VIVEVE MEDICAL, INC. - Quarter Report: 2011 June (Form 10-Q)

Table of Contents

 

 

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 June 30, 2011.

 

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)

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   x  No   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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.

 

 

 

Table of Contents

 

PLC SYSTEMS INC.

 

Index

 

Part I.	Financial Information:
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets (unaudited)	3
		Condensed Consolidated Statements of Operations (unaudited)	4
		Condensed Consolidated Statements of Cash Flows (unaudited)	5
		Notes to Condensed Consolidated Financial Statements (unaudited)	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
	Item 4.	Controls and Procedures	27
Part II.	Other Information:
	Item 1A.	Risk Factors	28
	Item 5.	Other Matters	28
	Item 6.	Exhibits	29

 

2

Table of Contents

 

Part I.         Financial Information

 

Item 1.        Financial Statements

 

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

		June 30, 2011			December 31, 2010
ASSETS
Current assets:
Cash and cash equivalents		$	4,059		$	1,324
Accounts receivable, net of allowance of $0 and $10 at June 30, 2011 and December 31, 2010, respectively		263			121
Inventories		154			310
Prepaid expenses and other current assets		268			252
Assets from discontinued operations		—			1,095
Total current assets		4,744			3,102
Equipment, furniture and leasehold improvements, net		23			27
Other assets		185			186
Total assets		$	4,952		$	3,315
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable		$	48		$	343
Accrued compensation		98			91
Accrued other		179			232
Deferred revenue		—			98
Liabilities from discontinued operations		—			1,117
Total current liabilities		325			1,881
Convertible notes		5,515			—
Warrant liabilities		1,896			—
Stockholders’ equity (deficit):
Preferred stock, no par value, unlimited shares authorized, none issued and outstanding		—			—
Common stock, no par value, unlimited shares authorized, 30,351 shares issued and outstanding as of June 30, 2011 and December 31, 2010		93,893			93,893
Additional paid in capital		941			848
Accumulated deficit		(97,297		)	(92,969		)
Accumulated other comprehensive loss		(321		)	(338		)
Total stockholders’ equity (deficit)		(2,784		)	1,434
Total liabilities and stockholders’ equity (deficit)		$	4,952		$	3,315

 

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

 

3

Table of Contents

 

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,
		2011			2010			2011			2010
Revenues		$	398		$	249		$	455		$	516
Cost of revenues		198			264			338			696
Gross profit (loss)		200			(15		)	117			(180		)
Operating expenses:
Selling, general and administrative		667			839			1,260			1,640
Research and development		373			113			445			366
Total operating expenses		1,040			952			1,706			2,006
Gain on the sale of assets		(40		)	(98		)	(40		)	(98		)
Loss from continuing operations		(800		)	(869		)	(1,549		)	(2,088		)
Other income (expense):
Interest expense		(115		)	—			(161		)	—
Financing costs associated with convertible notes		—			—			(530		)
Change in fair value of warrant liabilities		372			—			(1,104		)	—
Change in fair value of convertible notes		2			—			(2,216		)	—
Total other income (expense)		259			—			(4,011		)	—
Net loss from continuing operations		(541		)	(869		)	(5,560		)	(2,088		)
Discontinued operations:
Income from discontinued operations		—			670			53			1,328
Gain on sale of discontinued operations		—			—			1,179			—
Net income from discontinued operations		—			670			1,232			1,328
Net loss		$	(541	)	$	(199	)	$	(4,328	)	$	(760	)
Net loss per weighted average share, basic and diluted:
From loss on continuing operations attributable to common stockholders		$	(0.02	)	$	(0.03	)	$	(0.18	)	$	(0.07	)
From income on discontinued operations		—			0.02			0.00			0.04
From gain on sale of discontinued operations		—			—			0.04			—
Net loss attributable to common stockholders per weighted average share, basic and diluted		$	(0.02	)	$	(0.01	)	$	(0.14	)	$	(0.03	)
Weighted average shares outstanding:
Basic and diluted		30,351			30,351			30,351			30,351

 

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

 

4

Table of Contents

 

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Six Months Ended June 30,
		2011			2010
Cash flows from operating activities:
Net loss		$	(4,328	)	$	(760	)
Income from discontinued operations		(53		)	(1,328		)
Gain on sale of discontinued operations		(1,179		)	—
Depreciation and amortization		4			24
Stock-based compensation expense		93			174
Change in fair value of warrant liabilities		1,104			—
Change in fair value of convertible notes		2,216			—
Financing costs associated with convertible notes		530			—
Non-cash interest expense		91			—
Change in assets and liabilities:
Accounts receivable		(166		)	(36		)
Inventory		156			52
Prepaid expenses and other assets		(151		)	36
Accounts payable		(295		)	(71		)
Deferred revenue		(98		)	117
Accrued liabilities		(46		)	(131		)
Net cash flows used in operating activities		(2,122		)	(1,923		)
Cash flows from financing activities:
Net proceeds from issuance of convertible notes and warrants		3,605			—
Net cash provided by financing activities		3,605			—
Discontinued operations:
Net cash provided by operating activities		210			789
Net cash provided by investing activities		1,000			—
Net cash provided by discontinued operations		1,210			789
Effect of exchange rate changes on cash and cash equivalents		42			(78		)
Net increase (decrease) in cash and cash equivalents		2,735			(1,212		)
Cash and cash equivalents at beginning of period		1,324			2,686
Cash and cash equivalents at end of period		$	4,059		$	1,474
Supplemental disclosure of cash flow information:
Cash paid for interest		$	72		$	—
Supplemental disclosure of noncash investing and financing activities:
Warrant liabilities		$	792		$	—

 

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

 

5

 

Table of Contents

 

PLC SYSTEMS INC.

NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

June 30, 2011

 

1.             Business and Liquidity

 

PLC Systems Inc. (“PLC” or the “Company”) is a medical device company specializing in innovative technologies for the cardiac and vascular markets.  Over the past three years, the Company has begun commercialization outside the United States of its newest product, RenalGuard®, which represents the Company’s key strategic growth initiative and primary business focus.  The RenalGuard System consists of a proprietary console and accompanying single-use sets and is designed to reduce the potentially toxic effects that contrast media can have on the kidneys when it is administered to at-risk patients during certain medical imaging procedures. The Company conducts business operations as one operating segment.

 

Prior to February 1, 2011, including during all of 2010, in addition to advancing its RenalGuard program, the Company also was engaged in the manufacture and marketing of the CO2 Heart Laser System that cardiac surgeons use to perform carbon dioxide (CO2) transmyocardial revascularization, or TMR, to alleviate symptoms of severe angina. On February 1, 2011, the Company sold the assets of its TMR business to Novadaq Corp. (“Novadaq”), a subsidiary of Novadaq Technologies Inc. Novadaq acted as the Company’s exclusive distributor in the United States for the TMR business since being appointed to that role in March 2007.

 

The asset sale transaction, which was announced in November 2010, was approved by the Company’s shareholders at a special meeting on January 31, 2011 and the transaction closed on February 1, 2011. Novadaq paid $1 million in cash and assumed all TMR service-related obligations, valued at approximately $614,000, in exchange for acquiring substantially all TMR-related assets, including all regulatory approvals for the CO2 Heart Laser System, all manufacturing rights, substantially all product inventories and all equipment, intellectual property, clinical data and documentation related to the TMR business. The TMR business has been accounted for and reflected in the accompanying unaudited condensed consolidated financial statements as discontinued operations for all periods presented (see Note 10).

 

For the six months ended June 30, 2011, the Company incurred a loss from continuing operations of approximately $5,560,000 and negative cash flows from continuing operations of $2,122,000.  At June 30, 2011, the Company had an accumulated deficit of $97,000,000.  As discussed above, in the first quarter of 2011, the Company sold the assets related to its TMR business to Novadaq for $1,000,000 plus the relief of approximately $614,000 in service contract obligations. In addition, in February 2011, the Company issued $4,000,000 in secured convertible debt (see Note 11).  Management projects that its existing resources will be sufficient to fund operations through at least December 31, 2011.

 

2.             Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles (“GAAP”) 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 six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.  These financial statements should be read in conjunction with the consolidated

 

6

Table of Contents

 

financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

The preparation of financial statements in accordance with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

3.             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 June 30, 2011 and December 31, 2010, inventories consisted of the following (in thousands):

 

		June 30, 2011			December 31, 2010
Raw materials		$	89		$	130
Work in progress		—			—
Finished goods		65			180
		$	154		$	310

 

4.             Stock-Based Compensation

 

Stock Option Plans

 

In May 2005, the Company’s shareholders approved the 2005 Stock Incentive Plan (the “2005 Plan”).  Incentive stock options are issuable only to employees of the Company, while non-qualified stock options may be issued to non-employee directors, consultants and others, as well as to employees.  Under the 2005 Plan, 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 2005 Plan provides that the Company may not grant non-qualified stock options at an exercise price less than 85% of the fair market value of the Company’s common stock.

 

The Company grants stock options to its non-employee directors.  New non-employee directors receive an initial grant of an option to purchase 45,000 shares of the Company’s common stock that generally vest in quarterly 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 22,500 shares of the Company’s common stock that generally will vest in four equal quarterly installments. The Chairman of the Board receives an annual grant of an option to purchase 45,000 shares of the Company’s common stock that generally vests in four equal quarterly installments. All such options have an exercise price equal to the fair market value of the Company’s common stock on the date of grant.

 

As a result of employee terminations in 2011, options held by terminated employees to purchase a total of 173,000 shares of common stock with an exercise price of $0.24 per share were cancelled, but were replaced by the Company with new options, all of which were immediately vested, to purchase 173,000 shares of common stock at an exercise price of $0.24 per share.  The Company recorded an additional $2,000 in stock compensation expense related to these grants during the three months ended March 31, 2011.

 

7

Table of Contents

 

As a result of the workforce reduction that occurred during the three months ended March 31, 2010, options held by terminated employees to purchase a total of 498,000 shares of common stock with an exercise price of $0.24 per share were cancelled, but were, as part of the Company’s overall severance arrangement with the terminated employees, replaced by the Company with new options to purchase 498,000 shares of common stock at an exercise price of $0.24 per share.  These new options were fully vested upon grant and expire one year from the date of grant. The Company recorded an additional $37,000 in stock compensation expense related to these grants during the three months ended March 31, 2010.

