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PLC Systems 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1

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 September 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)

 

Yukon Territory, Canada

 

04-3153858

(State or Other Jurisdiction of

 

(I.R.S. Employer Identification No.)

Incorporation or Organization)

 

 

 

459 Fortune Boulevard, Milford, Massachusetts

 

01757

(Address of Principal Executive Offices)

 

(Zip Code)

 

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

 

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

 

Indicate by check mark whether the registrant 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.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

(Do not check if a smaller reporting company)

 

 

 

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

 

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

 

Class

 

Outstanding at November 10, 2011

Common Stock, no par value

 

30,351,092

 

 

 



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

28

 

 

 

 

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)

 

 

 

September 30,
2011

 

December 31,
2010

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

3,174

 

$

1,324

 

Accounts receivable, net of allowance of $0 and $10 at September 30, 2011 and December 31, 2010, respectively

 

237

 

121

 

Inventories

 

200

 

310

 

Prepaid expenses and other current assets

 

203

 

252

 

Assets from discontinued operations

 

 

1,095

 

Total current assets

 

3,814

 

3,102

 

Equipment, furniture and leasehold improvements, net

 

24

 

27

 

Other assets

 

185

 

186

 

Total assets

 

$

4,023

 

$

3,315

 

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

39

 

$

343

 

Accrued compensation

 

79

 

91

 

Accrued other

 

202

 

232

 

Deferred revenue

 

 

98

 

Other current liabilities

 

3

 

 

Liabilities from discontinued operations

 

 

1,117

 

Total current liabilities

 

323

 

1,881

 

Convertible notes

 

5,206

 

 

Warrant liabilities

 

1,664

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

Common stock, no par value, unlimited shares authorized, 30,351 shares issued and outstanding as of September 30, 2011 and December 31, 2010

 

93,893

 

93,893

 

Additional paid in capital

 

970

 

848

 

Accumulated deficit

 

(97,698

)

(92,969

)

Accumulated other comprehensive loss

 

(335

)

(338

)

Total stockholders’ equity (deficit)

 

(3,170

)

1,434

 

Total liabilities and stockholders’ equity (deficit)

 

$

4,023

 

$

3,315

 

 

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

 

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Table of Contents

 

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

27

 

$

17

 

$

482

 

$

533

 

Cost of revenues

 

17

 

39

 

355

 

632

 

Gross profit (loss)

 

10

 

(22

)

127

 

(99

)

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

591

 

545

 

1,850

 

2,184

 

Research and development

 

312

 

116

 

759

 

482

 

Total operating expenses

 

903

 

661

 

2,609

 

2,666

 

Gain on the sale of assets

 

 

 

(40

)

(98

)

Loss from continuing operations

 

(893

)

(683

)

(2,442

)

(2,667

)

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest expense

 

(116

)

 

(277

)

 

Financing costs associated with convertible notes

 

 

 

(530

)

 

Change in fair value of warrant liabilities

 

232

 

 

(872

)

 

Change in fair value of convertible notes

 

376

 

 

(1,840

)

 

Total other income (expense)

 

492

 

 

(3,519

)

 

Net loss from continuing operations

 

(401

)

(683

)

(5,961

)

(2,667

)

Discontinued operations:

 

 

 

 

 

 

 

 

 

Income from discontinued operations, net

 

 

678

 

53

 

1,903

 

Gain on sale of discontinued operations, net

 

 

 

1,179

 

 

Net loss

 

$

(401

)

$

(5

)

$

(4,729

)

$

(764

)

Net loss per weighted average share, basic and diluted:

 

 

 

 

 

 

 

 

 

From loss on continuing operations attributable to common stockholders

 

$

(0.01

)

$

(0.02

)

$

(0.20

)

$

(0.09

)

From income on discontinued operations

 

 

$

0.02

 

 

0.06

 

From gain on sale of discontinued operations

 

 

 

$

0.04

 

$

 

Net loss attributable to common stockholders per weighted average share, basic and diluted

 

$

(0.01

)

$

0.00

 

$

(0.16

)

$

(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.

