Viveve Medical (VIVE) 10-Q 2002 Q2 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
	For the quarterly period ended June 30, 2002.
	OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
	For the transition period from                             to

Commission File Number 1-11388

PLC SYSTEMS INC.

(Exact Name of Registrant as Specified in Its Charter)

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

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES   ý   NO   o

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

Class	Outstanding at July 29, 2002
Common Stock, no par value	29,738,432

PLC SYSTEMS INC.

Index

Part I.	Financial Information:
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets (unaudited)
		Condensed Consolidated Statements of Operations (unaudited)
		Condensed Consolidated Statements of Cash Flows (unaudited)
		Notes to Condensed Consolidated Financial Statements (unaudited)
	Item 2.	Management’s Discussion and Analysis ofFinancial Condition and Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Part II.	Other Information:
	Item 1.	Legal Proceedings
	Item 2.	Changes in Securities and Use of Proceeds
	Item 3.	Defaults Upon Senior Securities
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 5.	Other Information
	Item 6.	Exhibits and Reports on Form 8-K

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PLC SYSTEMS INC.

Part I. Financial Information

Item 1.        Financial Statements

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

	June 30, 2002			December 31,  2001
ASSETS
Current assets:
Cash and cash equivalents	$	5,342		$	4,977
Accounts receivable, net	1,600			2,544
Lease receivables, net	1,278			1,510
Inventories, net	946			1,001
Prepaid expenses and other current assets	500			222
Total current assets	9,666			10,254
Equipment, furniture and leasehold improvements, net	288			383
Lease receivables, net	725			1,326
Other assets	316			335
Total assets	$	10,995		$	12,298
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	456		$	968
Accrued compensation	368			444
Accrued expenses	862			859
Deferred revenue	743			507
Secured borrowings	1,480			1,691
Total current liabilities	3,909			4,469
Deferred revenue	79			73
Secured borrowings	725			1,446
Total long-term liabilities	804			1,519
Commitments and contingencies
Stockholders’ equity:
Preferred stock, no par value, unlimited shares authorized, no shares issued and outstanding	—			—
Common stock, no par value, unlimited shares authorized, 29,738 and 29,527 shares issued and outstanding at June 30, 2002 and December 31, 2001, respectively	93,545			93,419
Accumulated deficit	(86,127		)	(86,003		)
Accumulated other comprehensive loss	(1,136		)	(1,106		)
Total stockholders’ equity	6,282			6,310
Total liabilities and stockholders’ equity	$	10,995		$	12,298

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

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PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	Three Months Ended June 30,					Six Months Ended June 30,
	2002		2001			2002			2001
Revenues:
Product sales	$	1,850	$	2,202		$	3,906		$	4,059
Placement and service fees	329		379			693			863
Total revenues	2,179		2,581			4,599			4,922
Cost of revenues:
Product sales	769		1,284			2,047			2,278
Placement and service fees	129		197			277			420
Total cost of revenues	898		1,481			2,324			2,698
Gross profit	1,281		1,100			2,275			2,224
Operating expenses:
Selling, general and administrative	933		2,034			1,994			4,195
Research and development	228		273			435			513
Total operating expenses	1,161		2,307			2,429			4,708
Income (loss) from operations	120		(1,207		)	(154		)	(2,484		)
Other income, net	15		67			30			168
Net income (loss)	$	135	$	(1,140	)	$	(124	)	$	(2,316	)
Basic and diluted earnings (loss) per share	$	0.00	$	(0.04	)	$	(0.00	)	$	(0.08	)
Average shares outstanding:
Basic	29,713		29,347			29,643			29,029
Diluted	29,744		29,347			29,643			29,029

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

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PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Six Months Ended June 30,
	2002			2001
Operating activities:
Net loss	$	(124	)	$	(2,316	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization	113			401
Change in assets and liabilities:
Accounts receivable	943			(858		)
Inventory	55			117
Prepaid expenses and other assets	(282		)	20
Accounts payable	(518		)	(254		)
Deferred revenue	218			(133		)
Accrued liabilities	(123		)	(412		)
Net cash provided by (used for) operating activities	282			(3,435		)
Investing activities:
Purchase of equipment	—			(91		)
Proceeds from disposition of equipment	—			10
Purchase of marketable securities	—			(333		)
Maturity of marketable securities	—			288
Net cash used for investing activities	—			(126		)
Financing activities:
Net proceeds from sales of common shares	127			3,963
Secured borrowings	(99		)	(128		)
Net cash provided by financing activities	28			3,835
Effect of exchange rate changes on cash and cash equivalents	55			20
Net increase in cash and cash equivalents	365			294
Cash and cash equivalents at beginning of period	4,977			5,726
Cash and cash equivalents at end of period	$	5,342		$	6,020

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

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PLC SYSTEMS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2002

1.             Nature of Business

                PLC Systems Inc. (“PLC” or the “Company”) has developed a patented high-powered carbon dioxide (“CO₂”) laser system known as The Heart Laser (“HL1”) for use in the treatment of severe coronary artery disease in a surgical laser procedure, pioneered by the Company and its clinical investigators, known as transmyocardial revascularization (“TMR”).  In January 2001, the Company obtained U.S. Food and Drug Administration (“FDA”) approval to market its second-generation laser, the CO₂ Heart Laser 2 (“HL2”).   The HL2 is less than half the weight and size than the HL1, but delivers the equivalent laser energy, wavelength and beam characteristics.  The HL1 and HL2 collectively are referred to throughout this report as the “Heart Laser Systems”.

