UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2007.

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		(I.R.S. Employer Identification No.)
Incorporation or Organization)

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 x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large 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 mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No x

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 November 7, 2007
Common Stock, no par value		30,324,913

PLC SYSTEMS INC.

Index

Part I. Financial Information

Item 1. Financial Statements

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

	September 30, 2007			December 31, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	8,712		$	6,034
Short-term investments	—			4,000
Accounts receivable, net of allowance of $26 and $51 at September 30, 2007 and December 31, 2006, respectively	1,218			918
Inventories, net	855			1,255
Prepaid expenses and other current assets	718			595
Total current assets	11,503			12,802
Equipment, furniture and leasehold improvements, net	253			166
Other assets	199			208
Total assets	$	11,955		$	13,176

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	471		$	456
Accrued compensation	782			396
Accrued other	274			317
Deferred revenue	2,290			1,784
Total current liabilities	3,817			2,953
Deferred revenue	2,419			3,094
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, 30,325 and 30,311 shares issued and outstanding as of September 30, 2007 and December 31, 2006, respectively	93,889			93,882
Additional paid in capital	220			101
Accumulated deficit	(88,079		)	(86,531		)
Accumulated other comprehensive loss	(311		)	(323		)
Total stockholders’ equity	5,719			7,129
Total liabilities and stockholders’ equity	$	11,955		$	13,176

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

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,
	2007			2006			2007			2006
Revenues:
Product sales	$	975		$	1,205		$	3,629		$	4,262
Service fees	356			362			1,127			1,137
Total revenues	1,331			1,567			4,756			5,399
Cost of revenues:
Product sales	258			422			1,406			1,487
Service fees	210			168			631			516
Total cost of revenues	468			590			2,037			2,003
Gross profit	863			977			2,719			3,396
Operating expenses:
Selling, general and administrative	830			786			2,919			2,470
Research and development	637			394			1,684			1,385
Total operating expenses	1,467			1,180			4,603			3,855
Gain on the sale of manufacturing rights	—			—			—			1,432
Income (loss) from operations	(604		)	(203		)	(1,884		)	973
Other income, net	105			123			336			310
Net income (loss)	$	(499	)	$	(80	)	$	(1,548	)	$	1,283
Basic income (loss) per share	$	(0.02	)	$	(0.00	)	$	(0.05	)	$	0.04
Diluted income (loss) per share	$	(0.02	)	$	(0.00	)	$	(0.05	)	$	0.04
Average shares outstanding:
Basic	30,323			30,237			30,315			30,080
Diluted	30,323			30,237			30,315			30,518

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

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
	2007			2006
Operating activities:
Net income (loss)	$	(1,548	)	$	1,283

Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:
Depreciation and amortization	75			87
Compensation expense from stock options	119			68
Loss on retirement of equipment	—			77
Change in assets and liabilities:
Accounts receivable	(300		)	(248		)
Inventory	400			(201		)
Prepaid expenses and other assets	(123		)	84
Accounts payable	15			51
Deferred revenue	(172		)	(410		)
Accrued liabilities	343			(61		)
Net cash provided by (used for) operating activities	(1,191		)	730

Investing activities:
Purchase of investments	—			(4,000		)
Maturity of investments	4,000			5,400
Purchase of equipment	(153		)	(69		)
Net cash provided by investing activities	3,847			1,331

Financing activities:
Net proceeds from exercise of stock options	6			107
Net proceeds from issuance of common stock	1			1
Net cash provided by financing activities	7			108

Effect of exchange rate changes on cash and cash equivalents	15			15
Net increase in cash and cash equivalents	2,678			2,184
Cash and cash equivalents at beginning of period	6,034			2,560
Cash and cash equivalents at end of period	$	8,712		$	4,744

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

PLC SYSTEMS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007

1. Nature of Business

PLC Systems Inc. (“PLC” or the “Company”) is a medical device company specializing in innovative technologies for the cardiac and vascular markets. The Company pioneered and manufactures the CO2 Heart Laser System (the “Heart Laser System”) that cardiac surgeons use to perform carbon dioxide (CO2) transmyocardial revascularization, or TMR, to alleviate symptoms of severe angina. In addition, the Company has commenced clinical trials for the Company’s RenalGuard Therapy™and RenalGuard System™ (collectively “RenalGuard”). RenalGuard Therapy is designed to reduce the toxic effects that contrast media can have on the kidneys. This therapy is based on the theory that creating and maintaining a high urine output is beneficial to patients undergoing cardiovascular imaging procedures where contrast agents are used. The real-time measurement and matched fluid replacement design of the Company’s RenalGuard System is intended to ensure that a high urine flow is maintained before, during and after these procedures, thus allowing the body to rapidly eliminate contrast, reducing its toxic effects. The RenalGuard System, with its matched fluid replacement capability, is intended to minimize the risk of over- or under-hydration.

In December 2006, the Company received full FDA approval to conduct its first human clinical trial utilizing RenalGuard under an investigational device exemption. This 40-patient pilot clinical trial is designed to evaluate the safety of the RenalGuard System and its ability to accurately measure and balance fluid inputs and outputs on patients undergoing a catheterization imaging procedure where contrast media will be administered.

The Company hopes to be able to demonstrate through future clinical trials that RenalGuard is also safe and effective in preventing Contrast-Induced Nephropathy (“CIN”), a form of acute renal failure caused by exposure to contrast media for certain patients undergoing imaging procedures.

On March 20, 2007, the Company entered into a distribution agreement with Novadaq Corp. (“Novadaq”), a subsidiary of Novadaq Technologies Inc., pursuant to which the Company appointed Novadaq as its exclusive distributor in the United States for the TMR business. This agreement amended and restated the exclusive distribution agreement between the Company and Edwards Lifesciences LLC (“Edwards”), which was assigned by Edwards to Novadaq on the same date. The agreement with Novadaq reflects substantially the same roles, responsibilities and financial terms as the Company’s previous agreement with Edwards.

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 adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended

September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. 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, 2006.

3. New Accounting Pronouncement

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements.

Effective January 1, 2007, the Company has adopted the provisions of FIN 48. The adoption of FIN 48 did not have an impact on the Company’s consolidated financial statements. Effective with the adoption of FIN 48, the Company recognizes interest and penalties related to uncertain tax positions as a component of the provision for income taxes.

As of January 1, 2007, the Company had deferred tax assets of $51 million, primarily comprised of federal and state tax net operating loss carryforwards and federal and state research and development credit carryforwards. Under the Internal Revenue Code, certain substantial changes in the Company’s ownership may limit the amount of net operating loss carryforwards that can be utilized in any one year to offset future taxable income. Any carryforwards that will expire prior to utilization as the result of any limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance. Due to the existence of the valuation allowance, future changes in the Company’s unrecognized tax benefits will not impact its effective tax rate.

