PLC SYSTEMS INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

	For the quarterly period ended June 30, 2003.

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

	For the transition period from to

Commission File Number: 1-11388

PLC SYSTEMS INC.

(Exact Name of Registrant as Specified in Its Charter)

Yukon Territory, Canada		04-3153858
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

10 Forge Park, Franklin, Massachusetts		02038
(Address of Principal Executive Offices)		(Zip Code)

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes o No ý

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 August 6, 2003
Common Stock, no par value		29,836,307

PLC SYSTEMS INC.

Index

Part I.	Financial Information:

	Item 1.	Financial Statements

		Condensed Consolidated Balance Sheets (unaudited)

		Condensed Consolidated Statements of Operations (unaudited)

		Condensed Consolidated Statements of Cash Flows (unaudited)

		Notes to Condensed Consolidated Financial Statements (unaudited)

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

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk

	Item 4.	Controls and Procedures

Part II.	Other Information:

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

	Item 6.	Exhibits and Reports on Form 8-K

PLC SYSTEMS INC.

Part I. Financial Information

Item 1. Financial Statements

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

	June 30, 2003			December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	5,893		$	5,932
Accounts receivable, net of allowance of $185 in 2003 and $192 in 2002	1,481			1,349
Lease receivables	564			848
Inventories, net	1,095			912
Prepaid expenses and other current assets	809			371
Total current assets	9,842			9,412

Equipment, furniture and leasehold improvements, net	149			204
Lease receivables	155			408
Other assets	288			304
Total assets	$	10,434		$	10,328
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	530		$	400
Accrued compensation	320			446
Accrued other	556			757
Deferred revenue	1,027			354
Secured borrowings	643			985
Total current liabilities	3,076			2,942

Deferred revenue	254			253
Secured borrowings	155			408
Total long-term liabilities	409			661
Commitments and contingencies

Stockholders’ equity:
Preferred stock, no par value, unlimited shares authorized, no shares issued and outstanding	—			—
Common stock, no par value, unlimited shares authorized, 29,836 and 29,798 shares issued and outstanding at June 30, 2003 and December 31, 2002, respectively	93,605			93,586
Accumulated deficit	(85,480		)	(85,698		)
Accumulated other comprehensive loss	(1,176		)	(1,163		)
Total stockholders’ equity	6,949			6,725
Total liabilities and stockholders’ equity	$	10,434		$	10,328

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 June 30,				Six Months Ended June 30,
	2003		2002		2003		2002
Revenues:
Product sales	$	1,578	$	1,850	$	2,984	$	3,906
Placement and service fees	433		329		761		693
Total revenues	2,011		2,179		3,745		4,599

Cost of revenues:
Product sales	499		769		1,024		2,047
Placement and service fees	125		129		241		277
Total cost of revenues	624		898		1,265		2,324

Gross profit	1,387		1,281		2,480		2,275

Operating expenses:
Selling, general and administrative	975		933		1,831		1,994
Research and development	220		228		461		435
Total operating expenses	1,195		1,161		2,292		2,429

Income from operations	192		120		188		(154		)

Other income, net	11		15		30		30

Net income (loss)	$	203	$	135	$	218	$	(124	)

Basic and diluted earnings (loss) per share	$	0.01	$	0.00	$	0.01	$	(0.00	)

Average shares outstanding:
Basic	29,810		29,713		29,804		29,643
Diluted	30,019		29,744		29,916		29,643

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)

	Six Months Ended June 30,
	2003			2002
Operating activities:
Net income (loss)	$	218		$	(124	)

Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:
Depreciation and amortization	74			113
Change in assets and liabilities:
Accounts receivable	(139		)	943
Inventory	(183		)	55
Prepaid expenses and other assets	(443		)	(282		)
Accounts payable	129			(518		)
Deferred revenue	670			218
Accrued liabilities	(351		)	(123		)
Net cash provided by (used for) operating activities	(25		)	282