                In January 2001, the Company entered into a strategic marketing alliance and exclusive distribution agreement with Edwards Lifesciences LLC, a subsidiary of Edwards Lifesciences Corporation (collectively referred to as “Edwards”).  The distribution agreement is for five years with a five-year renewal option if certain conditions are met.  Under the terms of the agreement, Edwards will market and distribute the HL2, as well as all disposable TMR kits and accessories, to hospitals in the United States.  In January 2002, Edwards exercised a pre-existing option to assume full sales and marketing responsibilities in the United States for PLC’s HL2 and associated TMR kits.  Edwards is also the Company’s largest shareholder, owning approximately 18% of the Company’s outstanding shares as of December 31, 2001.

                Outside the United States, the Company markets and distributes its products primarily through an independent dealer network, although in certain countries it continues to sell its products directly to hospitals.

2.             Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three and six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.  Certain prior period items have been reclassified to conform with current period presentations.  These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2001.

3.             Net Income (Loss) per Share

                Basic earnings per share have been computed using only the weighted average number of common shares outstanding during the period while diluted earnings per share have been computed using the weighted average number of common shares outstanding during the period plus the effect of outstanding stock options using the treasury stock method.

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Basic and diluted loss per share have been computed using only the weighted average number of common shares outstanding during the period without giving effect to any potential future issues of common stock related to stock option programs and warrants since their inclusion would be antidilutive.

4.             Comprehensive Income (Loss)

Total comprehensive income for the three-month period ended June 30, 2002 amounted to $101,000, as compared to a total comprehensive loss of $1,164,000 for the three-month period ended June 30, 2001. Total comprehensive loss for the six-month period ended June 30, 2002 amounted to $154,000, as compared to a total comprehensive loss of $2,359,000 for the six-month period ended June 30, 2001.

5.             Inventories

                Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method and consist of the following (in thousands):

		June 30, 2002		December 31, 2001
Raw materials		$	662	$	618
Work in progress	��	210		107
Finished goods		74		276
		$	946	$	1,001

                At each of June 30, 2002 and December 31, 2001, inventories are stated net of a reserve of $1,107,000 and $1,167,000, respectively, for potentially obsolete inventory.

6.             Legal Proceedings

In January 1999, the Company settled its outstanding patent infringement litigation with CardioGenesis. The original CardioGenesis lawsuit, counterclaimed by the Company, dealt with the Company’s synchronization patent (U.S. Patent No. 5,125,926). Under the settlement, CardioGenesis agreed that U.S. Patent No. 5,125,926 and related international patents of the Company were valid and enforceable. PLC granted CardioGenesis a non-exclusive worldwide license to the patents in exchange for payment of a license fee and ongoing royalties over the life of the patents.  As part of the settlement, CardioGenesis agreed to pay the Company:

•a minimum of $2.5 million over 42 months which ended on June 30, 2002; and

•license fees and ongoing royalties on sales of all covered products until the expiration of all licensed patents.

7.             Revenue Recognition

The Company records revenue from the sale of TMR kits to Edwards at the time of shipment.  Heart Laser Systems are billed to Edwards in accordance with purchase orders received by the Company. Invoiced Heart Laser Systems are recorded as deferred revenue on the Company’s consolidated balance sheet until such time as the laser is shipped to a hospital, at

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which time the Company records revenue.

Under the terms of the Edwards distribution agreement, once Edwards has recovered a prescribed amount of revenue from a hospital for the use or purchase of a laser, any additional revenues earned by Edwards are shared with the Company pursuant to a formula established in the distribution agreement. The Company only records its share of such additional revenue, if any, at the time the revenue is earned.

The Company records revenue from the sale of TMR kits and Heart Laser Systems to international dealers or hospitals at the time of shipment. The Company generally requires its international customers to secure Heart Laser System sales through cash deposits and letters of credit.

Prior to entering into the Edwards distribution agreement, the Company installed Heart Laser Systems in hospitals under placement contracts which did not transfer substantial ownership of the equipment to the customer. Revenues from these transactions are recognized over the life of the placement agreement in accordance with the specific terms of the contract.

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

                Installation revenues related to a Heart Laser System transaction are recorded as a component of placement and service fees when the Heart Laser System is installed.

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

This quarterly report (including certain information incorporated herein by reference) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Statements containing terms such as “believes”, “plans”, “expects”, “anticipates”, “intends”, “estimates” and similar expressions contain uncertainty and are forward-looking statements. Forward-looking statements are based on current plans and expectations and involve known and unknown important risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such important factors and uncertainties include, but are not limited to, those set forth below under the heading “Factors Affecting Future Operating Results” and elsewhere in this quarterly report.

Overview

In January 2001, the Company obtained FDA approval to market its next generation laser, the HL2.  The HL2 is less than half the weight and size of the Company’s first generation laser, the HL1, but delivers the equivalent laser energy, wavelength and beam characteristics.  The HL1 and the HL2 collectively are referred to throughout this report as the “Heart Laser Systems”.