The Company maintained a reserve of $70,000 as of September 30, 2007 for any potential tax matters that could arise in the future. The reserve did not change during the nine months ended September 30, 2007.

The Company files income tax returns in the U.S. federal jurisdiction and in several state and foreign jurisdictions. For U.S. federal and state tax purposes, the tax years 2003 through 2006 remain open to examination. In addition, the amount of the Company’s federal and state net operating loss carryforwards may be subject to examination and adjustment. The examination periods for the Company’s foreign jurisdictions range from 1997 through 2006.

4. Inventories

Inventories are stated at the lower of cost (computed on a first-in, first-out method) or market value and include allocations of labor and overhead. As of September 30, 2007 and December 31, 2006, inventories consisted of the following (in thousands):

	September 30, 2007		December 31, 2006
Raw materials	$	610	$	791
Work in progress	98		118
Finished goods	147		346
	$	855	$	1,255

At September 30, 2007 and December 31, 2006, inventories are stated net of a specific obsolescence allowance of $507,000 and $548,000, respectively.

5. Stock-Based Compensation

Stock Option and Stock Purchase Plans

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

The number of stock options that may be granted under the 2005 Plan is equal to 2,156,175 shares of common stock (subject to adjustment in the event of stock splits and other similar events), plus such number of shares as may become available under the Previous Plans after the date of the adoption of the 2005 Plan because any award previously granted under any such plan expires or is terminated, surrendered or cancelled without having been fully exercised or is forfeited in whole or in part or results in any common stock not being issued, provided that such number of additional shares may not exceed 2,535,492. Incentive stock options are issuable only to employees of the Company, while non-qualified options may be issued to non-employee directors, consultants, and others, as well as to employees. The options granted under the Previous Plans and the 2005 Plan become exercisable either immediately, or ratably over one to four years from the date of grant, and expire ten years from the date of grant. The per share exercise price of incentive stock options may not be less than the fair market value of the common stock on the date the option is granted.

The Company grants stock options to its non-employee directors. Generally, new non-employee directors receive an initial grant of an option to purchase 30,000 shares of the 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 annual grant of an option to purchase 15,000 shares of the Company’s common stock that generally vests in four equal quarterly installments. The Chairman of the Board receives an annual grant of an option to purchase 30,000 shares of the Company’s common stock that generally vests in four equal quarterly installments in the same manner as the options granted annually to the other non-employee directors. All such options have an exercise price equal to the fair market value of the common stock on the date of grant.

Options granted during 2007 and 2006 will vest ratably annually over a three year period for employees and ratably quarterly over a one year period for non-employee directors.

The following is a summary of option activity under all plans (in thousands, except per option data):

	Number of Options		Weighted Average Exercise Price		Average Remaining Contractual Life (Years)
Outstanding, December 31, 2006	4,767		$	1.05
Granted	618		0.64
Exercised	(13	)	0.47
Forfeited	(7	)	0.75
Expired	(67	)	4.74
Outstanding, September 30, 2007	5,298		0.96		6.00
Exercisable, September 30, 2007	4,379		1.02		5.31

The following table summarizes unvested option activity during the nine months ended September 30, 2007:

	Number of Options		Weighted Average Grant Date Fair Value
	(in thousands, except weighted average data)
Unvested, December 31, 2006	531		$	0.51
Granted	618		0.44
Vested	(227	)	0.50
Forfeited	(3	)	0.50
Unvested, September 30, 2007	919		0.47

SFAS No. 123R

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-based Payment” (“SFAS No. 123R”), using the modified-prospective transition method, which did not require restatement of prior period results. In the three and nine months ended September 30, 2007, the Company recorded compensation expense of $49,000 and $119,000, respectively, for all share-based payments granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. The Company estimates an expected forfeiture rate based on its historical forfeiture activity. Actual results, and future changes in estimates, may differ substantially from the Company’s current estimates. As of September 30, 2007, the Company had $437,000 of total unrecognized compensation cost related to its unvested options, which is expected to be recognized over a weighted average period of 2.09 years.

The weighted average fair value of options issued during the nine months ended September 30, 2007 was estimated using the Black-Scholes model.

		Nine Months Ended September 30, 2007
Expected life (years)		5.50-6.00
Interest rate		4.62%-5.20%
Volatility		74.7%-77.4%
Expected dividend yield		None
Value of option granted		$0.43-$0.45

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

The expected 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 term period. Expected volatility is based exclusively on historical volatility data of the Company’s common stock.

The Company has a 2000 Employee Stock Purchase Plan (the “Purchase Plan”) for all eligible employees whereby shares of the Company’s common stock may be purchased at six-month intervals at 95% of the closing price of the Company’s common stock on the last business day of the relevant plan period. Employees may purchase shares having a value not exceeding 10% of their gross compensation during an offering period, subject to certain additional limitations. Under the Purchase Plan, employees of the Company purchased 612 shares and 1,235 shares of common stock in the nine months ended September 30, 2007 and the year ended December 31, 2006 at average prices of $0.64 and $0.65 per share, respectively. At September 30, 2007, 320,640 shares were reserved for future issuance under the Purchase Plan.

6. Revenue Recognition

The Company records revenue from the sale of TMR kits at the time of shipment to Novadaq. TMR kit revenues include the amount invoiced to Novadaq for kits shipped pursuant to purchase orders received, as well as an amortized portion of deferred revenue related to a payment of $4,533,333 received in February 2004. This payment was made in exchange for a reduction in the prospective purchase price the Company receives upon a sale of the kits. The Company is amortizing this payment into its Consolidated Statements of Operations as revenue over a seven year period (culminating in 2010) under the units-of-revenue method as prescribed by Emerging Issues Task Force 88-18, “Sales of Future Revenue”. The Company determined that a seven year timeframe was the most appropriate amortization period based on a valuation model it used to assess the economic fairness of the payment. Factors the Company considered in developing this valuation model included the estimated foregone revenues over a seven year period resulting from the reduction in the prospective purchase price payable to the Company, a discount rate deemed appropriate to this transaction and an estimate of the remaining economic useful life of the current TMR kit design, without any benefit being given to potential future product improvements the Company may make. The Company reviews annually, and adjusts if necessary, the prospective revenue amortization rate for kits based on its best estimate of the total number of kits likely remaining to be shipped to hospital customers by Novadaq through 2010. The Company recorded amortization of $132,000 and $503,000 in the three and nine months ended September 30, 2007, respectively, as compared to $158,000 and $483,000 in the three and nine months ended September 30, 2006, respectively, which is included in revenues in the Consolidated Statements of Operations.

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

Under the terms of the TMR distribution agreement, once Novadaq has recovered a prescribed amount of revenue from a hospital for the use or purchase of a TMR laser, any additional revenues earned by Novadaq 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 TMR lasers to international distributors or hospitals at the time of shipment.

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

Installation revenues related to a TMR laser transaction are recorded as a component of service fees when the laser is installed.