 

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Table of Contents

 

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(4,729

)

$

(764

)

Income from discontinued operations

 

(53

)

 

Gain on sale of discontinued operations

 

(1,179

)

(1,903

)

Depreciation and amortization

 

3

 

29

 

Stock-based compensation expense

 

123

 

211

 

Change in fair value of warrant liabilities

 

872

 

 

Change in fair value of convertible notes

 

1,840

 

 

Financing costs associated with convertible notes

 

530

 

 

Non-cash interest expense

 

158

 

 

Change in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(122

)

69

 

Inventory

 

108

 

(56

)

Prepaid expenses and other assets

 

(86

)

61

 

Accounts payable

 

(298

)

(215

)

Deferred revenue

 

(98

)

115

 

Accrued liabilities

 

(41

)

(100

)

Net cash flows used in operating activities

 

(2,976

)

(2,553

)

 

 

 

 

 

 

Cash flows used for investing activities:

 

 

 

 

 

Purchase of property and equipment

 

4

 

 

Net cash used for investing activities

 

4

 

 

 

 

 

 

 

 

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

 

1,204

 

Net cash provided by investing activities

 

1,000

 

 

Net cash provided by discontinued operations

 

1,210

 

1,204

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

11

 

(13

)

Net increase (decrease) in cash and cash equivalents

 

1,850

 

(1,362

)

Cash and cash equivalents at beginning of period

 

1,324

 

2,686

 

Cash and cash equivalents at end of period

 

$

3,174

 

$

1,324

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

122

 

$

 

 

 

 

 

 

 

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

September 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 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 nine months ended September 30, 2011, the Company incurred a loss from continuing operations of approximately $5,961,000 and negative cash flows from continuing operations of $2,976,000.  At September 30, 2011, the Company had an accumulated deficit of $97,700,000.  As discussed above, in the first quarter of 2011, the Company sold 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 March 31, 2012.

 

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 nine months ended September 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 September 30, 2011 and December 31, 2010, inventories consisted of the following (in thousands):

 

 

 

September 30,
2011

 

December 31, 
2010

 

Raw materials

 

$

58

 

$

130

 

Work in progress

 

 

 

Finished goods

 

142

 

180

 

 

 

$

200

 

$

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.

 

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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 that as of September 30, 2011 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.  During the three months ended September 30, 2011 the Company did not grant any options to employees or non-employees.

 

As of September 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, September 30, 2011

 

5,702

 

$

0.19

 

2.31

 

$

7

 

Exercisable, September 30, 2011

 

4,288

 

$

0.22

 

2.28

 

$

7

 

 

Stock-Based Compensation Expense

 

The Company recorded compensation expense of $29,000 and $123,000 in the three and nine months ended September 30, 2011, as compared to $36,000 and $210,000 in the three and nine months ended September 30, 2010.  As of September 30, 2011, the Company had $80,000 of total unrecognized compensation cost related to its unvested options, which is expected to be recognized over a weighted average period of 1.07 years.

 

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Table of Contents

 

The weighted average fair value of options issued, as estimated using the Black-Scholes model, was $0.11 and $0.08 during the nine months ended September 30, 2011 and 2010, respectively.  The Company did not issue any options during the three months ended September 30, 2011.  The assumptions used were as follows:

 

 

 

Nine Months Ended September 30,

 

 

 

2011

 

2010

 

Expected life (years)

 

1.00 – 6.00

 

1.00 – 6.00

 

Risk free rate

 

0.27–2.65%

 

0.26–2.27%

 

Volatility

 

107.2–132.1%

 

86–250%

 

Expected dividend yield

 

None

 

None

 

Value of options granted

 

$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 September 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 nine months ended September 30, 2011 or 2010.  At September 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. The Company’s 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 nine months ended September 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

 

9



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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.

 

For the three and nine months ended September 30, 2011, 46,102,000 shares attributable to outstanding warrants and stock options, and for the three and nine months ended September 30, 2010, 5,752,000 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 nine months ended September 30, 2011 was $415,000 and $4,726,000, respectively as compared to $33,000 and $769,000, respectively, in the three and nine months ended September 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 September 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

 

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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 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 net income attributable to discontinued operations for the three and ninemonths ended September 30, 2011 and 2010 are as follows:

 

 

 

Three months ended
September 30

 

Nine months ended
September 30

 

 

 

(In thousands)

 

(In thousands)

 

 

 

2011

 

2010

 

2011

 

2010

 

Revenues:

 

 

 

 

 

 

 

 

 

Product sales

 

 

$

573

 

$

455

 

$

1,568

 

Service fees

 

 

302

 

68

 

872

 

Total

 

 

875

 

523

 

2,440

 

 

 

 

 

 

 

 

 

 

 

Income from discontinued operations

 

$

 

$

678

 

$

53

 

$

1,903

 

 

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

 

 

 

September 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

 

 

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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.