 

During the three months ended March 31, 2011, the Company granted options to purchase 100,000 shares of the Company’s common stock to a non-employee that vested immediately, and granted options to purchase 200,000 shares of the Company’s common stock to an employee that vest ratably over a three year period.

 

During the three months ended June 30, 2011, the Company granted options to purchase 200,000 shares of the Company’s common stock to non-employees that vested immediately, granted options to purchase 565,000 shares of the Company’s common stock to employees with performance-based vesting, and granted options to purchase 112,500 shares of the Company’s common stock to non-employee directors which vest quarterly over one year.  Management has determined it is probable that the performance conditions associated with the performance based vesting will be met therefore the related expense is being recognized over a one year period.

 

As of June 30, 2011, there were 564,000 shares of common stock available to be granted under the 2005 Plan.

 

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)		Aggregate Intrinsic Value
Outstanding, December 31, 2010		5,529		$	0.24
Granted		1,350		0.15
Exercised		—		—
Forfeited		(1,004	)	0.25
Expired		—		—
Cancelled		(173	)	0.24
Outstanding, June 30, 2011		5,702		$	0.19		2.73		$	7
Exercisable, June 30, 2011		4,109		$	0.22		2.75		$	7

 

Stock-Based Compensation Expense

 

The Company recorded compensation expense of $63,000 and $93,000 in the three and six months ended June 30, 2011, as compared to $95,000 and $174,000 in the three and six months ended June 30, 2010.  As of June 30, 2011, the Company had $109,000 of total unrecognized compensation cost related to its unvested options, which is expected to be recognized over a weighted average period of 0.72 years.

 

8

Table of Contents

 

The weighted average fair value of options issued, as estimated using the Black-Scholes model, was $0.12 and $0.11 during the three months ended June 30, 2011 and 2010, respectively, and was $0.11 and $0.08 during the six months ended June 30, 2011 and 2010, respectively.  The assumptions used were as follows:

 

		Three Months Ended June 30,				Six Months Ended June 30,
		2011		2010		2011		2010
Expected life (years)		5.50–6.00		1.00 – 6.00		1.00 – 6.00		1.00 – 6.00
Risk free rate		2.20–2.65%		0.39–2.27%		0.27–2.65%		0.39–2.27%
Volatility		116.7–121.6%		86–250%		107.2–132.1%		86–250%
Expected dividend yield		None		None		None		None
Value of options granted		$0.12–0.13		$0.02–0.14		$0.01–0.13		$0.02–0.14

 

The expected life was calculated in 2011 and 2010 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.  Expected volatility is based exclusively on historical volatility data of the Company’s common stock.  The Company estimates an expected forfeiture rate by analyzing historical forfeiture activity and considering how future forfeitures are expected to differ from historical forfeitures.  The Company expects that all outstanding options at June 30, 2011 will fully vest over their requisite service period.  Actual results, and future changes in estimates, may differ substantially from the Company’s current estimates.

 

Stock Purchase Plan

 

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 average of the closing bid and ask prices 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.  There was no activity during the three or six months ended June 30, 2011 or 2010.  At June 30, 2011, 294,461 shares were reserved for future issuance under the Purchase Plan.

 

5.             Revenue Recognition

 

The Company recognizes revenue when the following basic revenue recognition criteria have been met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.  Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the price to the buyer charged for products delivered or services rendered and collectability of the sales price. The Company assesses credit worthiness of customers based upon prior history with the customer and assessment of financial condition. Our shipping terms are customarily Free On Board (“FOB”) shipping point. The Company records revenue at the time of shipment if all other revenue recognition criteria have been met.

 

6.             Loss per Share

 

In the three and six months ended June 30, 2011 and 2010, 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 or investor warrants, since their inclusion would be antidilutive.

 

9

Table of Contents

 

For the three and six months ended June 30, 2011, 45,702,000 shares attributable to outstanding warrants and stock options, and for the three and six months ended June 30, 2010, 5,782,000 shares attributable to outstanding stock options were excluded from the calculation of diluted earnings per share because the effect would have been antidilutive.

 

7.             Comprehensive Loss

 

Total comprehensive loss for the three and six months ended June 30, 2011 was $539,000 and $4,311,000, respectively as compared to $228,000 and $802,000, respectively, in the three and six months ended June 30, 2010.  Comprehensive loss is comprised of the net loss plus the increase/decrease in currency translation adjustment.

 

8.             Warranty and Preventative Maintenance Costs

 

The Company warranties its products against manufacturing defects under normal use and service during the warranty period.  The Company evaluates the estimated future unrecoverable costs of warranty and preventative maintenance services for its installed base of products 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.  There was no warranty liability recorded at June 30, 2011 or December 31, 2010.

 

9.             Sale of Assets

 

In May 2010, the Company sold to a newly-formed corporation affiliated with its principal OEM customer certain of its OEM surgical tube assets, comprised principally of inventory, equipment, intellectual property and certain other intangible assets, as well as all necessary manufacturing documentation needed to perform contract assembly services for general purpose CO2 lasers. The total sale price for these assets was $225,000, of which approximately $154,000 was paid at the time of closing, with the balance in a note receivable totaling $71,000.  At the closing of the transaction and as of December 31, 2010, the note receivable was fully reserved.  Following the sale, Dr. Robert I. Rudko, who was a director and a stockholder of the Company at the time, acquired a minority interest in the corporation that purchased the OEM assets. In conjunction with this transaction, in the year ended December 31, 2010, the Company recorded an initial gain on sale of assets of $98,000.  In March 2011, Dr. Rudko resigned from the Company’s board of directors.  Also in March 2011, the Company reached an agreement with the acquiring company to settle the note receivable at a reduced amount of $40,000.  This amount was collected in April 2011, and was recorded as a gain when cash was received during the second quarter.