7. Earnings (Loss) per Share

In the three and nine months ended September 30, 2007 and the three months ended September 30, 2006, 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 issuances of common stock related to stock option programs, since their inclusion would be antidilutive.

In the nine months ended September 30, 2006, basic earnings per share has been computed using only the weighted average number of common shares outstanding during the period, while diluted earnings per share was 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. In calculating diluted earnings per share, the dilutive effect of stock options is computed using the average market price for the respective period.

For the three months ended September 30, 2007 and 2006, 5,298,000 and 5,036,000 shares, respectively, and for the nine months ended September 30, 2007 and 2006, 5,298,000 and 5,036,000 shares, respectively, attributable to outstanding stock options were excluded from the calculation of diluted earnings per share because the effect would have been antidilutive. The following table sets forth the computation of basic and diluted earnings (loss) per share:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
	(In thousands, except per share data)
Basic:
Net income (loss)	$	(499	)	$	(80	)	$	(1,548	)	$	1,283

Weighted average shares outstanding	30,323			30,237			30,315			30,080
Basic earnings (loss) per share	$	(0.02	)	$	(0.00	)	$	(0.05	)	$	0.04

Diluted:
Net income (loss)	$	(499	)	$	(80	)	$	(1,548	)	$	1,283

Weighted average shares outstanding	30,323			30,237			30,315			30,080
Assumed impact of the exercise of outstanding dilutive stock options using the treasury stock method	—			—			—			438
Weighted average common and common equivalent shares	30,323			30,237			30,315			30,518

Diluted earnings (loss) per share	$	(0.02	)	$	(0.00	)	$	(0.05	)	$	0.04

8. Comprehensive Income (Loss)

Total comprehensive loss for the three and nine month periods ended September 30, 2007 amounted to $492,000 and $1,536,000, respectively, as compared to comprehensive loss of $78,000 in the three months ended September 30, 2006 and comprehensive income of $1,296,000 in the nine months ended September 30, 2006. Comprehensive income (loss) is comprised of net income (loss) plus the increase/decrease in currency translation adjustment.

9. Warranty and Preventative Maintenance Costs

The Company warranties its products against manufacturing defects under normal use and service during the warranty period. The Company obtains similar warranties from a majority of its suppliers, including those who supply critical Heart Laser System components. In addition, under the terms of its TMR distribution agreement with Novadaq, the Company is able to bill Novadaq for actual warranty costs, including preventative maintenance services, up to a specified amount during the warranty period.

The Company evaluates the estimated future unrecoverable costs of warranty and preventative maintenance services for its installed base of lasers on 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 the warranty accrual were as follows (in thousands):

	Nine Months Ended September 30,
	2007		2006
Balance, beginning of period	$	60	$	60
Payments made	—		—
Change in liability for warranties issued during the year	—		—
Change in liability for preexisting warranties	—		—
Balance, end of period	$	60	$	60

10. Gain on Sale of Manufacturing Rights

In February 2004, the Company signed an agreement with Edwards to assume development and manufacturing of the Optiwave 980 Cardiac Laser Ablation System (“Optiwave 980”) and related system disposables. In March 2006, the Company and Edwards terminated this agreement. The Company received $1,500,000 in consideration for selling its Optiwave 980 system related disposable manufacturing rights to Edwards. In conjunction with the sale, the Company wrote off certain inventory and capital assets acquired to manufacture the Optiwave 980 disposables and recorded a net gain of $1,432,000 in its Consolidated Statement of Operations during the nine months ended September 30, 2006.

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 (the “Exchange Act”). Statements containing terms such as “believes”, “plans”, “expects”, “anticipates”, “intends”, “estimates” and similar expressions reflect 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 in Part II, Item 1A. Risk Factors, and elsewhere in this quarterly report.

Overview

We are a medical device company specializing in innovative technologies for the cardiac and vascular markets. We pioneered and manufacture the Heart Laser System that cardiac surgeons use to perform TMR to alleviate symptoms of severe angina. In addition, in early 2007, we began treating patients in our pilot clinical safety trial for our RenalGuard Therapy and RenalGuard System. RenalGuard Therapy is designed to reduce the toxic effects that contrast media can have on the kidneys. This therapy is based on the theory that creating and maintaining a high urine output is beneficial to patients undergoing cardiovascular imaging procedures where contrast agents are used. The real-time measurement and matched fluid replacement design of our RenalGuard System is intended to ensure that a high urine flow is maintained before, during and after these procedures, thus allowing the body to rapidly eliminate contrast, reducing its toxic effects. The RenalGuard

System, with its matched fluid replacement capability, is intended to minimize the risk of over- or under-hydration.

In December 2006, we received full FDA approval to conduct our first human clinical trial utilizing RenalGuard under an investigational device exemption. This 40-patient pilot clinical trial is designed to evaluate the safety of the RenalGuard System and its ability to accurately measure and balance fluid inputs and outputs on patients undergoing a catheterization imaging procedure where contrast media will be administered.

We hope to be able to demonstrate through future clinical trials that RenalGuard is also safe and effective in preventing Contrast-Induced Nephropathy (“CIN”), a form of acute renal failure caused by exposure to contrast media for certain patients undergoing imaging procedures.

Our U.S. distributor (Novadaq currently and Edwards prior to March 20, 2007) is our largest customer, accounting for 88% and 85% of our total revenues in the three and nine months ended September 30, 2007, respectively, and 88% of our total revenues in the year ended December 31, 2006. We expect a high level of sales concentration to continue in the near future with Novadaq as our largest customer now that it holds the exclusive U.S. distribution rights for our TMR products.

Approximately 89% and 86% of our revenues in the three and nine months ended September 30, 2007, respectively, and 95% in the year ended December 31, 2006, came from the sale and service of TMR lasers and related disposable kits.

Aggregate TMR kit shipments to U.S. hospitals through Novadaq and Edwards decreased approximately 38% and 22% in the three and nine months ended September 30, 2007 as compared to the three and nine months ended September 30, 2006, respectively. We believe the decline in third quarter TMR kit shipments was primarily the result of (1) disruptions in the effectiveness of the sales channel resulting from a new organizational sales force structure that Novadaq implemented in the third quarter and (2) reduced marketing activities during the quarter on the part of the Novadaq sales force, as Novadaq was forced to divert attention to solving and explaining to customers a critical inventory component supply shortage for its principal product line (the SPY® Imaging System). We believe this reduced sales activity in the third quarter negatively impacted potential new sales of TMR kits to U.S. hospital customers.

We believe the decline in TMR kit shipments between the respective nine month periods is due to (1) lower than normal TMR sales activities conducted by Edwards during the first quarter of 2007, as Edwards focused its sales force on product lines other than TMR in anticipation of assigning its TMR distribution rights, (2) sales channel transition issues in the second quarter, which included the need to train the Novadaq sales force on TMR and the Heart Laser System, and (3) the aforementioned causes for the decline in third quarter TMR kit shipments under Novadaq.