In January 2001, the Company entered into a strategic marketing alliance and exclusive distribution arrangement with Edwards.  Under this arrangement, Edwards is marketing and distributing the HL2, as well as all disposable TMR kits and accessories, to customers in the United States.  In 2001, Edwards’ sales force was principally responsible for driving increased TMR procedures and kit utilization, as well as providing the Company’s capital sales force with HL2 sales leads. The Company maintained its capital sales force through January 2002 to assist Edwards in

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marketing the HL2 in the United States.

In January 2002, Edwards exercised a pre-existing option to assume full sales and marketing responsibility in the United States for PLC’s HL2 and associated TMR kits. The Company sells the HL2 and TMR kits to Edwards at a discount to list price and Edwards remarkets the HL2 and TMR kits to hospitals.  The Company has benefited from reduced domestic sales and marketing expenses of approximately $1,645,000 through the first six months of 2002 and expects similar savings to be realized over the remainder of 2002.

A portion of the Company’s operations is conducted outside of the United States.  Historically the impact of foreign currency fluctuations on the Company’s overall consolidated results of operations has not been material (as discussed below under the heading “Quantitative and Qualitative Disclosures About Market Risk”).

Results of Operations

                Total revenues of $2,179,000 for the three-month period ended June 30, 2002 decreased $402,000 or 16% when compared to total revenues of $2,581,000 for the three-month period ended June 30, 2001.  This decrease of 16% in total revenues was predominately the result of a corresponding 16% decrease in product sales.

                Total revenues of $4,599,000 for the six-month period ended June 30, 2002 decreased $323,000 or 7% when compared to total revenues of $4,922,000 for the six-month period ended June 30, 2001.  This decrease of 7% in total revenues was the result of a 4% decrease in product sales combined with a 20% decrease in placement and service fees.

Product Sales

Product sales for the three and six months ended June 30, 2002 were $1,850,000 and $3,906,000, decreases of $352,000 and $153,000, respectively, when compared with product sales of $2,202,000 and $4,059,000 for the three and six months ended June 30, 2001.

For the three-month period ended June 30, 2002, Heart Laser Systems revenue declined as a result of a lower volume of laser shipments. This decrease in the number of total laser shipments was partially offset by (1) an increase in the average sale price of domestic HL2 lasers to Edwards, (2) increased revenues generated from the sale of disposable kits and (3) revenue sharing earned under the distribution agreement with Edwards.

For the six-month period ended June 30, 2002, Heart Laser Systems revenue increased due to an increase in the volume of laser shipments, as well as from revenue sharing earned under the distribution agreement with Edwards. This increase was partially offset by (1) a decrease in the average sale price of Heart Laser Systems and (2) decreased revenues generated from the sale of disposable kits.

                Placement and Service Fees

Placement and service fees for the three and six months ended June 30, 2002 were $329,000 and $693,000, decreases of $50,000 and $170,000, respectively, when compared with placement and service fees of $379,000 and $863,000 for the three and six months ended June 30, 2001.  In the three and six months ended June 30, 2002, the decreases in placement and service fees reflect decreases of 36% and 53%, respectively, in placement fees partially offset by 5% and 34% increases, respectively, in service fees.

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Placement fees declined as a result of (1) various U.S. HL1 customers upgrading to an HL2, which results in a laser sale to Edwards and a corresponding shift in recorded disposable kit sales to these new HL2 customers as product sales instead of placement fees, and (2) a decline in international placement contract fees due to a decrease in kit shipments to international placement contract customers.

Service fees increased due to more lasers being placed in service throughout 2001 and 2002, which resulted in increased billings to Edwards for installation, warranty and preventative maintenance services.

Gross Profit

                Total gross profit for the three and six months ended June 30, 2002 were $1,281,000, or 59% of revenues, and $2,275,000, or 49% of revenues, as compared to $1,100,000, or 43% of revenues, and $2,224,000, or 45% of revenues, for the comparable periods in 2001.

                Gross profit improved in the three-month period ended June 30, 2002 as compared to the corresponding period in 2001 primarily due to Heart Laser System transactions generating a higher average selling price, as well as greater sales of higher margin disposable kits.  Gross profit also improved in the three and six months ended June 30, 2002 as compared to the corresponding periods in 2001 due to manufacturing cost savings and improved product yields, as well as lower depreciation charges.

Operating Expenses

Selling, general and administrative expenditures were $933,000 and $1,994,000 for the

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three and six months ended June 30, 2002, decreases of $1,101,000 and $2,201,000, respectively, when compared to expenditures of $2,034,000 and $4,195,000 in the three and six months ended June 30, 2001.  For the three and six months ended June 30, 2002, the overall decrease is primarily attributable to (1) reduced domestic sales and marketing expenditures as a result of the January 2002 Edwards exercise of a pre-existing option to assume the United States sales and marketing responsibility for the HL2 and associated TMR kits, (2) reduced international sales and marketing expenditures and (3) reduced administrative expenditures.  The Company expects that 2002 sales and marketing expenditures will continue to decrease significantly as compared to 2001, primarily due to Edwards’ exercise of the sales and marketing option in January 2002.

Research and development expenditures for the three and six months ended June 30, 2002 were $228,000 and $435,000, decreases of $45,000 and $78,000, respectively, when compared with expenditures of $273,000 and $513,000 for the three and six months ended June 30, 2001.  Throughout the remainder of 2002, research and development expenditures are expected to be comparable to the level of expenditures in the first six months of 2002.