 

10.          Sale of TMR Business to Novadaq/Discontinued Operations

 

On November 5, 2010, the Company entered into an agreement to sell its TMR business to Novadaq. This transaction was approved by the Company’s shareholders at a special meeting on January 31, 2011 and the transaction closed on February 1, 2011.

 

Under terms of the agreement, Novadaq acquired substantially all of the Company’s assets that were used in the TMR business including all manufacturing rights, substantially all product inventories, and all equipment, intellectual property, regulatory approvals, clinical data and documentation related to TMR, for a purchase price of $1 million in cash and the assumption of all the Company’s obligations under service

 

10

Table of Contents

 

contracts as of the closing date totaling $614,000.  The total carrying value of the assets sold as of the transaction date was $385,000.  In addition, the Company incurred transaction costs of $50,000.  The Company has recorded a gain on sale of discontinued operations of $1,179,000 in the statement of operations.

 

The operating results of these operations, including those related to the prior periods, have been reclassified from continuing operations to discontinued operations in the accompanying condensed consolidated financial statements.

 

Revenues and Cost of Sales attributable to discontinued operations for the three and six months ended June 30, 2011 and 2010 are as follows:

 

		Three months ended June 30						Six months ended June 30
		(In thousands)						(In thousands)
		2011			2010			2011			2010
Revenues:
Product sales		$	—		$	498		$	455		$	995
Service fees		—			273			68			571
Total		—			771			523			1,566
Cost of revenues:
Product sales		—			14			442			32
Service fees		—			87			28			206
Total		—			101			470			238
Income from discontinued operations		$	—		$	670		$	53		$	1,328

 

A summary of discontinued operations on the consolidated balance sheets at June 30, 2011 and December 31, 2010 are as follows:

 

		June 30, 2011			December 31, 2010
		(In thousands)
Current assets:
Accounts receivable, net		$	—		$	217
Inventory		—			526
Prepaid expenses and other current assets		—			352
		$	—		$	1,095
Current liabilities:
Accounts payable		—			$	30
Accrued compensation		—			27
Accrued expenses		—			50
Deferred revenue		—			1,010
		$	—		$	1,117

 

11

Table of Contents

 

11.          Convertible Notes and Warrant Liabilities

 

Features of the Convertible Notes and Investor Warrants

 

On February 22, 2011 (the “Original Issue Date”), the Company entered into a Securities Purchase Agreement (“Purchase Agreement”) and a 5% Senior Secured Convertible Debenture Agreement (the “Note Agreement”) with GCP IV LLC (the “Investors” or “Holders”) pursuant to which the Company agreed to issue and sell in a private placement to the Investors an aggregate principal amount of $4,000,000 of convertible notes due February 22, 2014 (the “Convertible Notes”) and 40,000,000 warrants, which expire February 22, 2016 (the “Investor Warrants”).  In addition, under the terms of the agreement, the Company may secure additional secured convertible debt funding from the Investors of up to $2 million in the aggregate in two separate $1 million tranches, based upon meeting certain operational milestones including sales and clinical trial objectives.

 

Convertible Notes

 

The Convertible Notes require payment of interest on the outstanding principal amount, in cash, at the rate of 5% per annum, payable quarterly on January 1, April 1, July 1, and October 1, beginning on the first such date following the Original Issue Date, on each conversion date (for the principal amount then being converted), on each optional redemption date (for the principal amount then being redeemed) and on the maturity date. Interest is calculated on the basis of a 360-day year and accrues daily commencing on the Original Issue Date until payment in full of the outstanding principal, together with all accrued and unpaid interest, liquidated damages and other amounts that may become due in connection with the Convertible Notes, has been made.

 

The Holders may convert the outstanding principal amount of the Convertible Notes into shares of the Company’s common stock at the conversion price of $0.10 (“Conversion Price”). The Conversion Price is subject to adjustment in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then Conversion Price.

 

At any time after February 2012, and upon entering into a change of control transaction or Fundamental Transaction, as defined in the Debenture Agreement, the Company may deliver a notice to the Holders of its irrevocable election to redeem all of the then outstanding principal of the Convertible Notes for cash in an amount equal to the sum of (a) the greater of (i) the outstanding amount of the Convertible Notes divided by the Conversion Price on the date of the mandatory default amount, as defined in the Purchase Agreement, is either (A) demanded or (B) paid in full, whichever has a lower conversion price, multiplied by the Volume Weighted Average Price (“VWAP”) of the date of the mandatory default amount is either (x) demanded or otherwise due or (y) paid in full, whichever has higher VWAP, plus all accrued and unpaid interest, or (ii) 130% of the outstanding principal amount of the Notes, plus 100% of accrued and unpaid interest, and (b) all other amounts, costs, expenses and liquidated damages due under the various agreements covering issuance of the Convertible Notes. Such amount would include the liquidated damages due under the default provision of the Purchase Agreement.