We believe it is likely to take at least several quarters for Novadaq’s sales force to regain both the volume of TMR kit shipments to customers and the level of TMR revenues that the Edwards sales channel was able to generate in 2006. As such, we believe that our fourth quarter revenues and results of operations for 2007 will likely be lower than those in the corresponding period in 2006. The transition of distribution responsibilities from Edwards to Novadaq also is expected to affect our revenue and operating results during future quarters in

2008 and we will be largely dependent on the success of Novadaq’s sales and marketing efforts in the future to increase our installed base of TMR lasers and increase TMR procedure volumes and revenues in the U.S.

Our management reviews a number of key performance indicators to assist in determining how to allocate resources and run our day to day operations. These indicators include (1) actual prior quarterly sales trends, (2) projected TMR laser and kit sales for the next four quarters, as provided by our exclusive U.S. distributor in a rolling twelve month sales forecast, (3) research and development progress as measured against internal project plan objectives, (4) budget to actual financial expenditure results, (5) inventory levels (both our own and our distributors’) and (6) short term and long term projected cash flows of the business.

Critical Accounting Policies and Estimates

Our financial statements are based on the application of significant accounting policies, many of which require us to make significant estimates and assumptions (see Note 2 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2006). We believe that the following are some of the more material judgment areas in the application of our accounting policies that currently affect our financial condition 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 and overhead. A specific obsolescence allowance is provided for slow moving, excess and obsolete inventory based on our best estimate of the net realizable value of inventory on hand taking into consideration factors such as (1) actual trailing twelve month sales, (2) expected future product line demand, based in part on sales forecast input received from our exclusive U.S. distributor, and (3) service part stocking levels which, in management’s best judgment, are advisable to maintain in order to meet warranty, service contract and time and material spare part demands. Historically, we have found our reserves to be adequate.

Accounts Receivable

Accounts receivable is stated at the amount we expect to collect from the outstanding balance. We continuously monitor collections from customers, and we maintain a provision for estimated credit losses based upon historical experience and any specific customer collection issues that we have identified. Historically, we have not experienced significant losses related to our accounts receivable, primarily from Edwards and, more recently, Novadaq. Collateral is not generally required. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Research and Development Expenses

Research and development expenses are expensed as incurred.

Warranty and Preventative Maintenance Costs

We warranty our products against manufacturing defects under normal use and service during the warranty period. We obtain similar warranties from a majority of our suppliers, including those who supply critical Heart Laser System components. In addition, under the terms of our TMR distribution agreement with Novadaq, we are able to bill Novadaq for actual warranty costs, including preventative maintenance services, up to a specified amount during the warranty period.

We evaluate the estimated future unrecoverable costs of warranty and preventative maintenance services for our installed base of lasers on a quarterly basis and adjust our warranty reserve accordingly. We consider all available evidence, including historical experience and information obtained from supplier audits.

Revenue Recognition

We record revenue from the sale of TMR kits at the time of shipment to Novadaq. TMR kit revenues include the amount invoiced to Novadaq for kits shipped pursuant to purchase orders received, as well as an amortized portion of deferred revenue related to a payment of $4,533,333 received in February 2004. This payment was made in exchange for a reduction in the prospective purchase price we receive upon a sale of the kits. We are amortizing this payment into our Consolidated Statements of Operations as revenue over a seven year period (culminating in 2010) under the units-of-revenue method as prescribed by Emerging Issues Task Force 88-18, “Sales of Future Revenue”. We determined that a seven year timeframe was the most appropriate amortization period based on a valuation model we used to assess the economic fairness of the payment. Factors we considered in developing this valuation model included the estimated foregone revenues over a seven year period resulting from the reduction in the prospective purchase price payable to us, a discount rate deemed appropriate to this transaction and an estimate of the remaining economic useful life of the current TMR kit design, without any benefit being given to potential future product improvements we may make. We review annually, and adjust if necessary, the prospective revenue amortization rate for kits based on our best estimate of the total number of kits likely remaining to be shipped to hospital customers by Novadaq through 2010. We recorded amortization of $132,000 and $503,000 in the three and nine months ended September 30, 2007, respectively, as compared to $158,000 and $483,000 in the three and nine months ended September 30, 2006, respectively, which is included in revenues in our Consolidated Statements of Operations.

TMR lasers are billed to Novadaq in accordance with purchase orders that we receive. Invoiced TMR lasers are recorded as other current assets and deferred revenue on our Consolidated Balance Sheet until such time as the laser is shipped to a hospital, at which time we record revenue and cost of revenue.

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

We record revenue from the sale of TMR kits and TMR lasers to international distributors or hospitals at the time of shipment.

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

Installation revenues related to a TMR laser transaction are recorded as a component of service fees when the laser is installed.

Results of Operations

Results for the three and nine months ended September 30, 2007 and 2006 and the related percent of revenues were as follows:

	Three Months Ended								Nine Months Ended
	September 30,								September 30,
	2007				2006				2007				2006
	$		%		$		%		$		%		$	%
	(dollars in thousands)

Total revenues	1,331		100		1,567		100		4,756		100		5,399	100
Total cost of revenues	468		35		590		38		2,037		43		2,003	37
Gross profit	863		65		977		62		2,719		57		3,396	63
Selling, general & administrative	830		62		786		50		2,919		62		2,470	46
Research & development	637		48		394		25		1,684		35		1,385	26
Total operating expenses	1,467		110		1,180		75		4,603		97		3,855	71
Gain on sale of manufacturing rights	—		—		—		—		—		—		1,432	27
Income (loss) from operations	(604	)	(45	)	(203	)	(13	)	(1,884	)	(40	)	973	18
Other income	105		8		123		8		336		7		310	6
Net income (loss)	(499	)	(37	)	(80	)	(5	)	(1,548	)	(33	)	1,283	24

	Three Months Ended September 30,				Increase (decrease)				Nine Months Ended September 30,			Increase (decrease)
	2007		2006		over 2006				2007		2006	over 2006
	$		$		$		%		$		$	$		%
	(dollars in thousands)

Product sales	975		1,205		(230	)	(19	)	3,629		4,262	(633	)	(15	)
Service fees	356		362		(6	)	(2	)	1,127		1,137	(10	)	(1	)
Total revenues	1,331		1,567		(236	)	(15	)	4,756		5,399	(643	)	(12	)
Product cost of sales	258		422		(164	)	(39	)	1,406		1,487	(81	)	(5	)
Service fees cost of sales	210		168		42		25		631		516	115		22
Total cost of revenues	468		590		(122	)	(21	)	2,037		2,003	34		2
Gross profit	863		977		(114	)	(12	)	2,719		3,396	(677	)	(20	)
Selling, general & administrative expenses	830		786		44		6		2,919		2,470	449		18
Research & development expenses	637		394		243		62		1,684		1,385	299		22
Total operating expenses	1,467		1,180		287		24		4,603		3,855	748		19
Gain on sale of manufacturing rights	—		—		—		—		—		1,432	(1,432	)	(100	)
Income (loss) from operations	(604	)	(203	)	(401	)	(198	)	(1,884	)	973	(2,857	)	(294	)
Other income	105		123		(18	)	(15	)	336		310	26		8
Net income (loss)	(499	)	(80	)	(419	)	524		(1,548	)	1,283	(2,831	)	(221	)