Other Income

Other income for the three and six months ended June 30, 2002 was $15,000 and $30,000, decreases of $52,000 and $138,000, respectively, when compared with other income of $67,000 and $168,000 for the three and six months ended June 30, 2001.  These decreases are a result of both a lower overall average investable balance and lower interest rates on invested funds.  Throughout 2002, other income is expected to be lower than 2001 due to lower average invested balances and lower interest rates on invested funds.

Net Income (Loss)

The Company recorded net income of $135,000 and a net loss of $124,000 for the three and six months ended June 30, 2002, compared to net losses of $1,140,000 and $2,316,000 for the three and six months ended June 30, 2001.  Net income in the three-month period ended June 30, 2002 and the lower net loss for the six-month period ended June 30, 2002 compared to the corresponding periods in 2001 resulted from the combination of higher gross margins and lower operating expenses, the latter being primarily related to the lower sales and marketing expenses discussed above.

In connection with the January 2002 sales and marketing option exercise by Edwards, Edwards will, pursuant to the terms of the distribution agreement with the Company, retain a greater share of the revenue generated from U.S. TMR kit sales.  In addition, royalty revenue is expected to decrease in the third and fourth quarters of 2002 because the guaranteed minimum royalties generated from the settlement of the CardioGenesis lawsuit ended on June 30, 2002.  Although CardioGenesis is required to pay an ongoing royalty on sales of covered products after June 30, 2002, the Company expects that royalty revenue will be significantly lower than the guaranteed minimum royalties for at least the remainder of 2002.  As a result, the Company expects that its gross profit in the third and fourth quarters of 2002 will likely be lower than the gross profit in the third and fourth quarters of 2001.

                Kit Shipments

Management of the Company monitors disposable kit shipments to end users as an important metric in evaluating its business.  Management believes kit shipments to end users, although not a direct measure, are a reasonable indicator of the pace of the adoption of TMR as a therapy in the marketplace.

                For the three and six months ended June 30, 2002, Edwards shipped a total of 473 and 872 disposable kits to end users.  This represented increases of 24% and 26%, respectively, over the 380 and 691 disposable kits shipped to end users during the three and six months ended June 30, 2001.

                Domestic kit shipments to end users increased by 6% and 47%, respectively, from 377 and 539 in the three and six months ended June 30, 2001 to 401 and 791 in the three and six months ended June 30, 2002, respectively.  Management believes the domestic kit shipment improvement is a result of (1) the benefits of the strategic partnership with Edwards, (2) the introduction of the HL2 in January 2001 and (3) the Company’s increased base of installed lasers.

                International kit shipments increased from 3 in the three-month period ended June 30, 2001 to 72 in the three-month period ended June 30, 2002, primarily due to a significant kit shipment to one customer in the 2002 period.  International kit shipments decreased from 152 in the six-month period ended June 30, 2001 to 81 in the six-month period ended June 30, 2002, primarily due to various international accounts using their existing inventories of disposable kits during the 2002 period.

Liquidity and Capital Resources

At June 30, 2002, the Company had cash and cash equivalents of $5,342,000.

During the six-month period ended June 30, 2002, the Company incurred a net loss of

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$124,000.  The combination of this net loss and favorable working capital changes, most notably the reduction in outstanding accounts receivable of $943,000, resulted in net cash provided by operating activities of approximately $282,000.  Cash provided by financing activities was approximately $28,000, consisting of the net proceeds of $127,000 obtained from the sale of the Company’s common stock offset by a reduction in secured borrowings of $99,000.  Although the Company generated positive cash flow from operating activities during the six-month period ended June 30, 2002, no assurance can be given that positive cash flow from operations will be sustained during the third and fourth quarters of 2002.

The Company believes that its existing cash resources will meet its working capital requirements through December 31, 2002. However, the Company is largely dependent on the success of Edwards’ sales and marketing efforts in the U.S. to substantially increase TMR procedural volumes and revenues.  Should TMR procedural volume not increase sufficiently to offset the impact of selling lasers and kits to Edwards at a discounted price, the Company’s liquidity and capital resources will be negatively impacted. Additionally, other unanticipated decreases in operating revenues or increases in expenses or further delays in third-party reimbursement to healthcare providers using the Company’s products may adversely impact the Company’s cash position and require further cost reductions or the need to obtain additional financing. No assurance can be given that the Company, working with Edwards and its international distributors, will be successful in achieving broad commercial acceptance of the Heart Laser Systems or that the Company will be able to operate profitably on a consistent basis.

The Company has seen a trend on the part of hospital customers to acquire the Heart Laser Systems on a usage basis rather than as a capital equipment purchase.  The Company believes that this trend is the result of limitations many hospitals currently have on acquiring expensive capital equipment as well as competitive pressures in the marketplace.  This shift to a usage business model may result in a longer recovery period for Edwards to recoup their investment in lasers they purchase from the Company.  This could result in (1) a delay in the Company’s ability to receive additional shared revenue, if any, that it otherwise is entitled to receive under the terms of its distribution agreement with Edwards and (2) a delay in the purchase of new lasers by Edwards if their installed base of placement lasers under usage contracts are under-performing and they choose to re-deploy these lasers to other new hospital sites in lieu of purchasing a new laser from the Company.   The Company’s cash position and its need for additional financing to fund operations will be dependent in part upon the number of hospitals that acquire Heart Laser Systems from Edwards on a usage basis and the number and frequency of TMR procedures performed by these hospitals.  No assurance can be given that a usage based sales model will be successful, whether implemented by the Company or Edwards.