Financing activities:
Proceeds from sales of common shares	19			127
Secured borrowings	(58		)	(99		)
Net cash provided by (used for) financing activities	(39		)	28

Effect of exchange rate changes on cash and cash equivalents	25			55
Net increase (decrease) in cash and cash equivalents	(39		)	365

Cash and cash equivalents at beginning of period	5,932			4,977
Cash and cash equivalents at end of period	$	5,893		$	5,342

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

PLC SYSTEMS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2003

1. Nature of Business

PLC Systems Inc. (“PLC” or the “Company”) has developed a patented high-powered carbon dioxide, or CO₂, laser system known as The Heart Laser for use in the treatment of severe coronary artery disease, or CAD, in a surgical laser procedure, known as transmyocardial revascularization, or TMR.

TMR is performed by a cardiovascular surgeon, who uses a laser to create channels through the myocardium of the heart in an attempt to restore perfusion to areas of the heart not being reached by diseased or clogged arteries. This technique is used as a late or last resort for relief of symptoms of severe angina in patients with ischemic heart disease not amenable to direct coronary revascularization interventions, such as angioplasty, stenting, or coronary arterial bypass grafting. In addition to providing new direct pathways for blood to reach the ischemic myocardium, the creation of TMR channels is also believed to promote the development of new blood vessels, or angiogenesis.

Each TMR procedure requires a sterile, single use TMR kit containing assorted TMR handpieces, drapes and other disposable items. In the United States, the Company markets and distributes its products through Edwards Lifesciences LLC, a subsidiary of Edwards Lifesciences Corporation (“Edwards”). Edwards has the exclusive right to market and distribute the Company’s TMR products to hospitals in the United States at least through January 2006. Outside the United States, the Company markets and distributes its products primarily through independent distributors.

Edwards is the Company’s largest shareholder, owning approximately 18% of the Company’s common stock as of June 30, 2003. Edwards is also the Company’s largest customer, accounting for approximately 87% of the Company’s total sales in 2002 and 86% of the Company’s total sales for the six months ended June 30, 2003. As a company, Edwards designs, develops and markets a comprehensive line of products and services to treat late-stage cardiovascular disease.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. Certain prior period items have been reclassified to conform with current period presentations. These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2002.

3. Earnings (Loss) per Share

Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding during the period plus the effect of outstanding stock options using the “treasury stock” method.

The components of basic and diluted earnings per share were as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2003		2002		2003		2002
	(In thousands, except earnings per share)

Net income (loss) available for common shareholders	$	203	$	135	$	218	$	(124	)
Weighted average outstanding shares of common stock	29,810		29,713		29,804		29,643
Dilutive effect of employee stock options	209		31		112		—
Common stock and common stock equivalents	30,019		29,744		29,916		29,643

Earnings per share:
Basic	$	0.01	$	0.00	$	0.01	$	(0.00	)

Diluted	$	0.01	$	0.00	$	0.01	$	(0.00	)

For the three and six months ended June 30, 2003 and 2002, 4,668,430 and 5,490,297 shares attributable to outstanding stock options and warrants were excluded from the calculation of diluted earnings per share because the effect was antidilutive.

4. Stock Based Compensation

The Company grants stock options for a fixed number of shares to employees and certain other individuals with exercise prices equal to the fair value of the shares at the dates of grant. The Company has adopted the disclosure only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-based Compensation (“FAS 123”), and will continue to account for its stock option plans in accordance with the provisions of Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees. In addition, the Company has made the appropriate disclosures as required under Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure.