Product Sales

Disposable TMR kit revenues, the largest component of product sales in the three months ended September 30, 2007, decreased by $119,000, or 16%, as compared to the three months ended September 30, 2006. Domestic disposable TMR kit revenues decreased $87,000 resulting from a lower volume of kit shipments to Novadaq than to Edwards in the 2006 period as well as decreased deferred kit revenue amortization. International disposable TMR kit revenues decreased $32,000 in the three months ended September 30, 2007 as compared to the three months ended September 30, 2006 due to a lower volume of kit shipments to international customers.

In the nine months ended September 30, 2007, disposable TMR kit revenues decreased by $378,000, or 18%, as compared to the nine months ended September 30, 2006. Domestic disposable TMR kit revenues decreased $399,000 resulting from a lower volume of kit shipments to Novadaq than to Edwards in the 2006 period. This decrease in TMR kit shipments to Novadaq was offset in part by a $20,000 increase in deferred kit revenue amortization. International disposable TMR kit revenues increased $1,000.

TMR laser revenues, the second largest component of product sales in the three months ended September 30, 2007, decreased by $179,000, or 24%, as compared to the three months ended September 30, 2006. This decrease resulted from (1) decreased revenue sharing earned under our TMR distribution agreements and (2) a lower average selling price on new domestic

TMR lasers.

In the nine months ended September 30, 2007, TMR laser revenues decreased by $678,000, or 35%, as compared to the nine months ended September 30, 2006. International TMR laser revenues decreased $276,000 due to the sale of two lasers to international customers in the nine months ended September 30, 2006, whereas there were no international TMR laser sales in the nine months ended September 30, 2007. Domestic TMR laser revenues decreased $402,000, or 24%, primarily as a result of (1) decreased revenue sharing earned under our TMR distribution agreements with Edwards and Novadaq and (2) a lower average selling price on new TMR lasers.

Other product sales increased $88,000, or 100%, and $343,000, or 162%, respectively, in the three and nine months ended September 30, 2007 as compared to the three and nine months ended September 30, 2006. These increases were driven primarily by (1) new manufacturing contract assembly product revenues, which we commenced as a new source of revenue during the fourth quarter of 2006, and (2) increased sales of new and refurbished surgical laser tubes to a single OEM customer. We believe the addition of new contract assembly work will result in increased revenues in this category of product sales during the remaining quarter of 2007 as compared to what we realized in this category in the corresponding quarter in 2006.

Optiwave 980 revenues to Edwards were $0 and $100,000 in the three and nine months ended September 30, 2007, respectively, while they were $20,000 in the three and nine months ended September 30, 2006. In December 2006, Edwards announced the discontinuation of the Optiwave 980, which we manufactured for Edwards under a supply agreement prior to its being discontinued. We do not expect to generate any revenues from this product line in the future.

Service Fee Revenues

Service fees decreased $6,000, or 2%, and $10,000, or 1%, respectively, in the three months and nine months ended September 30, 2007 as compared to the three and nine months ended September 30, 2006. The decreases are primarily related to decreases in international service billings.

Gross Profit

Total gross profit was $863,000, or 65% of total revenues, in the three months ended September 30, 2007 as compared with gross profit of $977,000, or 62% of total revenues, in the three months ended September 30, 2006. The improved gross profit percentage is primarily a result of both lower inventory obsolescence and period manufacturing expenses in the three months ended September 30, 2007 as compared to the three months ended September 30, 2006. The decrease in gross profit dollars is due to (1) lower disposable TMR revenues, (2) a decrease in revenue sharing earned under our U.S. TMR distribution agreements with Edwards and Novadaq and (3) a lower average selling price on new TMR lasers. These decreases were offset in part by higher gross profit dollars generated from (1) increased revenues from new and refurbished surgical tubes and contract assembly services, (2) a decrease in inventory obsolescence expense and (3) lower period manufacturing expenses.

Total gross profit was $2,719,000, or 57% of total revenues, in the nine months ended September 30, 2007 as compared with gross profit of $3,396,000, or 63% of total revenues, in the nine months ended September 30, 2006. The decrease in gross profit dollars is due to (1) lower disposable TMR revenues, (2) a decrease in revenue sharing earned under our U.S. TMR distribution agreements with Edwards and Novadaq, (3) lower international TMR laser revenue, and (4) a lower average selling price on new domestic TMR lasers. These decreases were offset in part by higher gross margin generated from (1) increased revenues from new and refurbished surgical tubes and contract assembly services, (2) a decrease in inventory obsolescence expense and (3) lower period manufacturing expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenditures increased 6% and 18%, respectively, in the three and nine months ended September 30, 2007 as compared to the three and nine months ended September 30, 2006. These increases are related to increased headcount and higher compensation expense, increased overall spending on sales and marketing activities related to RenalGuard, as well as higher corporate and legal expenditures incurred in connection with (1) the transfer of the U.S. TMR distribution agreement and (2) RenalGuard clinical trial contracts.

Research and Development Expenses

Research and development expenditures increased 62% and 22% in the three and nine months ended September 30, 2007 as compared to the three and nine months ended September 30, 2006. These increases are primarily due to increases in clinical trial expenditures for RenalGuard. These increases were partly offset by decreases in expenditures in connection with new product development costs related to RenalGuard.

We expect to continue to incur significant new research and development expenditures for the remainder of 2007 and future years. Our near term development efforts are focused on performing clinical trials of our newest product initiative, RenalGuard, which should lead to increased research and development expenditures from what we incurred in the first nine months of 2007 at least through 2009.

Gain on the Sale of Manufacturing Rights

In March 2006, we received $1,500,000 related to the sale our Optiwave 980 disposable manufacturing rights to Edwards. In conjunction with this transaction, we wrote off certain production equipment and inventory and recorded a net gain of $1,432,000 in the nine months ended September 30, 2006.

Other Income

The largest component of other income consists of interest income earned on our cash, cash equivalents and short-term investments.

Interest income decreased $18,000 in the three months ended September 30, 2007 as compared to the three months ended September 30, 2006. The decrease is primarily a result of lower investable cash balances in the three months ended September 30, 2007.

Interest income increased $26,000 in the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. The increase is primarily a result of a higher average interest rate earned on investable cash balance during the nine months September 30, 2007.