 

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Investor Warrants

 

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

 

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Table of Contents

 

Level 1

 

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

 

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 September 30, 2011:

 

 

 

 

 

Fair Value Measurements at Reporting Date Using:

 

 

 

 

 

Quoted 
Prices

 

 

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

Balance as of

 

Identical

 

Observable

 

Unobservable

 

 

 

September 30,

 

Assets

 

Inputs

 

Inputs

 

Description

 

2011

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Convertible notes

 

$

5,206,000

 

$

 

$

 

$

5,206,000

 

Warrant liabilities

 

$

1,664,000

 

$

 

$

 

$

1,664,000

 

 

 

 

 

 

 

 

 

 

 

Total Liabilities

 

$

6,870,000

 

$

 

$

 

$

6,870,000

 

 

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

 

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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 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 September 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 September 30, 2011, the Convertible Notes have been marked to fair value resulting in a derivative liability of $5.2 million. The net charge to other income (expense) was income of $376,000 in the three months ended September 30, 2011 and expense of $1.8 million in the nine months ended September 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 $67,000 and $158,000 for the three and nine months ended September 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 September 30, 2011, the Investor Warrants have been marked to fair value resulting in a derivative liability of $1.7 million. The charge to other income (expense) for the three and nine months ended September 30, 2011 was income of $232,000 in the three months ended September 30, 2011 and expense of $872,000 in the nine months ended September 30, 2011.

 

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

 

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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

 

$

158,000

 

$

 

$

158,000

 

Fair value adjustment

 

$

1,371,000

 

$

756,000

 

$

2,127,000

 

Balance September 30, 2011

 

$

5,206,000

 

$

1,664,000

 

$

6,870,000

 

 

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 nine months ended September 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 September 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

 

September 30,
2011

 

Stock Price

 

$

0.0755

 

$

0.12

 

Exercise Price

 

$

0.15

 

$

0.15

 

Expected Life (in years)

 

5.00

 

4.40

 

Stock Volatility

 

90

%

95

%

Risk-Free Rate

 

2.16

%

0.80

%

Dividend Rate

 

0

%

0

%

Outstanding Shares of Common Stock

 

30,351,092

 

30,351,092

 

 

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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 September 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

 

September 30,
2011

 

Stock Price

 

$

0.0755

 

$

0.1200

 

Strike Price

 

$

0.10

 

$

0.10

 

Expected remaining term (in years)

 

3.00

 

2.40

 

Stock Volatility

 

95

%

100

%

Risk-Free Rate

 

1.22

%

0.32

%

Dividend Rate

 

0

%

0

%

Outstanding Shares of Common Stock

 

30,351,092

 

30,351,092

 

Effective discount rate

 

20.3

%

16.4

%

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

 

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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.                               Lease Commitments

 

In June 2011, the Company entered in to a three year facility lease for office 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

 

$

9

 

2012

 

38

 

2013

 

41

 

2014

 

30

 

Total

 

$

120

 

 

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Table of Contents

 

13.                               Subsequent Event

 

The Company has evaluated all events or transactions through the date of this filing. During this period the Company did not have any material subsequent events that impacted its consolidated financial statements or disclosures.

 

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 0% and 58% of RenalGuard sales in the three and nine months ended September 30, 2011 as compared to 0% and 54% in the comparable 2010 periods. Artech accounted for 0% and 43% of our total sales in the three and nine months ended September 30, 2011 as compared to 0% and 30% 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 Unaudited Condensed 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

 

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Table of Contents

 

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 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) 

 

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Table of Contents

 

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 nine months ended September 30, 2011 and 2010 were as follows:

 

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Table of Contents

 

 

 

Three Months Ended
September 30,

 

Increase (decrease)

 

Nine Months Ended
September 30,

 

Increase (decrease)

 

 

 

2011

 

2010

 

over 2010

 

2011

 

2010

 

over 2010

 

 

 

$

 

$

 

$

 

%

 

$

 

$

 

$

 

%

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

27

 

17

 

10

 

59

 

482

 

533

 

(51

)

(10

)

Cost of revenues

 

17

 

39

 

(22

)

(56

)

355

 

632

 

(277

)

(44

)

Gross profit (loss)

 