 

The Company is required to repay, in cash, any outstanding principal amount of the Convertible Notes on February 22, 2014 and is not permitted, except upon entering into a change of control transaction or fundamental transaction as noted above, to prepay any portion of the principal amount without prior written consent of the Holders.

 

Investor Warrants

 

On February 22, 2011, the Company issued warrants for the purchase of up to 40,000,000 shares of

 

12

Table of Contents

 

common stock at the exercise price of $0.15 per share and with an expiration date of February 22, 2016 (the “Warrants”). The following is a summary of the Warrants outstanding as of June 30, 2011:

 

		Warrants		Exercise Price
Beginning balance		40,000,000		$	0.15
Add: Adjustments (pursuant to warrants agreement)		0		n/a
Less: Exercised (prior to 3/31/2011)		0		n/a
Ending balance		40,000,000		$	0.15

 

The Warrants are exercisable in cash to purchase shares of the Company’s common stock (the “Warrant Shares”). The Exercise Price may be paid pursuant to a cashless exercise provision if the Warrant Shares have not been registered within six months after the Warrants are issued. The Exercise Price of the Warrants shall be adjusted in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then Exercise Price.

 

In connection with a Fundamental Transaction, as defined in the Purchase Agreement, that is an all-cash transaction, the Company shall have the right to purchase from the Holders all, but not less than all, of the unexercised portion of the Warrants by paying in cash to the Holders an amount equal to 30% of the Exercise Price multiplied by the number of shares of Common Stock for which the Warrants are exercisable immediately prior to such change of control transaction.

 

Fair Value Measurements

 

The Company measures and reports fair value in accordance with Accounting Standards Codifications (“ASC”) 820 — Fair Value Measurements and Disclosures (ASC 820). ASC 820 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value investments.

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of an asset should reflect its highest and best use by market participants, principal (or most advantageous) markets, and an in-use or an in-exchange valuation premise. The fair value of a liability should reflect the risk of nonperformance, which includes, among other things, the Company’s credit risk.

 

Valuation techniques are generally classified into three categories: the market approach; the income approach; and the cost approach. The selection and application of one or more of the techniques may require significant judgment and are primarily dependent upon the characteristics of the asset or liability, and the quality and availability of inputs. Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. ASC 820 also provides fair value hierarchy for inputs and resulting measurement as follows:

 

Level 1

 

Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets or liabilities;

 

13

Table of Contents

 

Level 2

 

Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities; and

 

Level 3

 

Unobservable inputs for the asset or liability that are supported by little or no market activity and that are significant to the fair values.

 

Fair value measurements are required to be disclosed by the Level within the fair value hierarchy in which the fair value measurements in their entirety fall. Fair value measurements using significant unobservable inputs (in Level 3 measurements) are subject to expanded disclosure requirements including a reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to the following: (i) total gains or losses for the period (realized and unrealized), segregating those gains or losses included in earnings, and a description of where those gains or losses included in earning are reported in the statement of income.

 

The following summarizes the Company’s assets and liabilities measured at fair value as of June 30, 2011:

 

 

 

					Fair Value Measurements at Reporting Date Using:
					Quoted Prices
					in Active			Significant
					Markets for			Other			Significant
		Balance as of			Identical			Observable			Unobservable
		June 30,			Assets			Inputs			Inputs
Description		2011			(Level 1)			(Level 2)			(Level 3)
Liabilities
Convertible notes		$	5,515,000		$	—		$	—		$	5,515,000
Warrant liabilities		$	1,896,000		$	—		$	—		$	1,896,000
Total Liabilities		$	7,411,000		$	—		$	—		$	7,411,000

 

Accounting for the Convertible Notes and Investor Warrants

 

Investor Warrants

 

In June 2008, the FASB issued ASC 815-40-15 (formerly EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock), which was effective for the Company in 2009. This issued guidance requires that derivative instruments be evaluated for certain contingencies and anti-dilution provisions that would affect their equity classification as a derivative under ASC 815, Derivatives and Hedging (ASC 815) and requires the instruments to be classified as liabilities and

 

14

 

Table of Contents

 

reported at fair value.

 

Upon issuance, the Investor Warrants were not considered indexed to the Company’s own stock and therefore are required to be accounted for as freestanding derivative instruments and classified as a liability. As a result, the Investor Warrants are recorded as a liability at fair value as of February 22, 2011 and June 30, 2011 with subsequent changes in fair value recorded in the consolidated statement of operations.

 

Convertible Notes

 

The Company has determined that the Convertible Notes constitute a hybrid instrument that has the characteristics of a debt host contract containing several embedded derivative features that would require bifurcation and separate accounting as a derivative instrument pursuant to the provisions of ASC 815. The Company has identified all of the derivatives associated with the February 22, 2011 financing.  As permitted under ASC 825-10-10 — Financial Instruments, as it relates to the fair value option, the Company has elected, as of February 22, 2011, to measure the Convertible Notes in their entirety at fair value with changes in fair value recognized in the Consolidated Statement of Operations as either a gain or loss until the notes are settled. As such, the Company has appropriately valued the embedded derivatives as a single hybrid contract together with the Convertible Notes. This election was made by the Company after determining the aggregate fair value of the Convertible Notes to be more meaningful in the context of the Company’s financial statements than if separate fair values were assigned to each of the multiple embedded instruments contained in the Convertible Notes.

