withrespect to our current Heart Laser Systems PMA.

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

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

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

*Japan —*Our HL1 Heart Laser System received marketingapproval from the Japanese Ministry of Health, Labor and Welfare (“MHLW”) inMay 2006. However, the MHLW could impose restrictions in the future or reverseits ruling and prohibit use of the Heart Laser Systems at any time.

In addition, it is unclear what impact theintroduction of the HL2 into the U.S. and other international markets will haveon the ability of our Japanese distributor to market our older, firstgeneration HL1 in Japan. Although our Japanese distributor has indicated to usthat it plans to seek MHLW approval in the future to market our newer HL2, wecan provide no assurance that the distributor will be successful in obtainingthe necessary approvals or how long it may take to secure the requiredapprovals.

***Optiwave 980 System***

*United States —*The FDA has given clearance to the Optiwave 980System through the 510(k) premarket notification process with indications foruse as a surgical instrument for coagulation of soft tissue, including cardiactissue, in conjunction with or without endoscopic equipment in the contact ornon-contact mode in open or closed surgical procedures.

Although the Optiwave 980System has received clearance from the FDA only for the indications of usestated above, physicians, under the practice of medicine exception, may use thedevice in any manner they choose in treating an individual patient, includingusing the device to treat patients with AF. However, neither we nor Edwards have conducted any clinical trialsdesigned to obtain data to submit to the FDA for the purpose of obtaining aspecific indication for use of the Optiwave 980 System that would allow Edwardsto make claims or otherwise market this device for the treatment of AF. We areaware of several other companies that have announced their plans to conductclinical trials in support of a labeling claim that would allow them to markettheir devices for the treatment of AF if clearance is obtained from the FDA.

In the event these othercompetitors are successful in obtaining specific indications of use for theirdevices in the treatment of AF, the Optiwave 980 System may be at a competitivemarketing disadvantage until such time, if ever, that Edwards conducts aclinical trial, submits sufficient data to the FDA by means of a new 510(k) andobtains clearance to market the Optiwave 980 System for the treatment of AF. Wecannot provide any assurance that Edwards will ever conduct such a clinicaltrial or, if they do, that the data they obtain and submit to the FDA will besufficient for the FDA to expand the current indications of use and provideclearance for the Optiwave 980 System to be marketed for the treatment of AF.Also, we cannot assure you that even if such clearance is obtained, that itwill be obtained in a timely enough fashion for our products to remaincompetitive in the marketplace.

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*Europe —*The Optiwave 980 System cannot be marketed in the EUuntil such time as it receives CE Mark approval. Edwards needs to complete andsubmit the relevant technical documentation to the appropriate certifying bodyin order to be able to apply the CE Mark to the product.  If approval to apply the CE Mark is granted,the Optiwave 980 System will then be able to be distributed in the EU.

***RenalGuard***

We presently have no governmental approvals tomarket our RenalGuard System. We must receive either FDA approval or clearancebefore we can market our product in the United States. We must also receive CEMark approval before we can market our product in the EU. Other internationalcountries may require their own approvals prior to our being able to market ourproduct in those countries.

The process of obtaining and maintaining regulatoryapprovals and clearances to market a medical device can be costly and timeconsuming, and we cannot predict when, if ever, such approvals or clearanceswill be granted. Pursuant to FDA regulations, unless exempt, the FDA permitscommercial distribution of a new medical device only after the device hasreceived 510(k) clearance or is the subject of an approved PMA application. TheFDA will clear marketing of a medical device through the 510(k) process only ifit is demonstrated that the new product is substantially equivalent to other510(k)-cleared products.

At the present time we are not aware of any clearpredicates with substantially the same proposed indications for use which wouldenable us to conclude that RenalGuard is likely to be cleared by the FDA as a510(k) device. Therefore, we believe RenalGuard most likely will need to gothrough the PMA application process.

Because the PMA application process is more costly,lengthy and uncertain than the 510(k) process and must be supported byextensive data, including data from preclinical studies and human clinicaltrials, we cannot predict when our product may eventually come to market.Should we be unable to obtain FDA or CE Mark approval for RenalGuard, or shouldthe approval process take longer than we anticipate, our future revenue growthprospects could be materially and adversely affected.

***Changes in third party reimbursement foreither TMR or cardiac tissue ablation procedures and our ability to secure thirdparty reimbursement for RenalGuard could materially affect future demand forour products.***

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

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

Cardiac tissue ablation procedures, such as thosethat are expected to be performed using the Optiwave 980 System, are alsocurrently reimbursed by Medicare when performed as a sole therapy.  In instances where a surgeon might perform acardiac tissue ablation procedure in combination with another heart relatedprocedure, such as a valve replacement or repair, we believe the otherprocedure will normally carry a higher reimbursement and, therefore, will bethe procedure that the hospital bills to Medicare.

No assurance can be given,however, that these payers will continue to reimburse healthcare providers whoperform TMR or cardiac tissue ablation procedures using our products now or inthe future. Further, no assurance can be given that additional payers willreimburse healthcare providers who perform TMR or cardiac tissue ablationprocedures using our products or that reimbursement, if provided, will betimely or adequate.

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

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

In addition, the market for 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.

***Securingintellectual property rights for our RenalGuard System is critical to ourfuture business plans, but may prove to be difficult or impossible for us to obtain.***

We have filedseven patent applications and have one provisional patent application pendingat the United States patent office related to our RenalGuard System and otherintellectual property in the general field of preventing acute renal failure.Securing patent protection over our intellectual property ideas in this fieldis, we believe, critical to our plans to successfully differentiate and marketour RenalGuard System and grow our future revenues. We can provide noassurance, however, that we will be successful in securing any patentprotection for our intellectual property ideas in this chosen field or that ourefforts to obtain patent protection will not prove more difficult, andtherefore more costly, than we are otherwise expecting. Furthermore, even if weare successful in securing patent protection for some or all of ourintellectual property ideas in this field, we cannot predict when in the futureany such potential patents may be issued, how strong such patent protectionwill prove to be, or whether these patents will be issued in a timely enoughfashion to afford us any commercially meaningful advantage in marketing ourRenalGuard System against other potentially competitive devices.