10

 

(22

)

32

 

(145

)

127

 

(99

)

226

 

(228

)

Selling, general & administrative expenses

 

591

 

545

 

46

 

8

 

1,850

 

2,184

 

(334

)

(15

)

Research & development expenses

 

312

 

116

 

196

 

169

 

759

 

482

 

277

 

57

 

Total operating expenses

 

903

 

661

 

242

 

37

 

2,609

 

2,666

 

(57

)

(2

)

Gain on the sale of assets

 

 

 

 

 

(40

)

(98

)

58

 

(59

)

Loss from continuing operations

 

(893

)

(683

)

(210

)

31

 

(2,442

)

(2,667

)

225

 

(8

)

Interest expense

 

(116

)

 

(116

)

100

 

(277

)

 

(277

)

100

 

Financing costs associated with convertible notes

 

 

 

 

 

(530

)

 

(530

)

100

 

Change in fair value of warrant liabilities

 

232

 

 

232

 

100

 

(872

)

 

(872

)

100

 

Change in fair value of convertible notes

 

376

 

 

376

 

100

 

(1,840

)

 

(1,840

)

100

 

Total other expense

 

492

 

 

492

 

100

 

(3,519

)

 

(3,519

)

100

 

Net loss from continuing operations

 

(401

)

(683

)

282

 

(41

)

(5,961

)

(2,667

)

(3,294

)

124

 

Income from discontinued operations

 

 

678

 

(678

)

(100

)

53

 

1,903

 

(1,850

)

(97

)

Gain on sale of discontinued operations

 

 

 

 

 

1,179

 

 

1,179

 

100

 

Net income from discontinued operations

 

 

678

 

(678

)

(100

)

1,232

 

1,903

 

(671

)

(35

)

Net Loss

 

(401

)

(5

)

(396

)

7,920

 

(4,729

)

(764

)

(3,965

)

519

 

 

Revenues

 

RenalGuard revenues increased $10,000, or 59%, and decreased by $65,000, or 22%, in the three and nine months ended September 30, 2011, as compared to the three and nine months ended September 30, 2010, respectively.  RenalGuard Console sales increased $8,000 and $110,000 in the three and nine months ended September 30, 2011, respectively due to a higher volume of RenalGuard consoles sold to international distributors.  RenalGuard single use set revenues decreased $2,000 and $45,000 in the three and nine months ended September 30, 2011, respectively due to a lower volume of RenalGuard single-use sets sold to international distributors.

 

Gross Profit (Loss)

 

Gross profit was $10,000 and $127,000 in the three and nine months ended September 30, 2011, as compared with a gross loss of $22,000 and $99,000 in the three and nine months ended September 30, 2010, respectively.  Gross margin generated from the low volume of OEM and RenalGuard revenues was not

 

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sufficient to offset the fixed manufacturing costs incurred the three and nine months ended September 30, 2010.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenditures increased 8% and decreased 15% in the three and nine months ended September 30, 2011, respectively as compared to the three and nine months ended September 30, 2010. The increase in the three month comparative period represents an increase in legal fees and investor relation services.  The decrease in the nine months comparative period is a result of lower compensation-related costs, reflecting the decrease in headcount associated with our 2010 workforce reductions.

 

Research and Development Expenses

 

Research and development expenditures increased 169% and 57% in the three and nine months ended September 30, 2011, respectively as compared to the three and nine months ended September 30, 2010, due to the RenalGuard U.S. clinical trial costs, offset in part by lower compensation-related costs as a result of our 2010 workforce reductions.

 

As we resume our U.S clinical trial for our RenalGuard program, we expect our Research and development expenses to significantly increase for the remainder of 2011 and all of 2012.

 

Gain on Sale of Assets

 

During the nine months ended September 30, 2011, we recorded a gain on the sale of assets related to the OEM business of $40,000, as compared to $98,000 in the nine months ended September 30, 2010.

 

Other Income (Expense)

 

In February 2011, the Company entered into a Securities Purchase Agreement and a 5% Senior Secured Convertible Debenture Agreement as described in Note 11 of the Consolidated Financial Statements. As a result of this transaction, interest expense on the Convertible Notes of $116,000 and $277,000 was recorded in the three and nine months ended September 30, 2011, respectively.  In addition, financing costs associated with convertible note of $530,000 was recorded in the three months ended March 31, 2011.