The following table illustrates the effect on net income (loss) and basic earnings (loss) per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based employee compensation:

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
	(In thousands, except per share data)

Net income (loss) attributable to common stockholders— As reported	$	203		$	135		$	218		$	(124	)
Deduct total stock-based compensation expense determined under fair value based method for all stock option awards	(26		)	(62		)	(43		)	(108		)
Net income (loss) attributable to common stockholders—Pro forma	$	177		$	73		$	175		$	(232	)
Earnings (loss) per basic and diluted share attributable to common stockholders—As reported	$	0.01		$	0.00		$	0.01		$	(0.00	)
Earnings (loss) per basic and diluted share attributable to common stockholders—Pro forma	$	0.01		$	0.00		$	0.01		$	(0.01	)

The fair value of options issued at the date of grant were estimated using the Black-Scholes model with following weighted average assumptions:

	Three Months Ended June 30,
	2003		2002
Expected life (years)	3		3
Interest rate	1.59	%	3.82	%
Volatility	.585		.738

5. Comprehensive Income (Loss)

Total comprehensive income for the three and six month periods ended June 30, 2003 amounted to $201,000 and $205,000, respectively, as compared to total comprehensive income of $101,000 in the three-month period ended June 30, 2002 and a total comprehensive loss of $154,000 for the six-month period ended June 30, 2002. Comprehensive income (loss) is comprised of net income (loss) plus the increase/decrease in currency translation adjustment.

6. Inventories

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

	June 30, 2003		December 31, 2002
Raw materials	$	736	$	663
Work in progress	69		111
Finished goods	290		138
	$	1,095	$	912

At June 30, 2003 and December 31, 2002, inventories are stated net of a reserve of $805,000 and $1,019,000, respectively, for potentially obsolete inventory.

7. Revenue Recognition

The Company records revenue from the sale of TMR kits to Edwards at the time of shipment. Heart Laser Systems are billed to Edwards in accordance with purchase orders received by the Company. Invoiced Heart Laser Systems are included in other current assets and revenue is deferred 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 Edwards distribution agreement, once Edwards has recovered a prescribed amount of revenue from a hospital for the use or purchase of a laser, any additional revenues earned by Edwards are shared with the Company pursuant to a formula established in the distribution agreement. The Company only records its share of such additional revenue, if any, at the time the revenue is earned.

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

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

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

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

8. Guarantees

In November 2002, the FASB issued Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 elaborates on previously existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002.

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 distribution agreement with Edwards, the Company is able to bill Edwards for actual warranty costs, including preventative maintenance services, up to a specified amount during the warranty period.

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

For the six months ended June 30, 2003, the Company's accrual for warranty and preventative maintenance costs remained unchanged from the December 31, 2002 balance of $100,000.

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

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

Overview

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

In January 2001, we entered into a strategic marketing alliance and exclusive distribution arrangement with Edwards. In January 2002, Edwards exercised a pre-existing option to assume full sales and marketing responsibility in the U.S. for our HL2 and associated TMR kits. We sell the HL2 and TMR kits to Edwards at a discount to list price and Edwards remarkets the HL2 and TMR kits to hospitals.

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

Application of Critical Accounting Policies

This management’s discussion and analysis of financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Our significant accounting policies are more fully described in Note 2 of the Notes to Consolidated Financial Statements as well as in “Item 7- Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2002. No significant changes were made to those policies during the three months ended June 30, 2003.

Results of Operations

Total revenues were $2,011,000 and $3,745,000 for the three and six month periods ended June 30, 2003, decreases of $168,000 or 8% and $854,000 or 19% when compared to total revenues of $2,179,000 and $4,599,000 for the three and six month periods ended June 30, 2002.

Product Sales

Product sales for the three and six months ended June 30, 2003 were $1,578,000 and $2,984,000, a decrease of $272,000 and $922,000, respectively, when compared with product sales of $1,850,000 and $3,906,000 for the three and six months ended June 30, 2002.

Domestic Heart Laser System revenues, the largest component of product sales, decreased by $352,000 and $1,162,000 for the three and six month periods ended June 30, 2003 as compared to the three and six month periods ended June 30, 2002. The decreases in domestic Heart Laser System revenues were due to a decrease in the number of domestic Heart Laser System units sold partially offset by increased revenue sharing earned under the distribution agreement with Edwards. Additionally, during the six months ended June 30, 2003, the average selling price of Heart Laser Systems increased by approximately 17% compared to the corresponding six-month period in 2002. This increase in average selling price partially offset

the decrease in product sales resulting from a lower volume of Heart Laser System shipments in the six-month period ended June 30, 2003.