The Company may need to raise additional capital to fund operations during the next twelve months.  There can be no assurance that, should the Company require additional financing, such financing will be available on terms and conditions acceptable to the Company. Should additional financing not be available on terms and conditions acceptable to the Company, additional actions may be required that could adversely impact the Company’s ability to continue to realize assets and satisfy liabilities in the normal course of business. The consolidated financial statements set forth in this quarterly report do not include any adjustments to reflect the possible future effects of these uncertainties.

Factors Affecting Future Operating Results

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

Our company has a history of operating losses

PLC Systems Inc. was founded in 1987.  We have incurred operating losses in every year of our existence except 1995.  We incurred net losses of $3,902,000 for the year ended December 31, 2001, $7,410,000 for the year ended December 31, 2000 and $6,555,000 for the year ended December 31, 1999. As of December 31, 2001, we had an accumulated deficit of $86,003,000.  We have achieved profitability in the second quarter of 2002 for the first time in more than five years. However, there is no assurance that we will continue to be profitable in the future.  Although our business is not seasonal in nature, our revenues tend to vary significantly from fiscal quarter to fiscal quarter.

Our company is dependent on one principal product line

We develop and market one principal product line, which consists of two patented high-powered carbon dioxide laser systems known as the Heart Laser Systems and related disposables. Approximately 90% of our revenues in the six months ended June 30, 2002 as well as in the years ended December 31, 2001 and December 31, 2000 were derived from the sales and service of our Heart Laser Systems and related disposables.

Our company is dependent on one principal customer

Pursuant to a distribution agreement with Edwards, Edwards is our exclusive distributor for our HL2 and TMR kits in the United States.  As a result of this relationship, Edwards accounted for 85% and 68% of our total revenue in the six months ended June 30, 2002 and the year ended December 31, 2001, respectively, and we expect Edwards to account for the majority of our revenue in the future.  If our relationship with Edwards does not progress or if Edwards’ sales and marketing strategies fail to generate sales of our HL2 and TMR kits in the future, our revenue will decrease significantly and our business, financial condition and results of operations will be seriously harmed.

Our company is dependent on certain suppliers

Some of the components for our laser systems, most notably the power supply, ECG card and certain optics and fabricated parts, are only available from one supplier, and we have no assurance that we will be able to source any of our sole-sourced components from additional suppliers. In the past, we have experienced delays in product delivery from our sole suppliers and, because we do not have an alternative supplier to produce these products for us, we have little leverage to enforce timely delivery. Any delay in product delivery or other interruption in supply from these suppliers could prevent us from meeting our commercial demands for the Heart Laser Systems, which could have a material adverse effect on our business, financial

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condition and results of operations.  Furthermore, we do not require significant quantities of any components because we produce a limited number of Heart Laser Systems each year.  Our low-quantity needs may not generate substantial revenue for our suppliers.  Therefore, it may be difficult for us to continue our relationships with our current suppliers or establish relationships with additional suppliers on commercially reasonable terms, if at all.

We have limited manufacturing experience building the HL2

We only began manufacturing the HL2 in 2001.  The HL2 is based on a different design than the HL1.  In order to achieve certain manufacturing cost savings, we have taken a more vertically integrated approach to the manufacture of the HL2 than we did with the HL1.  As a result, we may experience manufacturing difficulties, including but not limited to:

•       shortages in component parts due to supplier manufacturing or procurement delays;

•       supplier quality problems;

•       lack of experienced technical personnel;

•       low production yields; and

•       changing processes and controls over the manufacturing procedures employed.

If we are unable to successfully manufacture the HL2 in a timely manner, we may lose customers and our business, financial condition and results of operations may be seriously harmed.

Our common stock may be delisted from AMEX

We may in the future fall out of compliance with AMEX’s continued listing guidelines.  If so, we may be unable to regain compliance with AMEX’s continued listing guidelines within a satisfactory period and our common stock could be delisted from AMEX.  If our common stock were delisted from AMEX, we could face a number of negative implications, including reduced liquidity in our common stock as a result of the loss of market efficiencies associated with AMEX and the loss of federal preemption of state securities laws, as well as the potential loss of confidence by investors, suppliers, customers and employees, fewer business development opportunities and greater difficulty in obtaining financing.

Our company may be unable to raise needed funds

As of June 30, 2002, we had cash and cash equivalents totaling $5,342,000. Based on our current operating plan, we anticipate that our existing capital resources should be sufficient to meet our working capital requirements through December 31, 2002. However, if our business does not progress in accordance with our current business plan, we may need to raise additional funds. We may not be able to raise additional capital upon satisfactory terms or at all, and our business, financial condition and results of operations could be materially and adversely affected. To the extent that we raise additional capital by issuing equity or convertible securities, ownership dilution to our stockholders will result.

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In order to compete effectively, our Heart Laser Systems need to gain commercial acceptance

The Heart Laser Systems are designed for use in the treatment of coronary artery disease in a surgical laser procedure we pioneered known as transmyocardial revascularization. Transmyocardial revascularization is commonly referred to in our industry as “TMR.” TMR is a new technology that is only recently becoming known. Our products may never achieve widespread commercial acceptance. To be successful, we need to:

•       demonstrate to the medical community in general, and to heart surgeons and cardiologists in particular, that TMR procedures and the Heart Laser Systems are effective, relatively safe and cost effective;

•       support third-party efforts to document the medical processes by which TMR procedures relieve angina, if any;

•       have more heart surgeons trained to perform TMR procedures using the Heart Laser Systems; and

•       obtain widespread third-party reimbursement for the TMR procedure.