 

The Company recorded other income of $232,000 and other expense of $872,000 in the three and nine months ended September 30, 2011, respectively, as a result of a fair value adjustment related to the Warrant Liabilities. The Company recorded other income of $376,000 and other expense of $1,840,000 in the three and nine months ended September 30, 2011, respectively, as a result of a fair value adjustment related to the Convertible Notes.

 

Discontinued Operations

 

In February 2011, we sold the TMR business to Novadaq as disclosed in Note 10.  Income from discontinued operations related to TMR activities prior to the sale of the TMR business was $0 and $53,000 in the three and nine months ended September 30, 2011, as compared to $678,000 and $1,903,000 in the three and nine months ended September 30, 2010, respectively.

 

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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 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 transactions costs of $50,000.  The Company has recorded a gain on sale of discontinued operations of $1,179,000.

 

Net Loss

 

In the three months ended September 30, 2011, our net loss increased $396,000, compared to the net loss reported for the three months ended September 30, 2010, due to the absence of income generated from discontinued operations and higher operating expenses, which were offset in part by higher other income and gross margin.

 

In the nine months ended September 30, 2011, our net loss increased $3,965,000, or 519%, compared to the net loss reported for the nine months ended September 30, 2010, due to higher other expense associated with our February 2011 financing, lower income generated from discontinued operations, higher operating expenses and a lower gain on the sale of assets, offset in part by the gain on the sale of discontinued operations, and gross margin.

 

Liquidity and Capital Resources

 

We compete in the highly regulated and competitive medical device market place where products can take significant time to develop, gain regulatory approval and then introduce to distributors and end users. We have incurred recurring quarterly operating losses over the past few years as we have worked to bring our RenalGuard System through development and initial commercialization efforts outside the United States. We expect such operating losses will continue until such time, if ever, that RenalGuard product sales increase sufficiently to generate profitable results.

 

Cash and cash equivalents totaled $3,174,000 as of September 30, 2011, an increase of $1,850,000 from $1,324,000 as of December 31, 2010. We have historically funded our working capital requirements through cash received from public and private offerings of our common stock and to a lesser extent, through our sales of products and services. In February 2011, we sold our TMR business for $1 million in cash plus the relief of approximately $614,000 in service contract obligations, and we issued $4 million in senior secured convertible notes to an institutional investor. We believe that our existing resources, based on our currently projected financial results, are sufficient to fund operations through the second quarter of 2012.  Based on current and anticipated revenue projections from foreign sales of our RenalGuard product, and the anticipated costs of our U.S. patient trials, we expect that we will need to raise additional capital during the first half of 2012.  Under the terms of the Securities Purchase Agreement, we may raise up to an additional $2 million from the Holders of the Convertible Notes in two separate $1 million tranches, based upon meeting certain operational milestones including sales and clinical trial objectives.

 

Our plan is to seek additional capital through the sale of equity and/or debt securities to fund operations. However, there can be no assurance that such capital will be available at all, or if available, that the terms of such financing will not be dilutive to our existing stockholders. The Holders of the Convertible Notes have a right to participate in up to 50% of any subsequent financing. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of the company by our stockholders would be diluted. In addition, any debt securities would have rights, preferences and

 

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privileges senior to our common stock and we may sell equity or other convertible debt financing securities which would have rights, preferences and privileges senior to our common stock.

 

If we are unable to generate adequate cash flows or obtain sufficient additional funding when needed, we may have to take certain actions including, but not limited to, cutting back our operations, selling some or all of our assets, licensing potentially valuable technologies to third parties, and/or ceasing some or all of our operations.

 

Cash flows used in operating activities in the nine months ended September 30, 2011 were $2,976,000 due to our net loss and unfavorable working capital changes, partially offset by non cash activity including 1) the change in fair value of convertible notes and warrant liabilities 2) non-cash interest expense; 3) depreciation expense; 4) stock-based compensation expense; and 5) financing costs associated with convertible notes.  Cash flows from financing activities in the nine months ended September 30, 2011 were $3,605,000 from the issuance of $4 million in senior secured convertible notes to an institutional investor, net of financing costs. Cash provided by discontinued operations was $1,210,000. The effect of exchange rate changes was an $11,000 increase in cash.