 

Upon issuance of the Convertible Notes, the Company allocated the proceeds received to the Convertible Notes and Investor Warrants on a relative fair value basis. As a result of such allocation, the Company determined the initial carrying value of the Notes to be $3.21 million. The Notes were immediately marked to fair value, resulting in a derivative liability in the amount of $3.68 million. As of June 30, 2011, the Convertible Notes have been marked to fair value resulting in a derivative liability of $5.52 million. The net charge to other income (expense) was income of $2,000 in the three months ended June 30, 2011 and expense of $2.2 million in the six months ended June 30, 2011. The debt discount in the amount of $792,000 (resulting from the allocation of proceeds) is being amortized to interest expense using the effective interest method over the expected term of the Convertible Notes. The Company amortized $66,000 and $91,000 for the three and six months ended June 30, 2011, which is a component of interest expense.

 

Upon issuance, the Company allocated $792,000 of the initial proceeds to the Investor Warrants and immediately marked them to fair value resulting in a derivative liability of $908,000. As of June 30, 2011, the Investor Warrants have been marked to fair value resulting in a derivative liability of $1.9 million. The charge to other income (expense) for the three and six months ended June 30, 2011 was income of $372,000 in the three months ended June 30, 2011 and expense of $1.1 million in the six months ended June 30, 2011.

 

A summary of changes in the Convertible Notes and Investor Warrants is as follows:

 

15

Table of Contents

 

		Fair Value of Convertible Notes			Fair Value of Warrant Liabilities			Total
Allocation of initial proceeds		$	3,208,000		$	792,000		$	4,000,000
Initial fair value adjustment		$	469,000		$	116,000		$	585,000
February 22, 2011		$	3,677,000		$	908,000		$	4,585,000
Amortization of debt discount		$	91,000		$	—		$	91,000
Fair value adjustment		$	1,747,000		$	988,000		$	2,735,000
Balance June 30, 2011		$	5,515,000		$	1,896,000		$	7,411,000

 

The Company records the fair value of Convertible Notes and Investor Warrants as a long term liability.

 

Financing Costs

 

Financing costs include costs associated with obtaining the February 22, 2011 financing.  Financing costs totaling $530,000 have been recorded in other income (expense) in the six months ended June 30, 2011, $134,000 of which were recorded in prepaid expenses and other current assets at December 31, 2010 and expensed upon closing of the transaction.

 

Valuation — Methodology and Significant Inputs Assumptions

 

Fair values for the Company’s derivatives and financial instruments are estimated by utilizing valuation models that consider current and expected stock prices, volatility, dividends, market interest rates, forward yield curves and discount rates.  Such amounts and the recognition of such amounts are subject to significant estimates that may change in the future. The methods and significant inputs and assumptions utilized in estimating the fair value of the Warrant Liabilities and Convertible Notes are discussed below. Each of the measurements is considered a Level 3 measurement as a result of at least one unobservable input.

 

Warrant Liabilities

 

A Black-Scholes-Merton option-pricing model, with dilution effects, was utilized to estimate the fair value of the Warrant Liabilities as of February 22, 2011 and June 30, 2011. This model is widely used in estimating value of European options dependent upon a non-paying dividend stock and fixed inputs. This model is subject to the significant assumptions discussed below and requires the following key inputs with respect to the Company and/or instrument:

 

Input		February 22, 2011			June 30, 2011
Stock Price		$	0.0755		$	0.12
Exercise Price		$	0.15		$	0.15
Expected Life (in years)		5.00			4.65
Stock Volatility		90		%	95		%
Risk-Free Rate		2.16		%	1.59		%
Dividend Rate		0		%	0		%
Outstanding Shares of Common Stock		30,351,092			30,351,092

 

16

Table of Contents

 

Convertible Notes

 

A binomial lattice model was utilized to estimate the fair value of the Convertible Notes as of February 22, 2011 and June 30, 2011. The binomial model considers the key features of the Convertible Notes, as noted above, and is subject to the significant assumptions discussed below. First, a discrete simulation of the Company’s stock price, without effects of dilution due to the conversion feature, was conducted at each node and throughout the expected life of the instrument. Second, a discrete simulation of the Company’s stock price, with effects of dilution due to the conversion feature, was conducted at each node and throughout the expected life of the instrument. Third, based upon the simulated stock price with dilution effect, an analysis of the higher position of a conversion position, redemption position, or holding position (i.e. fair value of the respective future nodes value discounted using the applicable discount rate) was conducted relative to each node until a final fair value of the instrument is conducted at the node representing the measurement date. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input		February 22, 2011			June 30, 2011
Stock Price		$	0.0755		$	0.1200
Strike Price		$	0.10		$	0.10
Expected remaining term (in years)		3.00			2.65
Stock Volatility		95		%	100		%
Risk-Free Rate		1.22		%	0.68		%
Dividend Rate		0		%	0		%
Outstanding Shares of Common Stock		30,351,092			30,351,092
Effective discount rate		20.3		%	16.6		%
Probability of forced redemption		20		%	20		%

 

The following are significant assumptions utilized in developing the inputs:

 