To date, only a limited number of heart surgeons have been trained and we are dependent on Edwards to expand TMR related marketing and training efforts in the United States.

Although the Heart Laser Systems have received FDA approval and the CE Mark, they have not yet received widespread commercial acceptance. If we are unable to maintain regulatory approvals or to achieve widespread commercial acceptance of the Heart Laser Systems, our business, financial condition and results of operations will be materially and adversely affected.

Results of long-term clinical studies may adversely affect our business

Patients have only been treated with the Heart Laser Systems since January 1990, and, as a result, there have been few long-term follow-up studies. If patients suffer harmful, long-term consequences from the Heart Laser Systems, our business, financial condition and results of operations will be materially and adversely affected.

Our business may be adversely affected by a clinical study, the results of which were released on October 20, 2000 at the Transcatheter Therapeutics Conference.  The clinical study, which used a Johnson & Johnson holmium PMR laser, demonstrated no significant differences in the clinical outcomes measured between patients receiving PMR therapy and patients in the control group.  The principal investigator of the clinical study concluded that the similar outcomes in patients in the treatment group and patients in the control group suggests a strong placebo effect, as opposed to any real therapeutic benefit from the PMR laser revascularization procedure.  Although we believe that there are distinct clinical differences and therapeutic outcomes between a surgical laser TMR procedure and an interventional laser PMR procedure, the negative publicity resulting from the clinical study with respect to all laser revascularization

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procedures, including our CO2 laser TMR approach, makes it more challenging for us to distinguish our surgical TMR from PMR, and our CO2 laser from holmium lasers.  If we or Edwards are unable to distinguish these procedures and therapies, the Heart Laser Systems may never gain broad commercial acceptance and, therefore, our business will be materially and adversely affected.

Rapid technological changes in our industry could make the Heart Laser Systems obsolete

Our industry is characterized by rapid technological change and intense competition. New technologies and products and new industry standards will develop at a rapid pace, which could make the Heart Laser Systems obsolete.  The advent of new devices and procedures and advances in new drugs and genetic engineering are especially threatening.  Our future success will depend upon our ability to develop and introduce product enhancements to address the needs of our customers.  Material delays in introducing product enhancements may cause customers to forego purchases of our product and purchase those of our competitors.

Many potential competitors have substantially greater financial resources and are in a better financial position to exploit marketing and research and development opportunities.  Our current competitor in the TMR market, CardioGenesis, uses a different type of laser (holmium) than we use in the Heart Laser Systems and we have no assurance that our laser will be able to gain more widespread market acceptance.

In addition, CardioGenesis is attempting to obtain FDA approval to market their PMR laser, which would provide a less invasive method of creating channels in the heart.  If PMR can be shown to be safe and effective and is approved by the FDA, it would eliminate the need in certain patients to make an incision in the chest, reducing costs and speeding recovery. PMR and other new technologies and methods may erode the potential TMR market, which could have a material adverse effect on our business, financial condition and results of operations.

We must receive and maintain government approval in order to market our product

General

The Heart Laser Systems and our manufacturing activities are subject to extensive, rigorous and changing federal and state regulation in the United States and to similar regulatory requirements in other major markets, including the European Union and Japan. To date, we have received regulatory approval in the United States and have the ability to market the Heart Laser Systems in the European Union (excluding France). We have not received regulatory approval in Japan. Without regulatory approval, we cannot market the Heart Laser Systems in Japan. Even if granted, regulations may significantly restrict the use of the Heart Laser Systems. The process of obtaining and maintaining required regulatory approval is lengthy, expensive and uncertain.

United States -- Although we have received FDA approval, the FDA has restricted the use of the Heart Laser Systems and could reverse its approval at any time

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We received FDA approval to market the HL1 and HL2 for TMR procedures in August 1998 and January 2001, respectively. However, the FDA:

•       has not allowed us to market the Heart Laser Systems to treat patients whose condition is amenable to conventional treatments, such as heart bypass surgery and angioplasty; and

•       could reverse its ruling and prohibit use of the Heart Laser Systems at any time.

Europe — Although we have the ability to market our product in the European Union, individual members of the European Union could, and France has, prohibited commercial use of the Heart Laser Systems

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

•       the European Union could reverse its ruling and prohibit use of the Heart Laser Systems at any time;

•       we cannot market the Heart Laser Systems in France; and

•       other European Union countries could prohibit or restrict use of the Heart Laser Systems.

The French Ministry of Health instituted a commercial moratorium on TMR procedures in October 1997.  In its opinion, the procedure is considered to be experimental and should only be performed within the context of a clinical study.  There can be no assurance that this moratorium will be lifted on a timely basis or at all.

Asia  —  We cannot market our product in major Asian markets until we receive government approval

We believe that Japan represents the largest potential market for the Heart Laser Systems in Asia. Prior to marketing the Heart Laser Systems in Japan, we must receive approval from the Japanese government.  This approval requires a clinical study in Japan with at least 60 patients.  A study was completed in 1998 with the HL1.  Although the results of this study have been submitted to the Japanese government, we do not know whether the clinical study will be sufficient or when, if ever, we will receive approval to sell the HL1 in Japan.  In addition, it is unclear what impact the introduction of the HL2 into the U.S. and other international markets will have on our ability to market the HL1 in Japan.