Net Income (Loss)

In the three months ended September 30, 2007, we recorded a net loss of $499,000 as compared to a net loss of $80,000 in the three months ended September 30, 2006. This increased net loss is primarily a result of higher operating expenses and lower sales and gross margin in the three months ended September 30, 2007 as compared to the three months ended September 30, 2006.

In the nine months ended September 30, 2006, we recorded a gain from the sale of our Optiwave 980 disposable manufacturing rights to Edwards. This non-recurring gain as well as higher sales, gross margin and lower operating expenses resulted in recorded net income of $1,283,000 in the nine months ended September 30, 2006 as compared to a net loss of $1,548,000 in the nine months ended September 30, 2007.

Kit Shipments

Although we have generally viewed disposable kit shipments to end users as an important metric in evaluating our business, we believe that specific short-term factors not indicative of long-term trends negatively affected shipments of disposable kits in 2007 as previously indicated above. Disposable kit shipments to end users were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007	2006	% Increase (Decrease) Over 2006		2007	2006	% Increase (Decrease) Over 2006

Domestic (by U.S. Distributor)	313	502	(38	)	1,194	1,530	(22	)
International	2	13	(85	)	32	38	(16	)
Total	315	515	(39	)	1,226	1,568	(22	)

In addition to the impact of factors previously discussed that we believe affected kit shipments in the first nine months of 2007, it is our belief that TMR kit shipments in recent years have largely been affected by what we believe is an ongoing downward trend in the number of bypass surgeries being performed. We believe the proliferation of interventional cardiac procedures being performed, particularly with the use of drug eluting stents, is causing a delay in the number of patients being referred to cardiac surgeons for surgical treatment of their cardiovascular disease. Because a significant number of the total TMR procedures performed each year by cardiac surgeons are done in combination with bypass surgery, we believe the growth in the number of TMR procedures may be being adversely impacted by this reduction in the number of bypass surgeries being performed.

Liquidity and Capital Resources

Cash, cash equivalents and short-term investments totaled $8,712,000 as of September 30, 2007, a decrease of $1,322,000 from $10,034,000 as of December 31, 2006. We have no debt obligations. We believe that our existing cash resources will meet our working capital requirements through at least the next 12 months.

Cash used for operating activities in the nine months ended September 30, 2007 was $1,191,000 due to our net loss, partially offset by favorable working capital changes, non-cash depreciation and amortization and compensation related to stock options. We used $153,000 for the purchase of equipment. Additional cash of $7,000 resulted from the exercise of stock options and proceeds from our employee stock purchase plan and $15,000 was provided by the effect of exchange rate changes.

We will be largely dependent on the future success of Novadaq’s sales and marketing efforts in the U.S. to continue to increase the installed base of our second generation Heart Laser System, the HL2, and to substantially increase TMR procedural volumes and revenues. Should the installed base of HL2 lasers or TMR procedural volume not increase sufficiently, our liquidity and capital resources will be negatively impacted. Additionally, other unanticipated decreases in operating revenues or increases in expenses or changes or delays in third-party reimbursement to healthcare providers using our products may adversely impact our cash position and require further cost reductions or the need to obtain additional financing. It is not certain that we, working with Novadaq and our international distributors, will be successful in achieving broad commercial acceptance of the Heart Laser Systems, or that we will be able to operate profitably in the future on a consistent basis, if at all.

Some hospital customers prefer to acquire the Heart Laser Systems on a usage basis rather than as a capital equipment purchase. We believe this is the result of limitations many hospitals currently have on acquiring expensive capital equipment as well as competitive pressures in the marketplace. A usage business model will result in a longer recovery period for Novadaq to recoup its investment in lasers it will purchase from us in the future. This results in (1) a delay in our ability to receive additional shared revenue, if any, that we otherwise are entitled to receive under the terms of our new distribution agreement with Novadaq and (2) a potential delay in the purchase of new lasers by Novadaq if the installed base of lasers placed under usage contracts are under-performing and Novadaq chooses to re-deploy these lasers to other hospital sites in lieu of purchasing a new laser from us. Our cash position and our potential need for additional financing to fund operations will be dependent in part upon the number of hospitals that acquire Heart Laser Systems from Novadaq on a usage basis and the number and frequency of TMR procedures performed by these hospitals.

We believe we will incur losses at least through 2009 as we increase our research and development spending in order to conduct the clinical trials that are necessary to obtain the regulatory approval to market RenalGuard. We cannot be certain that future sales, if any, of RenalGuard will justify the investments we plan to make. If we are unsuccessful in implementing our business strategy to introduce RenalGuard, or if the introduction of RenalGuard takes longer or costs more than anticipated, our liquidity and capital resources will be adversely affected and we may need to obtain additional financing.

There can be no assurance that, should we require additional financing, such financing will be available on terms and conditions acceptable to us. Should additional financing not be available on terms and conditions acceptable to us, additional actions may be required that could adversely impact our ability to continue to realize assets and satisfy liabilities in the normal course of business. The consolidated financial statements set forth in this report do not include any adjustments to reflect the possible future effects of these uncertainties.

Off-Balance Sheet Arrangements

None.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

A portion of our operations consists of sales activities in foreign jurisdictions. We manufacture our products exclusively in the U.S. and sell our products in the U.S. and abroad. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we distribute our products. Our operating results are exposed to changes in exchange rates between the U.S. dollar and foreign currencies, especially the Euro. When the U.S. dollar strengthens against the Euro, the value of foreign 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 will not adversely affect our business, financial condition and results of operations, although at present we do not believe that our exposure is significant, as international sales represented only 1% and 4% of our consolidated sales during the three and nine months ended September 30, 2007, respectively, and 8% of our consolidated sales in the year ended December 31, 2006. We do not hedge any balance sheet exposures or intercompany balances against future movements in foreign exchange rates.

Our interest income and expense are sensitive to changes in the general level of U.S. and foreign interest rates. In this regard, changes in U.S. and foreign interest rates affect the interest earned on our cash and cash equivalents. We do not believe that a 10% change to the applicable interest rates would have a material impact on our future results of operations or cash flows.

Item 4. Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2007. The term “disclosure controls and procedures”, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2007, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

No change in our internal control 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, 2007

that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1A. Risk Factors

The risks and uncertainties described below are not the only risks we face. Additional risks and uncertainties not presently known to us or 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.

We expect to incur significant operating losses in the near future.

We expect to incur net losses in future quarters, at least through 2009, as we increase our research and development on clinical studies of RenalGuard. We cannot provide any assurance that we will be successful with our business strategy, that RenalGuard will receive FDA approval or commercial acceptance, or that we will ever return to profitability.

We are dependent on our new distributor of TMR products in the U.S. to attempt to increase our TMR revenues.