Domestic TMR kit revenues, the second largest component of product sales, increased by $62,000 and $320,000 in the three and six month periods ended June 30, 2003 as compared to the three and six month periods ended June 30, 2002. These increases are primarily related to an increase in the number of TMR kits shipped to Edwards during the three and six months ended June 30, 2003 as compared to the three and six months ended June 30, 2002.

International revenues from product sales of Heart Laser Systems and TMR kits increased $152,000 and $167,000 in the three and six month periods ended June 30, 2003 as compared to the three and six month periods ended June 30, 2002 as a result of (1) an increase in the number of TMR kits shipped to international customers and (2) the recognition of one HL1 Heart Laser System sale in the second quarter of 2003.

Royalty revenue, a component of product sales, decreased $111,000 and $234,000 in the three and six-month periods ended June 30, 2003 as compared to the three and six month periods ended June 30, 2002. These decreases are due to the termination of guaranteed minimum royalties due from CardioGenesis Corporation (“CardioGenesis”) after June 30, 2002. Although CardioGenesis is required to pay an ongoing royalty on actual sales of covered products after June 30, 2002, we expect that until such time, if ever, that CardioGenesis obtains FDA approval for its PMR device, and provided that device remains a covered product under the terms of the license agreement, royalty revenue will be insignificant.

Other product sales decreased $23,000 and $11,000 in the three and six month periods ended June 30, 2003, as compared to the three and six month periods ended June 30, 2002.

Placement and Service Fees

Placement and service fees for the three and six months ended June 30, 2003 were $433,000 and $761,000, increases of $104,000 and $68,000, when compared with placement and service fees of $329,000 and $693,000 for the three and six month periods ended June 30, 2002.

Service fees increased $104,000 and $156,000 for the three and six month periods ended June 30, 2003 as compared to the three and six month periods ended June 30, 2002 due to more domestic lasers in service throughout 2003, which resulted in increased billings to Edwards for warranty and preventative maintenance services.

Placement fees were flat for the three-month period ended June 30, 2003 as compared to the three-month period ended June 30, 2002 and declined $88,000 for the six-month period ended June 30, 2003 as compared to the six-month period ended June 30, 2002. Approximately $63,000 of this $88,000 decline is attributable to a reduction in domestic placement fees. The reduction in domestic placement fees is in part the result of various U.S. HL1 customers upgrading to the newer HL2. Each upgrade resulted in a laser sale to Edwards and a corresponding shift in recorded disposable TMR kit sales to these new HL2 customers as product sales instead of placement fees.

The remaining $26,000 of the $88,000 decline was the result of lower international placement contract fees due to decreased kit shipments to international placement contract customers.

Gross Profit

Total gross profit for the three and six months ended June 30, 2003 were $1,387,000, or 69% of revenues, and $2,480,000, or 66% of revenues, respectively, as compared to $1,281,000, or 59% of revenues, and $2,275,000, or 49% of revenues, for the comparable periods in 2002.

The improvement in gross profit in the three and six month periods of 2003 as compared to the three and six month periods of 2002 is due to (1) higher overall disposable TMR kit revenues which carry a higher margin, (2) a higher average selling price and additional shared revenue on Heart Laser System transactions and (3) an increase in service related revenues. These increases were offset in part by (1) lower royalty revenue (2) fewer Heart Laser System unit sales and (3) lower placement contract revenue.

Operating Expenses

Selling, general and administrative expenditures were $975,000 and $1,831,000 for the three and six months ended June 30, 2003, an increase of $42,000 and a decrease of $163,000, respectively, when compared to expenditures of $933,000 and $1,994,000 in the three and six months ended June 30, 2002. The overall increase in the three months ended June 30, 2003 is primarily related to certain compensation program expenses. The overall decrease in the six months ended June 30, 2003 is primarily related to a reduction in field sales personnel costs and overall administrative expenditures.