 

Forward-Looking Statements

 

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements containing terms such as “believes”, “plans”, “expects”, “anticipates”, “intends”, “estimates” and similar expressions reflect uncertainty and are forward-looking statements. Forward-looking statements are based upon 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:

 

·      We expect to incur significant net losses in future quarters;

·      Our quarterly operating results have varied in the past and will continue to vary significantly in the future, causing volatility in our stock price;

·      With the sale of our TMR business in February 2011, our future prospects are solely dependent upon the successful commercialization of RenalGuard. To date we have recorded only a limited amount of sales of RenalGuard, principally to a single customer in one country, Italy. Sales of RenalGuard alone are currently insufficient, and may never grow to be sufficient, to sustain our ongoing operations;

·      Our ability to effectively market RenalGuard outside the U.S. is largely dependent on the results of the MYTHOS and REMEDIAL II investigator-sponsored clinical trials, which we do not control. We have no assurance that the results from these two trials will be viewed as clinically meaningful or that they will lead to increased sales of RenalGuard;

·      We may never be successful in establishing a broad distribution channel for RenalGuard outside the U.S., and any distribution channel we may establish may never generate sufficient sales for us to attain profitability;

·      If we are required to change our pricing models to compete successfully, our margins and operating results may be adversely affected;

·      We plan to commence our U.S. pivotal clinical trial in 2011 to study RenalGuard, which is necessary to obtain FDA pre-market approval to market RenalGuard in the U.S. This study will take a significant amount of time and money to complete and will require us to raise additional capital in the future. We can provide no assurance that we will be able to complete this study or, if we are able to complete it, that

 

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RenalGuard will be shown to be safe or effective in preventing CIN, or that the degree of any positive safety and efficacy results will be sufficient to either obtain FDA approval or otherwise successfully market our product. Furthermore, the completion of a U.S. pivotal clinical trial is dependent upon many factors, some of which are not entirely within our control, including, but not limited to, our ability to successfully recruit investigators, the availability of patients meeting the inclusion criteria of our clinical study, the competition for these particular study patients among other clinical trials being conducted by other companies at these same study sites, the ability of the sites participating in our study to successfully enroll patients in our trial, and proper data gathering on the part of the investigating sites. Should a U.S. pivotal clinical trial take longer than we expect, our competitive position relative to existing preventative measures, or relative to new devices, drugs or therapies that may be developed, could be seriously harmed and our ability to successfully fund the completion of the trial and bring RenalGuard to market may be adversely affected;

·      Our RenalGuard System has only had limited testing in a clinical setting and we may need to modify it substantially in the future for it to be commercially acceptable in the broader market;

·      Any potential future modifications required to make RenalGuard commercially acceptable for the broader market may result in substantial additional costs and/or market introduction delays;

·      Rapid technological change in the medical device industry could make our products obsolete and requires substantial research and development expenditures and responsiveness to customer needs.  We expect to continue to face substantial competition from different treatment modalities and if we do not compete effectively with these alternatives, our market share may never grow and could decline;

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

·      Securing patent protection over our intellectual property ideas in the field of CIN prevention is, we believe, critical to our plans to successfully differentiate and market our RenalGuard System and grow our future revenues. However, we can provide no assurance as to how strong our issued patents will prove to be. Furthermore we can provide no assurance that we will be successful in securing any additional patent protection for our intellectual property ideas in this field or that our efforts to obtain patent protection will not prove more difficult, and therefore more costly, than we are otherwise expecting. Finally, even if we are successful in securing patent protection for some of our pending patent applications, or for additional intellectual property ideas in this field, we cannot predict when in the future any such potential patents may be issued, how strong such additional patent protection will prove to be, or whether these patents will be issued in a timely enough fashion to afford us any commercially meaningful advantage in marketing our RenalGuard System against other potentially competitive devices;

·      We are exposed to risks associated with outsourcing activities, which could result in supply shortages that could affect our ability to meet customer needs;

·      If we deliver systems with defects, our credibility may be harmed, sales and market and regulatory approvals acceptance of our systems may decrease, and we may incur liabilities associated with those defects;

·      If we require additional capital in the future, it may not be available, or if available, may not be on terms acceptable to us;

 

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·      We are exposed to various risks related to the regulatory environment for medical devices.  Compliance with medical device health and safety regulations may be very costly, and the failure to comply could result in liabilities, fines and cessation of our business;

·      Our share price will fluctuate based upon a number of factors including, but not limited to:

·      actual or anticipated fluctuations in our results of operations;

·      changes in estimates of our future results of operations by us or securities analysts;