We could incur substantial costs defending against possible legal claims in the future

We have been sued for alleged securities law violations in the past, and may be subject to similar claims or other claims in the future.  Between August 1997 and November 1997, we were named as defendant in 21 class action lawsuits alleging violations of federal securities laws because we failed to obtain a favorable FDA panel recommendation to market the HL1.  Nineteen of the claims were consolidated into a single action and some of the claims were

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dismissed in 1999.  All remaining claims were settled in February 2001.  The settlement of these claims did not have a material impact on our financial statements.  However, any future litigation or claims, whether or not valid, could result in substantial costs and diversion of resources with no assurance of success.

Asserting and defending intellectual property rights may impact our results of operations

In our industry, competitors often assert intellectual property infringement claims against one another. The success of our business depends on our ability to successfully defend our intellectual property. Future litigation may have a material impact on our financial condition even if we are successful in marketing the Heart Laser Systems. We may not be successful in defending or asserting our intellectual property rights.

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

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

We may be subject to product liability lawsuits; our insurance may not be sufficient to cover damages

We may be subject to product liability claims. The United States Supreme Court has stated that compliance with FDA regulations will not shield a company from common-law negligent design claims or manufacturing and labeling claims based on state rules. Such claims may absorb significant management time and could degrade the reputation of PLC and the marketability of the Heart Laser Systems. If product liability claims are made with respect to our products, we may need to recall the implicated product which could have a material adverse effect on our business, financial condition and results of operations. In addition, although we maintain product liability insurance, we cannot be sure that our insurance will be adequate to cover potential product liability lawsuits. Our insurance is expensive and in the future may not be available on acceptable terms, if at all. If a successful product liability claim or series of claims exceeded our insurance coverage, it could have a material adverse effect on our business, financial condition and results of operations.

We are subject to risks associated with international operations

A portion of our product sales are generated from operations outside of the United States. Establishing and expanding international sales can be expensive. Managing and overseeing foreign operations may be difficult and products may not receive market acceptance. Risks of

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doing business outside the U.S. include the following: agreements may be difficult to enforce and receivables difficult to collect through a foreign country’s legal system; foreign customers may have longer payment cycles; foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade; U.S. export licenses may be difficult to obtain; and the protection of intellectual property in foreign countries may be more difficult to enforce. There can be no assurance that our international business will grow or that any of the foregoing risks will not result in a material adverse effect on our business or results of operations.

Because we are incorporated in Canada, you may not be able to enforce judgments against us and our Canadian directors

Under Canadian law, you may not be able to enforce a judgment issued by courts in the United States against us or our Canadian directors. The status of the law in Canada is unclear as to whether a U.S. citizen can enforce a 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.

Antitakeover provisions may prevent you from realizing a premium return

Provisions of Canadian law could make it more difficult for a third party to acquire us, even if the acquisition would be beneficial to you. Specifically, Canadian law requires any person who makes a tender offer that would increase the person’s stock ownership to more than 20% of our outstanding common stock to make a tender offer for all of our common stock.  These provisions could prevent you from realizing the premium return that stockholders may realize in conjunction with corporate takeovers.

In addition, we have three classes of directors, with approximately one-third elected each year for a three-year term. These provisions may have the effect of delaying or preventing a corporate takeover or a change in our management.  This could adversely affect the market price of our common stock.

The market price of our stock may fall if other shareholders sell their stock

Certain current shareholders hold large amounts of our restricted stock, which they may be able to sell in the public market in the near future.  Sales of a substantial number of shares of our common stock within a short period of time could cause our stock price to fall.  In addition, the sale of these shares could impair our ability to raise capital through the sale of additional stock.

The value of your common stock may decrease if other security holders exercise their options and warrants

As shown in the table below, as of June 30, 2002, we have reserved an additional 7,348,856 shares of common stock for future issuance upon exercise of outstanding options, warrants and shares purchasable under an employee stock purchase plan.

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	Range of Exercise/ Conversion Prices	Weighted Average Exercise/ Conversion Price		Shares Reserved for Future Issuance
Options	$.52 — $8.88	$	2.47	3,535,772
Warrants	$1.00 — $27.81	$	3.33	3,327,215
Employee Stock Purchase Plan	$.425 — $.51	$	.45	485,869
Total				7,348,856

We may issue additional options and warrants in the future. If any of these securities are exercised, you may experience significant dilution in the market value of your common stock.

We have no intention to pay dividends

We have never paid any cash dividends on our common stock. We currently intend to retain all future earnings, if any, for use in our business and do not expect to pay any dividends in the foreseeable future.

Our actual results could differ materially from those anticipated in forward-looking statements

This quarterly report and information incorporated by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements deal with our current plans and expectations and involve known and unknown risks and uncertainties.  Statements containing terms such as believes, does not believe, plans, expects, intends, estimates, anticipates and other phrases of similar meaning are considered to contain uncertainty and are forward-looking statements.