Research and development expenditures for the three and six months ended June 30, 2003 were $220,000 and $461,000, a decrease of $8,000 and an increase of $26,000, respectively, when compared with expenditures of $228,000 and $435,000 for the three and six months ended June 30, 2002. The overall increase in the six months ended June 30, 2003 is primarily due to increased international clinical study-related expenditures due to a new study launched in November 2002.

Net Income (Loss)

Net income for the three and six months ended June 30, 2003 was $203,000 and $218,000, increases of $68,000 and $342,000, respectively, when compared to net income of $135,000 and a net loss of $124,000 for the three and six months ended June 30, 2002. The increase in the three months ended June 30, 2003 is due to a higher gross margin, partially offset by higher operating expenses. The increase in the six months ended June 30, 2003 is due to a higher gross margin coupled with reduced operating expenses.

Kit Shipments

Our management monitors disposable kit shipments as an important metric in evaluating its business. Management believes kit shipments, although not a direct measure, are one indicator of the pace of the adoption of TMR as a therapy in the marketplace.

For the three and six months ended June 30, 2003, a total of 609 and 1,022 disposable kits were shipped to end users. This represented an increase of 29% and 17%, respectively, over the 473 and 872 disposable kits shipped to end users during the three and six months ended June 30, 2002.

Domestic kit shipments to end users increased by 31% and 15%, respectively, from 401 and 791 in the three and six months ended June 30, 2002 to 524 and 907 in the three and six months ended June 30, 2003. Management believes the increase in domestic kit shipments is due primarily to (1) an increase in the total number of installed lasers in 2003 and (2) lasers installed and available for only a portion of 2002 while being available for all of 2003.

International kit shipments increased by 18% and 42%, respectively, from 72 and 81 in the three and six months ended June 30, 2002 to 85 and 115 in the three and six months ended June 30, 2003. The increases are mainly attributable to kits shipped pursuant to a new European clinical study launched in November 2002.

Liquidity and Capital Resources

At June 30, 2003, the Company had cash and cash equivalents of $5,893,000.

During the six-month period ended June 30, 2003, the Company recorded net income of $218,000. The net income was offset by unfavorable working capital changes which resulted in net cash used for operating activities of approximately $25,000. Cash used in financing activities was approximately $39,000, consisting of a reduction in secured borrowings of $58,000 offset partially by proceeds of $19,000 from the sale of common stock under the Company’s Employee Stock Purchase Plan. The Company believes that its existing cash resources will meet its working capital requirements through December 31, 2003.

However, we are largely dependent on the success of Edwards’ sales and marketing efforts in the U.S. to continue to increase the installed base of HL2 lasers and 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 further 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 Edwards 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 on a consistent basis.

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 may result in a longer recovery period for Edwards to recoup its investment in lasers it purchases from us. This could result 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 distribution agreement with Edwards and (2) a delay in the purchase of new lasers by Edwards if its installed base of placement lasers under usage contracts are under-performing and it chooses to re-deploy these lasers to other new hospital sites in lieu of purchasing a new laser from us. Our cash position and our need for additional financing to fund operations will be dependent in part upon the number of hospitals that acquire Heart Laser Systems from Edwards on a usage basis and the number and frequency of TMR procedures performed by these hospitals. We cannot predict whether a usage based sales model will be successful, whether implemented by us or Edwards.

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 quarterly report do not include any adjustments to reflect the possible future effects of these uncertainties.

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.

Our company has a history of operating losses

PLC Systems Inc. was founded in 1987. Prior to 2002 when we recorded a net profit, we had incurred operating losses in every year of our existence except 1995. We incurred net losses of $3,902,000 for the year ended December 31, 2001 and $7,410,000 for the year ended December 31, 2000. As of June 30, 2003, we had an accumulated deficit of $85,480,000. We have only just recently achieved profitability, and we cannot provide any assurance that we will continue to be profitable in the future. Moreover, although our business is not seasonal in nature, our revenues may vary significantly from fiscal quarter to fiscal quarter.