·                  The Company’s common stock shares are traded on the OTC Bulletin Board and, accordingly, the stock price input is based upon bid prices as of the valuation dates due to the extremely thin trading volume, broker-driven market (vs. exchange market) and the wide bid/ask spread as of the valuation date;

 

·                  The expected future stock prices of the Company’s stock were modeled to include the effect of dilution upon conversion of the instruments to shares of common stock;

 

·                  Stock volatility was estimated by considering (i) the annualized monthly volatility of the Company’s stock price during the historical period preceding the respective valuation dates and measured over a period corresponding to the remaining life of the instruments (monthly data set is more relevant given the extremely thin trading volume of the Company’s common stock) and (ii) the annualized daily volatility of comparable companies’ stock price during the historical period preceding the respective valuation dates and measured over a period corresponding to the remaining life of the instrument. Historic prices of the Company and comparable companies’ common stock were used to estimate volatility as the Company did not have traded options as of

 

17

Table of Contents

 

the valuation dates;

 

·                  Based upon the Company’s historical operations and management’s expectations for the foreseeable future, the Company’s stock was assumed to be a non-dividend-paying stock;

 

·                  With respect to the Convertible Notes, the Company is expected to pay all accrued interest due to the Holders on each Interest Payment Date;

 

·                  With respect to the Convertible Notes, based upon management’s expectations for a change of control or fundamental transaction to occur prior to the maturity date of the Convertible Notes, a low probability of a forced redemption;

 

·                  Upon a change of control redemption, the change of control redemption amount shall equal to the sum of:

 

I.      the greater of:

 

(i)                                     the outstanding amount of the debt divided by the Conversion Price on the date of the mandatory default amount is either (A) demanded or (B) paid in full, whichever has a lower conversion price, multiplied by the VWAP of the date of the mandatory default amount is either (x) demanded or otherwise due or (y) paid in full, whichever has higher VWAP, plus all accrued and unpaid interest, or

 

(ii)                                  130% of the outstanding principal amount of the debt, plus 100% of accrued and unpaid interest, and

 

II.             all other amounts, costs, expenses and liquidated damages due under the various agreements covering issuance of the debt.

 

Additionally, it is assumed that no amounts are due pursuant to clause (II) above in any period and that the stock price at each respective node represents a reasonable approximation of the VWAP requirements.

 

The changes in fair value between reporting periods are related to the changes in the price of the Company’s common stock as of the measurement dates, the volatility of the Company’s common stock during the remaining term of the instrument, changes in the conversion price and effective discount rate.

 

12.          Workforce Reduction

 

During the first quarter of 2010, the Company announced a one-third reduction in its workforce.  As a result of this reduction, in the three months ended March 31, 2010, the Company recorded a charge of $204,000, comprised of $167,000 of severance pay and $37,000 of stock option compensation expense.  This charge is included in the accompanying Consolidated Statement of Operations in continuing operations as a component of Selling, general and administrative, and Research and development in the amounts of $48,000 and $90,000, respectively.  The remaining charge of $66,000 is included in discontinued operations as cost of revenues.  During the three months ended March 31, 2010, the Company paid $65,000 of severance. The remaining severance payments of $102,000 were made during the second quarter of 2010 and no further severance payments are due beyond the $167,000 already paid to these former employees.

 

18

Table of Contents

 

13.          Lease Commitments

 

The Company leases its corporate office in Franklin, Massachusetts, under an operating lease agreement that expires in August 2011. In June 2011, the Company entered in to a three year facility lease for a smaller space at a new location in Milford, Massachusetts, beginning August 2011.  In addition to the minimum lease payments, the new lease agreement requires payment of the Company’s pro-rata share of property taxes and building operating expenses.

 

Under the new lease, future minimum lease payments are estimated to be as follows (in thousands):

 

Year		Future Minimum Lease Payments
2011		$	13
2012		38
2013		41
2014		30
Total		$	122

 

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

 

Overview

 

We are a medical device company specializing in innovative technologies for the cardiac and vascular markets. Our key strategic growth initiative is our newest marketable product, RenalGuard.

 

RenalGuard is designed to reduce the potentially toxic effects that contrast media can have on the kidneys when administered to at-risk patients during certain medical imaging procedures. It is believed that allowing contrast media to dwell in the kidneys of certain higher risk patients can lead to contrast induced nephropathy (CIN), a potentially deadly form of acute kidney injury. By inducing and maintaining a high urine flow rate before, during and after these medical imaging procedures, we believe the incidence rates of CIN in at-risk patients can be reduced. RenalGuard facilitates this increased urine clearance automatically, enabling the body to more rapidly void the contrast media, thereby reducing its overall resident time and potential toxic effects in the kidney.

 

The RenalGuard System consists of a proprietary console and accompanying single-use sets. RenalGuard operates by first collecting and measuring patient urine outputs and then in real-time precisely matching these urine outputs with a prescribed replacement fluid by means of intravenous infusion. With its automated matched fluid replacement capability, RenalGuard is intended to promote and maintain high urine outputs and minimize the risk to patients of over- or under-hydration during image-guided catheterization procedures where contrast media are routinely administered.

 

We obtained a CE Mark for RenalGuard in December 2007 and began our initial commercialization efforts in the EU in Italy in April 2008. We are now marketing RenalGuard in Europe and several additional countries around the world. In the U.S. we must first successfully complete a pivotal clinical study assessing the safety and effectiveness of RenalGuard in reducing the rates of CIN in at-risk patients and obtain FDA pre-market approval in order to market and sell RenalGuard. We intend to begin this U.S. pivotal study in 2011.