No forward-looking statement is a guarantee of future performance.  Our actual results could differ materially from those anticipated in these forward-looking statements.  We have identified a number of important factors, including the risk factors identified above, that could cause our actual results to differ materially from our forward-looking statements.  You should read these important factors as being applicable to all related forward-looking statements, wherever they appear in this quarterly report, in the materials referred to in this quarterly report, in the materials incorporated by reference into this quarterly report or in our press releases. You should not place undue reliance on any forward-looking statement.

Item 3.        Quantitative and Qualitative Disclosures About Market Risk

A portion of the Company’s operations consists of sales activities in foreign jurisdictions. The Company manufactures its products exclusively in the United States and sells the products in the

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United States and abroad. As a result, the Company’s financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. The Company’s operating results are exposed to changes in exchange rates between the U.S. dollar and foreign currencies, especially the Swiss Franc and the Euro. When the U.S. dollar strengthens against the Franc or Euro, the value of nonfunctional currency sales decreases. When the U.S. dollar weakens, the functional currency amount of sales increases. No assurance can be given that foreign currency fluctuations in the future may not adversely affect the Company’s business, financial condition and results of operations, although at the present time the Company does not believe that its exposure is significant.

                The Company’s interest income is sensitive to changes in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on the Company’s cash equivalents.

PLC SYSTEMS INC.

Part II.  Other Information

Item 1.        Legal Proceedings

                    See Note 6 to Notes to Condensed Consolidated Financial Statements filed with this Form 10-Q, which is incorporated herein by reference.

Item 2.        Changes in Securities and Use of Proceeds

    None.

Item 3.        Defaults Upon Senior Securities

                    None.

Item 4.        Submission of Matters to a Vote of Security Holders

On May 22, 2002, the Company held its 2002 Annual and Special Meeting of Shareholders (the “Shareholders Meeting”).  At the Shareholders Meeting, the following matters were approved by the vote specified below:

1.An amendment to Appendix 2 to the Company’s Articles of Continuance to provide that (i) the directors or the shareholders may fix the number of directors from time to time, subject to certain restrictions; (ii) the directors or shareholders, by special resolution, may vary the term of office of any director; and (iii) a vacancy on the Board of Directors shall not exist where the directors or the shareholders decrease the number of directors upon the expiration of the term of office of one or more of the directors, subject to certain restrictions, was approved.  The votes were cast as follows: 11,429,645 shares of common stock were voted for the amendment, 1,076,803 shares of common stock were voted against the amendment and 15,252,518 shares of common stock either abstained from the vote or were not voted.

2.A resolution of the Company’s Board of Directors to fix the number of directors of the Company at nine was approved.  The votes were cast as follows: 27,156,540 shares of common stock were voted for the resolution, 525,286 shares of common stock were

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voted against the resolution and 77,140 shares of common stock abstained from the vote.

3.Kevin J. Dunn and H.B. Brent Norton, M.D. were elected to serve as directors until the annual meeting of shareholders in 2005 or until their successors are duly elected and qualified.  Mr. Dunn received 27,399,149 shares of common stock voting in favor of his election and 359,817 shares of common stock were withheld.  Dr. Norton received 27,377,475 shares of common stock voting in favor of his election and 381,491 shares of common stock were withheld.  In addition, the terms of the following directors continued after the Shareholders Meeting: Edward H. Pendergast, Donald E. Bobo, Jr., Benjamin L. Holmes, Alan H. Magazine, Kenneth J. Pulkonik, Robert I. Rudko, Ph.D. and Mark R. Tauscher.

4.An amendment increasing the number of shares of common stock authorized for issuance under the Company’s 2000 Employee Stock Purchase Plan from 400,000 to 800,000 was approved.  The votes were cast as follows: 26,328,364 shares of common stock were voted for the amendment, 1,256,514 shares of common stock were voted against the amendment and 174,087 shares of common stock abstained from the vote.

5.The ratification of the appointment of Ernst & Young LLP as the Company’s independent auditors for the year ending December 31, 2002 was approved.  The votes were cast as follows: 27,588,826 shares of common stock were voted for the ratification, 103,241 shares of common stock were voted against the ratification and 66,899 shares of common stock abstained from the vote.

Item 5.        Other Information

None.

Item 6.        Exhibits and Reports on Form 8-K

a)Exhibits

3.1Articles of Continuance of the Company, as amended, incorporated by reference to the Company’s registration statement on Form S-8 (SEC File No. 333-91430), as previously filed with the Securities and Exchange Commission.

b)        Reports on Form 8-K

None.

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SIGNATURES

                Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PLC SYSTEMS INC.
Dated:  August 12, 2002	By:	/s/ James G. Thomasch
		Chief Financial Officer
		(Principal Financial Officer and Chief Accounting Officer)

STATEMENT PURSUANT TO 18 U.S.C. §1350

                Pursuant to 18 U.S.C. §1350, each of the undersigned certifies that this quarterly report on Form 10-Q for the period ended June 30, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in this quarterly report fairly presents, in all material respects, the financial condition and results of operations of PLC Systems Inc.

	/s/ Mark R. Tauscher
Dated:  August 12, 2002	Mark R. Tauscher
	Chief Executive Officer
	/s/ James G. Thomasch
Dated:  August 12, 2002	James G. Thomasch
	Chief Financial Officer

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Exhibit Index

Exhibit No.	Description
3.1	Articles of Continuance of the Company, as amended, incorporated by reference to the Company’s registration statement on Form S-8 (SEC File No. 333-91430), as previously filed with the Securities and Exchange Commission.

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