Our company is dependent on one principal product line

We develop and market one principal product line, which consists of two patented high-powered carbon dioxide laser systems, known as the Heart Laser Systems, and related TMR disposable kits. Approximately 95% of our revenues in both the three and six months ended June 30, 2003 and 92% in the year ended December 31, 2002, were derived from the sales and service of our Heart Laser Systems and related disposables.

Our company is dependent on one principal customer

Pursuant to a distribution agreement with Edwards, Edwards is our exclusive distributor for our HL2 and TMR kits in the U.S. As a result of this relationship, Edwards accounted for 82% and 86% of our total revenue in the three and six months ended June 30, 2003 and 87% in the year ended December 31, 2002, respectively, and we expect Edwards to account for the majority of our revenue in the future. If our relationship with Edwards does not progress or if Edwards’ sales and marketing strategies fail to generate sales of our HL2 and TMR kits in the future, our revenue will decrease significantly and our business, financial condition and results of operations will be seriously harmed.

Our company is dependent on certain suppliers

Some of the components for our laser systems, most notably the power supply and certain optics and fabricated parts, are only available from one supplier, and we have no assurance that we will be able to source any of our sole-sourced components from additional suppliers. In the past, we have experienced delays in product delivery from our sole suppliers and, because we do not have an alternative supplier to produce these products for us, we have little leverage to

enforce timely delivery. Any delay in product delivery or other interruption in supply from these suppliers could prevent us from meeting our commercial demands for the HL2, 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 HL2s each year. Our low-quantity needs may not generate substantial revenue for our suppliers. Therefore, it may be difficult for us to continue our relationships with our current suppliers or establish relationships with additional suppliers on commercially reasonable terms, if at all.

We may experience manufacturing difficulties and delays in building the HL2

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

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

• supplier quality problems;

• lack of experienced technical personnel;

• low production yields; and

• changing processes and controls over the manufacturing procedures employed.

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

Our company may be unable to raise needed funds

As of June 30, 2003, we had cash and cash equivalents totaling $5,893,000. Based on our current operating plan, we anticipate that our existing capital resources should be sufficient to meet our working capital requirements through December 31, 2003. However, if our business does not progress in accordance with our current business plan, we may need to raise additional funds. We may not be able to raise additional capital upon satisfactory terms, or at all, and our business, financial condition and results of operations could be materially and adversely affected. To the extent that we raise additional capital by issuing equity or convertible securities, ownership dilution to our stockholders will result.

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

TMR is an emerging technology. Our products may never achieve widespread commercial acceptance. To be successful, we need to:

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

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

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

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

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

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

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

CardioGenesis is attempting to obtain FDA approval to market their percutaneous transmyocardial revascularization or PMR laser, which would provide a less invasive method of creating channels in the heart. If PMR can be shown to be safe and effective and is approved by the FDA, it would eliminate the need in certain patients to make an incision in the chest, reducing costs and speeding recovery. It is unclear what impact, if any, an approval of a PMR device would have on the future adoption rate for TMR procedures. If PMR is approved, it could erode the potential TMR market which could have a material adverse effect on our business, financial condition and results of operations.

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

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

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

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

The Heart Laser Systems 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 markets, including the European Union and Japan. To date, we have received regulatory approval in the U.S. and have the ability to market the Heart Laser Systems in the European Union (excluding France). We have not received regulatory approval in Japan.

Without regulatory approval, we cannot market the Heart Laser Systems in Japan. Even if granted, regulations may significantly restrict the use of the Heart Laser Systems. The process of obtaining and maintaining required regulatory approval is lengthy, expensive and uncertain.