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

In our industry, competitors often assertintellectual property infringement claims against one another and occasionallyattempt to challenge, invalidate or circumvent patents that are issued to otherparties.  The success of our businessdepends on our ability to successfully defend our intellectual property.  Future litigation may have a material impacton our financial condition even if we are successful in marketing our products.We may not be successful in defending or asserting our intellectual propertyrights.

An adverse outcome in any litigation or interferenceproceeding could subject us to significant liabilities to third parties andrequire us to cease using the technology that is at issue or to license thetechnology from third parties.  Inaddition, a finding that any of our intellectual property is invalid couldallow our competitors to more easily and cost-effectively compete with us.  Thus, an unfavorable outcome in any patentlitigation or interference proceeding could have a material adverse effect onour business, financial condition or results of operations.

The cost to us of any patent litigation orinterference proceeding could be substantial. Uncertainties resulting from the initiation and continuation of patentlitigation or interference proceedings could have a material adverse effect onour ability to compete in the marketplace. Patent litigation and interference proceedings may also absorbsignificant management time.

***We may be subjectto product liability lawsuits; our insurance may not be sufficient to coverdamages.***

We may be subject to product liability claims.  Such claims may absorb significant managementtime and could degrade our reputation and the marketability of ourproducts.  If product liability claimsare made with respect to our products, we may need to recall the implicatedproduct which could have a material adverse effect on our business, financialcondition and results of operations. In addition, although we maintain productliability insurance, we cannot be sure that our insurance will be adequate tocover potential product liability lawsuits. Our insurance is expensive and inthe future 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 torisks associated with international operations.***

A portion of our product sales are generated fromoperations outside of the U.S. Establishing, maintaining and expanding international sales can beexpensive.  Managing and overseeingforeign operations are difficult and products may not receive marketacceptance.  Risks of doing business outsidethe U.S. include, but are not limited to, the following: agreements may bedifficult to enforce and receivables difficult to collect through a foreigncountry’s legal system; foreign customers may have longer payment cycles;foreign countries may impose additional withholding taxes or otherwise tax ourforeign income, impose tariffs or adopt other restrictions on foreign trade;U.S. export licenses may be difficult to obtain; and the protection ofintellectual property rights in foreign countries may be more difficult toenforce.  There can be no assurance thatour international business will grow or that any of the foregoing risks willnot result in a material adverse effect on our business or results of operations.

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***We will soon have to comply withrequirements regarding internal control over financial reporting.***

Pursuant toSection 404 of the Sarbanes-Oxley Act of 2002, beginning with our fiscal yearending December 31, 2007, our management will be required to provide a reporton the effectiveness of our internal control over financial reporting.  We are developing a program to perform thisevaluation in order to comply with these requirements.  Compliance with these requirements is expectedto be expensive and time-consuming.  Ifwe fail to timely complete this evaluation, we could be subject to regulatoryaction and public confidence in us could be adversely affected and our stockprice could decline.  In addition, anyfailure to implement required new or improved controls, or difficultiesencountered in their implementation, could harm our operating results or causeus to fail to meet our reporting obligations.

***Because we are incorporated inCanada, you may not be able to enforce judgments against us and our Canadiandirectors.***

Under Canadian law, you may not be able to enforce ajudgment issued by courts in the U.S. against us or our Canadian directors. Thestatus of the law in Canada is unclear as to whether a U.S. citizen can enforcea judgment from a U.S. court in Canada for violations of U.S. securities laws.A separate suit may need to be brought directly in Canada.

***Our stock price has historically fluctuated and may continue tofluctuate significantly in the future which may result in losses for ourinvestors.***

Our stock price has been and may continue to bevolatile. Some of the factors that can affect our stock price are:

·                  theannouncement of new products, services or technological innovations by us orour competitors;

·                  actualor anticipated quarterly increases or decreases in revenue, gross margin orearnings, and changes in our business, operations or prospects;

·                  speculationor actual news announcements in the media or industry trade journals about ourcompany, our products, the TMR or cardiac ablation procedures or changes inreimbursement policies by Medicare and/or private insurance companies;

·                  announcementsrelating to strategic relationships or mergers;

·                  conditionsor trends in the medical device industry;

·                  changesin the economic performance or market valuations of other medical devicecompanies; and

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

***The market priceof our stock may fall if shareholders sell their stock.***

Certain current shareholders hold large amounts of our stock, whichthey could 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 could cause our stock price tofall.  In addition, the sale of theseshares could impair our ability to raise capital through the sale of additionalstock.

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***We have no intention to pay dividends.***

We have never paid any cash dividends on our common stock. We currentlyintend to retain all future earnings, if any, for use in our business and donot expect to pay any dividends in the foreseeable future.

**Item 6.          Exhibits**
| Exhibit Number | ** ** | **Description of Document**                                                                                                                                                                           |
|----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           |       |                                                                                                                                                                                                  |
| 31.1           |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) or Rule 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 Chief Financial Officer pursuant to  Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|           |       |                                                                                                                                                                                                  |
| 32.1           |       | Certifications pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                             |

 

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|                              |   | PLC SYSTEMS INC. |
|------------------------------|--------|------------------|
|                         |   |             |
| Date: November 14, 2006 |   | 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 Chief 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 Chief 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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