 

Our distributor in Italy, Artech, accounted for 75% and 62% of RenalGuard sales in the three and six months ended June 30, 2011 as compared to 91% and 57% in the comparable 2010 periods. Artech

 

19

Table of Contents

 

accounted for 53% and 46% of our total sales in the three and six months ended June 30, 2011 as compared to 65% and 31% in the same periods in 2010.

 

With the sale of our TMR business to Novadaq in February 2011, as discussed in Note 10 to the Consolidated Financial Statements, our ability to increase revenues depends solely upon higher sales of our RenalGuard products into international markets. This dependency on international RenalGuard revenue growth will continue until such time, if ever, that we may obtain FDA pre-market approval and are permitted to begin selling RenalGuard 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 sales for the next four quarters, (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 upon 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).  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.  We regularly review slow-moving and excess inventories, and writes down inventories to net realizable value if the ultimate expected proceeds from the disposals of excess inventory are less than the carrying cost of the inventory.

 

Accounts Receivable

 

Accounts receivable are stated at the amount we expect to collect from the outstanding balances.  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. 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 might be required.

 

Valuation of Convertible Notes and Warrant Liabilities

 

The valuation of our convertible notes and our warrant liabilities as derivative instruments utilizes certain estimates and judgments that affect the fair value of the instruments. Fair values are estimated by utilizing valuation models that consider current and expected stock prices, volatility, dividends, forward yield curves and discount rates.  Such amounts and the recognition of such amounts are subject to significant estimates that may change in the future.

 

Warranty and Preventative Maintenance Costs

 

We warranty our products against manufacturing defects under normal use and service during the

 

20

Table of Contents

 

warranty period.  We obtain similar warranties from a majority of our suppliers.

 

We evaluate the estimated future unrecoverable costs of warranty and preventative maintenance services for our installed base of products 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 recognize revenue when the following basic revenue recognition criteria have been met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.  Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the price to the buyer charged for products delivered or services rendered and collectability of the sales price. We assess credit worthiness of customers based upon prior history with the customer and assessment of financial condition. Our shipping terms are customarily Free On Board (“FOB”) shipping point. We record revenue at the time of shipment, if all other revenue recognition criteria have been met.

 

Results of Operations

 

Results for the three and six months ended June 30, 2011 and 2010 were as follows:

 

21

Table of Contents

 

		Three Months Ended								Six Months Ended
		June 30,				Increase (decrease)				June 30,				Increase (decrease)
		2011		2010		over 2010				2011		2010		over 2010
		$		$		$		%		$		$		$		%
		(dollars in thousands)
Revenues		398		249		149		60		455		516		(61	)	(12	)
Cost of revenues		198		264		(66	)	(25	)	338		696		(358	)	(51	)
Gross profit (loss)		200		(15	)	215		(1,433	)	117		(180	)	297		(165	)
Selling, general & administrative expenses		667		839		(172	)	(21	)	1,260		1,640		(380	)	(23	)
Research & development expenses		373		113		260		230		446		366		80		22
Total operating expenses		1,040		952		88		9		1,706		2,006		(300	)	(15	)
Gain on the sale of assets		(40	)	(98	)	58		(59	)	(40	)	(98	)	58		(59	)
Loss from continuing operations		(800	)	(869	)	69		8		(1,549	)	(2,088	)	539		26
Interest expense		(115	)	—		(115	)	100		(161	)	—		(161	)	100
Financing costs associated with convertible notes		—		—		—		—		(530	)	—		(530	)	100
Change in fair value of warrant liabilities		372		—		372		100		(1,104	)	—		(1,104	)	100
Change in fair value of convertible notes		2		—		2		100		(2,216	)	—		(2,216	)	100
Total other expense		259		—		259		100		(4,011	)	—		(4,011	)	100
Net loss from continuing operations		(541	)	(869	)	328		38		(5,560	)	(2,088	)	3,472		(166	)
Income from discontinued operations		—		670		(670	)	(100	)	53		—		53		100
Gain on sale of discontinued operations		—		—		—		—		1,179		1,328		(149	)	(11	)
Net income from discontinued operations		—		670		(670	)	(100	)	1,232		1,328		(96	)	(7	)
Net Loss		(541	)	(199	)	(342	)	(172	)	(4,328	)	(760	)	3,568		469

 

Revenues

 

RenalGuard revenues increased $102,000, or 58%, and $55,000, or 20%, in the three and six months ended June 30, 2011, as compared to the three and six months ended June 30, 2010, respectively.  RenalGuard Console sales increased $122,000 and $102,000 in the three and six months ended June 30, 2011, respectively due to a higher volume of RenalGuard consoles sold to international distributors.  RenalGuard single use set revenues decreased $20,000 and $47,000 in the three and six months ended
June 30, 2011, respectively due to a lower volume of RenalGuard single-use sets sold to international distributors.

 

OEM revenues increased $48,000 and decreased $115,000 in the three and six months ended
June 30, 2011, respectively, as compared to the 2010 periods. The OEM assets were sold in May 2010 and all transactions previously deferred have been recognized in full.  There will be no additional OEM revenues in future periods.

 

22