·      announcements of technological innovations or new products or services by us or our competitors;

·      changes affecting the medical device industry;

·      announcements of significant acquisitions, strategic partnerships, joint ventures or capital commitments by us or our competitors;

·      additions or departures of key technical or management personnel;

·      issuances of debt or equity securities;

·      significant lawsuits, including patent or stockholder litigation;

·      changes in the market valuations of similar companies;

·      sales of our common stock by us or our stockholders in the future;

·      dilution caused by the conversion of convertible debt currently outstanding or which may be issued to our current secured lender and its assignees as well as the exercise of warrants issued to this lender, as well as by the exercise of employee stock options or the issuance of shares on the vesting of restricted stock units;

·      trading volume of our common stock; and

·      other events or factors that may directly or indirectly affect the value or perceived value of our business and/or prospects, including the risk factors identified in this prospectus.

·      We have pledged all of our assets to our secured debtholders. We are not currently permitted, nor do we currently intend, to pay any cash dividends on our common stock in the foreseeable future and therefore our shareholders may not be able to receive a return on their shares unless they sell them at an amount greater than the price paid for such shares;

·      Our secured debtholders may be able to exert significant control over the company through restrictive covenants contained in such debt agreements or through the conversion to our equity securities of the convertible debt and warrants issued and/or issuable to these debtholders;

·      Sales of a substantial number of shares of our common stock in the public market could cause our stock price to fall.  Future sales and issuances of our common stock or rights to purchase common stock, including pursuant to our stock plans, could result in additional dilution of the percentage ownership of our stockholders and could cause our stock price to fall;

·      U.S. broker-dealers may be discouraged from effecting transactions in shares of our common stock because they may be considered penny stocks and thus be subject to the penny stock rules; and

·      Our ability to recruit and retain management and other qualified personnel is crucial to our ability to develop, market, sell and support our products.

 

Off-Balance Sheet Arrangements

 

None.

 

Item 3.        Quantitative and Qualitative Disclosures about Market Risk

 

Pursuant to Item 305(e) of Regulation S-K, we are not required to provide this information because

 

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we are a smaller reporting company.

 

Item 4.        Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our chief executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2011.  The term “disclosure controls and procedures”, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.  Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based upon the evaluation of our disclosure controls and procedures as of June 30, 2011, our chief executive officer and principal financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Part II.  Other Information

 

Item 1A.       Risk Factors

 

Pursuant to the instructions to Item 1A. of Form 10-Q, we are not required to provide this information because we are a smaller reporting company.

 

Item 5.    Other Matters

 

On October 3, 2011, the Company appointed Gregory W. Mann, age 35, as its Chief Financial Officer.  Mr. Mann most recently served as Business Unit CFO at Virtusa Corporation (NASDAQ:VRTU) a global information technology services company, which provides a broad range of information technology, including IT consulting, technology implementation and application outsourcing.  At Virtusa, Mr. Mann held a variety of finance roles during seven years with the company. He has also held finance and accounting positions at companies including Acusphere, BeFree, and Intergen Energy.

 

Mr. Mann does not have a written employment agreement but has received an incentive stock option issued pursuant to our 2005 stock option plan to purchase up to 150,000 shares of our common stock at an exercise price of $0.12 per share. 50,000 options vest after the first year of employment and the remaining 100,000 options vest in two equal annual installments thereafter. The options are exercisable during a ten year period from the date of grant. Upon a sale of the Company or other applicable change of control, 100% of the unvested options will immediately vest.

 

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Table of Contents

 

Item 6.            Exhibits

 

Exhibit
Number

 

Description of Document

 

 

 

31.1

 

Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

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

 

 

 

101

 

The following materials from PLC Systems Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (Extensible Business Reporting Language), (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

 

SIGNATURES

 

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

 

 

PLC SYSTEMS INC.

 

 

 

Date:     November 14, 2011

By:

/s/ Mark R. Tauscher

 

 

Mark R. Tauscher

 

 

President and Chief Executive Officer
(Principal Executive Officer)

 

30



Table of Contents

 

EXHIBIT INDEX

 

Exhibit
Number

 

Description of Document

 

 

 

31.1+

 

Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2+

 

Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1+

 

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

 

 

 

101+

 

The following materials from PLC Systems Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (Extensible Business Reporting Language), (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.

 


+ Exhibits marked with a plus sign (“+”) are filed herewith.

 

31


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