Novadaq’s sales organization is responsible for selling a number of different products, including our TMR products. We will be largely dependent on the future success of Novadaq’s sales and marketing efforts in the U.S. to increase the installed base of HL2 lasers and TMR procedural volumes and revenues. If our relationship with Novadaq does not progress as anticipated, or if Novadaq’s sales and marketing strategies fail to generate sales of our products in the future, our revenue will decrease significantly and our business, financial condition and results of operations will be seriously harmed.

Our company is currently dependent on one principal customer.

Pursuant to the terms of our new TMR distribution agreement with Novadaq, Novadaq is our exclusive distributor for our HL2 TMR laser and TMR kits in the United States. As a result of this exclusive arrangement, Novadaq has become our principal customer, just as Edwards was our principal customer prior to the assignment of the distribution rights.

Our U.S. distributor accounted for 88% and 85% of total revenues in the three and nine months ended September 30, 2007, respectively, and 88% in the year ended December 31, 2006. As a result of this expected concentration of sales with our U.S. distributor, we bear an increased financial risk of timely sales collection if, for any reason, Novadaq’s business condition should suffer.

Our company is currently dependent on one principal product line to generate revenues.

We currently sell one principal product line, the Heart Laser Systems, which accounts for the majority of our total revenues. Approximately 89% and 86% of our revenues in the three and

nine months ended September 30, 2007, respectively, and 95% in the year ended December 31, 2006, were derived from the sales and service of our Heart Laser Systems. This absence of a diversified product line means that we are directly and materially impacted by changes in the market for Heart Laser Systems.

Our company is dependent on certain suppliers.

Some of the components for our Heart Laser Systems, most notably the power supply and certain optics and fabricated parts for the HL2, 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. We are dependent upon our sole suppliers to perform their obligations in a timely manner. 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 our products, which could have a material adverse effect on our business, financial condition and results of operations. Furthermore, we do not require significant quantities of any components because we produce a limited number of our products 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, and such difficulties may seriously harm our business, financial condition and results of operations.

We are dependent upon our key personnel and will need to hire additional key personnel in the near future.

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

Our company may be unable to raise needed funds.

As of September 30, 2007, we had cash and cash equivalents totaling $8,712,000. Based on our current operating plan, we anticipate that our existing capital resources should be sufficient to meet our working capital requirements for at least the next 12 months; however, we may need to raise additional funds in the future. 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 shareholders will result. To the extent that we raise additional capital through the incurrence of debt, our activities may be restricted by the repayment obligations and other restrictive covenants related to the debt.

In order to compete effectively, our current and future products need to gain commercial acceptance.

Our current TMR products may never achieve widespread commercial acceptance. To be

successful, we and Novadaq need to:

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

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

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

• maintain and expand third-party reimbursement for the TMR procedure.

To date, only a limited number of heart surgeons have been trained in the use of TMR using the Heart Laser Systems. We are dependent on Novadaq to expand related marketing and training efforts in the U.S. for the use of our products.

The Heart Laser Systems have not yet received widespread commercial acceptance. We believe that concerns over the lack of a consensus view on the reason or reasons why a TMR procedure relieves angina in patients who undergo the procedure has limited demand for and use of the Heart Laser Systems. Until there is consensus, if ever, of the medical processes by which TMR procedures relieve angina, we believe some hospitals will delay the implementation of a TMR program.

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

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

We have only completed the first generation product design for our RenalGuard System and we are testing the device in a clinical hospital setting as part of our pilot human clinical study. We may need to make substantial modifications to the design, features or functions of our device in order for it to obtain FDA approval or meet customer expectations. These changes may not be able to be completed in a timely fashion, if at all. Should any such modifications prove to be significantly more costly or time consuming to engineer than we estimate, our ability to bring this product to market may be severely and negatively impacted.

Our planned future clinical trials to study the safety and effectiveness of RenalGuard in preventing contrast-induced nephropathy will take us a significant amount of time to complete, if we can complete them at all, and the results of these clinical trials may not show sufficient safety and efficacy for us to either obtain FDA approval or otherwise be able to successfully market and sell the product.

Our business strategy to grow our revenues and profitability is largely dependent on our success in timely completion of our planned future clinical trials of RenalGuard. We hope to be able to demonstrate through clinical trials that RenalGuard is safe and effective in preventing CIN, a

form of acute renal failure caused by exposure to contrast media for patients undergoing imaging procedures.

We can provide no assurance that when studied in humans, RenalGuard will be shown to be safe or effective in preventing CIN, or that the degree of any positive safety and efficacy results will be sufficient to either obtain FDA approval or otherwise successfully market our product. Furthermore, the completion of our planned clinical trials is dependent upon many factors, some of which are not entirely within our control, including, but not limited to, our ability to successfully recruit investigators, the availability of patients meeting the inclusion criteria of our clinical study, the competition for these particular study patients amongst other clinical trials being conducted by other companies at these same study sites, the ability of the sites participating in our study to successfully enroll patients in our trial, and proper data gathering on the part of the investigating sites.

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

We will need to build a direct sales and marketing organization or otherwise enter into one or more distribution arrangements in order to market our RenalGuard System if and when it is approved for sale.

We currently do not have a direct sales force. Instead, we market our existing TMR products through Novadaq in the United States and through independent distributors outside the U.S. We do not plan to use Novadaq to market our RenalGuard System if and when it becomes commercially available to customers. We will need to either build an internal direct sales and marketing organization or find distribution partners in order to successfully market our RenalGuard System.

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

If we instead choose to pursue an indirect distribution strategy, we may not be able to identify 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 and conditions that are acceptable to us, including ensuring that our product receives adequate sales force focus and attention.

Our primary competitor in TMR may obtain FDA approval to market a new device, the impact of which is uncertain on the future adoption rate of TMR.

Our primary TMR competitor, CardioGenesis, has attempted in the past and may attempt in the future to obtain FDA approval to market its “percutaneous” method of performing myocardial revascularization, previously known as PMR, and recently rebranded as PMC

(percutaneous myocardial channeling), which would provide a less invasive method of creating channels in the heart. If PMC 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. It is unclear what impact, if any, approval of a PMC device would have on the future adoption rate for TMR procedures. If PMC is approved, it could erode the potential TMR market, which would have a material adverse effect on our business, financial condition and results of operations.

Rapid technological changes in our industry could make our products 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 our current and future planned products obsolete. The advent of new devices and procedures and advances in new drugs and genetic engineering are especially concerning competitive threats. 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 products 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.

We must receive and maintain government clearances or approvals in order to market our products.

Our products and our manufacturing activities are subject to extensive, rigorous and changing federal and state regulation in the U.S. and to similar regulatory requirements in other major international markets, including the European Union and Japan. These regulations and regulatory requirements are broad in scope and govern, among other things:

• product design and development;

• product testing;

• product labeling;

• product storage;

• premarket clearance and approval;

• advertising and promotion; and

• product sales and distribution.