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

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

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

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

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

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

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

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

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

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

Japan — We cannot market our product in Japan until we receive government approval

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

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

We have been sued for alleged securities law violations in the past, and may be subject to

similar claims or other claims in the future. Between August 1997 and November 1997, we were named as defendant in 21 class action lawsuits alleging violations of federal securities laws because we failed to obtain a favorable FDA panel recommendation to market the HL1. Nineteen of the claims were consolidated into a single action and some of the claims were dismissed in 1999. All remaining claims were settled in February 2001. The settlement of these claims did not have a material impact on our financial statements. However, any future litigation or claims, whether or not valid, could result in substantial costs and diversion of resources with no assurance of success.

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

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

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

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

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

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

overseeing foreign operations may be 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 in foreign countries may be more difficult to enforce. There can be no assurance that our international business will grow or that any of the foregoing risks will not result in a material adverse effect on our business or results of operations.

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

Under Canadian law, you may not be able to enforce a judgment issued by courts in the 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.

Anti-takeover provisions may prevent you from realizing a premium return

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

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

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

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

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

As shown in the table below, as of June 30, 2003, we have reserved an additional 8,023,766 shares of common stock for future issuance upon exercise of outstanding options, warrants and shares purchasable under an employee stock purchase plan.

	Range of Exercise/ Conversion Prices	Weighted Average Exercise/ Conversion Price		Shares Reserved for Future Issuance
Options	$.45 - $8.88	$	1.40	4,535,772
Warrants	$1.00 - $3.50	$	2.45	3,100,000
Employee Stock Purchase Plan				387,994

Total				8,023,766

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

We have no intention to pay dividends

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

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

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

A portion of 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 significantly 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 Swiss Franc and the Euro. When the U.S. dollar strengthens against the Franc or 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 may not adversely affect our business, financial condition and results of operations, although at the present we do not believe that our exposure is significant.

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.

The Company does not hedge any balance sheet exposures and intercompany balances against future movements in foreign exchange rates. We do not believe that a 10% change to the applicable exchange rates would have a material impact on our future results of operations or cash flows.

Item 4. Controls and Procedures

The Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2003. Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that, as of June 30, 2003, the Company’s disclosure controls and procedures were (1) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the Company’s chief executive officer and chief financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by the 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.

No change in the Company’s 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 June 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. Other Information

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

On May 14, 2003, the Company held its 2003 Annual and Special Meeting of Shareholders (the “Shareholders Meeting”). At the Shareholders Meeting, the following matters were approved by the vote specified below:

1. Benjamin L. Holmes and Alan H. Magazine were elected to serve as directors until the annual meeting of shareholders in 2006 or until their successors are duly elected and qualified. Mr. Holmes received 27,398,631 shares of common stock voting in favor of his election and 621,871 shares of common stock were withheld. Mr. Magazine received 27,397,890 shares of common stock voting in favor of his election and 622,612 shares of common stock were withheld. In addition, the terms of the following directors continued after the Shareholders Meeting:

Edward H. Pendergast, Donald E. Bobo, Jr., Kevin J. Dunn, H.B. Brent Norton, M.D., Robert I. Rudko, Ph.D. and Mark R. Tauscher.

2. An amendment increasing the number of shares of common stock authorized for issuance under the Company’s 2000 Equity Incentive Plan from 500,000 to 1,500,000 was approved. The votes were cast as follows: 26,257,357 shares of common stock were voted for the amendment, 1,528,161 shares of common stock were voted against the amendment and 234,984 shares of common stock abstained from the vote.

3. The ratification of the appointment of Ernst & Young LLP as the Company’s independent auditors for the year ending December 31, 2003 was approved. The votes were cast as follows: 27,785,455 shares of common stock were voted for the ratification, 158,991 shares of common stock were voted against the ratification and 76,056 shares of common stock abstained from the vote.

Item 6. Exhibits and Reports on Form 8-K

a) Exhibits

31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

b) Reports on Form 8-K

The Company filed a current report on Form 8-K on April 30, 2003 announcing its financial results for the quarter ended March 31, 2003.

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: August 13, 2003	By:	/s/ James G. Thomasch
		Chief Financial Officer
		(Principal Financial Officer and Chief
		Accounting Officer)

Exhibit Index

Exhibit No.		Description of Document

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, amended.

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.