Furthermore, regulatory authorities subject a marketed product, its manufacturer and the manufacturing facilities to continual review and periodic inspections. We are subject to ongoing FDA requirements, including required submissions of safety and other post-market information and reports, registration requirements, Quality Systems regulations, and recordkeeping requirements. The FDA’s Quality Systems regulations include requirements relating to quality

control and quality assurance, as well as the corresponding maintenance of records and documentation. Depending on its activities, Novadaq may also be subject to certain requirements under the U.S. Food, Drug, and Cosmetic Act and the regulations promulgated thereunder, and state laws and registration requirements covering the distribution of our products. Regulatory agencies may change existing requirements or adopt new requirements or policies that could affect our regulatory responsibilities or the regulatory responsibilities of a distributor like Novadaq. We may be slow to adapt or may not be able to adapt to these changes or new requirements.

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

• warning letters;

• patient or physician notification;

• restrictions on our products or manufacturing processes;

• voluntary or mandatory recalls;

• product seizures;

• refusal to approve pending applications or supplements to approved applications that we submit;

• refusal to permit the import or export of our products;

• fines;

• injunctions;

• suspension or withdrawal of marketing approvals or clearances; and

• civil and criminal penalties.

Should any of these enforcement actions occur, our business, financial condition and results of operations could be materially and adversely affected.

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

Heart Laser Systems

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

• has restricted the use of the Heart Laser Systems by not allowing us to market these

products to treat patients whose condition is amenable to conventional treatments, such as heart bypass surgery, stenting and angioplasty; and

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

In addition, as a condition of our original FDA approval for our TMR products, we were required by the FDA to perform a postmarket surveillance study. The FDA recently requested that we submit a PMA Postapproval Study report summarizing this postmarket surveillance study. As part of this report, the FDA requested that we analyze and discuss the adverse event and mortality rates seen in the postmarket study and compare these results to the premarket study which was presented as part of our initial FDA PMA application. We filed this postapproval study report with the FDA on February 28, 2007.

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

Europe — 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 impose additional restrictions or reverse its ruling and prohibit use of the Heart Laser Systems at any time; and

• France has prohibited, and other European Union countries could prohibit or restrict, use of the Heart Laser Systems.

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

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

RenalGuard

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

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

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

Because the PMA application process is more costly, lengthy and uncertain than the 510(k) process and must be supported by extensive data, including data from preclinical studies and human clinical trials, 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 should the approval process take longer than we anticipate, our future revenue growth prospects could be materially and adversely affected.

Changes in third party reimbursement for TMR procedures or our inability to obtain third party reimbursement for RenalGuard could materially affect future demand for our products.

Demand for medical devices is often affected by whether third party reimbursement is available for the devices and related procedures. Currently Medicare coverage is provided for TMR when it is performed as a sole therapy treatment. In addition, when two or more medical procedures are performed in combination with each other, Medicare rules generally allow hospitals to bill for whichever of the two procedures carries the higher reimbursement amount. Therefore, in situations where sole therapy TMR reimbursement rates exceed that provided for bypass surgery alone, if hospitals perform a combination procedure where both bypass surgery and adjunctive TMR are performed on a patient, the hospital is able to bill for the higher TMR procedure reimbursement payment. In these instances, the doctor also can bill an additional amount for performing multiple procedures.

Certain private insurance companies and health maintenance organizations also currently provide reimbursement for TMR procedures performed with our products and physician reimbursement codes have been established for both surgical procedures.

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

Should third party insurance reimbursement for TMR procedures be reduced or eliminated in the future, our business, financial condition and results of operations would be materially and adversely affected.

Furthermore, we know of no existing Medicare coverage or other third party reimbursement that would be available to either hospitals or physicians that would help defray the additional cost that would result from the future purchase and/or use of our RenalGuard System. We also can provide no assurance that we will ever be able to obtain Medicare coverage or other third party reimbursement for the use of RenalGuard, which could materially and adversely affect the potential future demand for this product.

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

Securing intellectual property rights for our RenalGuard System is critical to our future business plans, but may prove to be difficult or impossible for us to obtain.

We have filed seven patent applications and have one provisional patent application pending at the United States patent office related to our RenalGuard System, RenalGuard Therapy and other intellectual property in the general field of preventing contrast-induced nephropathy and acute renal failure. Securing patent protection over our intellectual property ideas in this field is, we believe, critical to our plans to successfully differentiate and market our RenalGuard System and grow our future revenues. We can provide no assurance, however, that we will be successful in securing any patent protection for our intellectual property ideas in this chosen field or that our efforts to obtain patent protection will not prove more difficult, and therefore more costly, than we are otherwise expecting. Furthermore, even if we are successful in securing patent protection for some or all of our intellectual property ideas in this field, we cannot predict when in the future any such potential patents may be issued, how strong such patent protection will prove to be, or whether these patents will be issued in a timely enough fashion to afford us any commercially meaningful advantage in marketing our RenalGuard System against other potentially competitive devices.

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 our products. 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. Such claims may absorb significant management time and could degrade our reputation and the marketability of our products. 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 exceeds 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 is generated from operations outside of the U.S. Establishing, maintaining and expanding international sales can be expensive. Managing and overseeing foreign operations are difficult and products may not receive market acceptance. Risks of doing business outside the U.S. include, but are not limited to, 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 rights 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.

We will soon have to comply with requirements regarding internal control over financial reporting.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our fiscal year ending December 31, 2007, our management will be required to provide a report on the effectiveness of our internal control over financial reporting. We are working to perform this evaluation in order to comply with these requirements. Compliance with these requirements is expected to be expensive and time-consuming. If we fail to timely complete this evaluation, we could be subject to regulatory action and public confidence in us could be adversely affected and our stock price could decline. In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations.

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 U.S. 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.

Our stock price has historically fluctuated and may continue to fluctuate significantly in the future which may result in losses for our investors.

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

• the announcement of new products, services or technological innovations by us or our competitors;

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

• speculation or actual news announcements in the media or industry trade journals about our company, our products, the TMR or CIN prevention procedures or changes in reimbursement policies by Medicare and/or private insurance companies;

• announcements relating to strategic relationships or mergers;

• conditions or trends in the medical device industry;

• changes in the economic performance or market valuations of other medical device companies; and

• general market conditions or domestic or international macroeconomic and geopolitical factors unrelated to our performance.

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

Certain current shareholders, including Edwards, hold large amounts of our stock, which they could sell in the public market from time to time. 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.

Item 6. Exhibits

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.

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.

Date: November 14, 2007	By:	/s/ James G. Thomasch
		James G. Thomasch
		Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer)

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.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Good

Viveve Medical (VIVE) 10-Q2007 Q3 Quarterly report

Content analysis

9. Warranty and Preventative Maintenance Costs

Overview

Critical Accounting Policies and Estimates

Inventories

Accounts Receivable

Warranty and Preventative Maintenance Costs

Revenue Recognition

Results of Operations

Item 4. Controls and Procedures