10KSB 1 c08718e10ksb.htm FORM 10KSB e10ksb
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-KSB
     
þ   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2006
     
o   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-24635
 
Hypertension Diagnostics, Inc.
(Name of Small Business Issuer in Its Charter)
     
Minnesota
(State or Other Jurisdiction of
Incorporation or Organization)
  41-1618036
(I.R.S. Employer
Identification No.)
2915 Waters Road, Suite 108, Eagan, Minnesota 55121
(Address of Principal Executive Offices, including Zip Code)
Issuer’s Telephone Number: (651) 687-9999
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock ($.01 par value)
(Title of Class)
Redeemable Class B Warrant
(Title of Class)
     Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. o
     Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 þ No o
     Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. o
     The issuer’s revenues for the fiscal year ended June 30, 2006 were $1,789,546.
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
     State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of a specified date within the past 60 days. (See definition of affiliate in Rule 12b-2 of the Exchange Act.)__________
     The aggregate market value of the Company’s common stock and Series A Convertible Preferred Stock held by non-affiliates of the issuer as of September 14, 2006, when the last sale price of the Company’s common stock was $0.13 as reported by the OTC Bulletin Board, was approximately $4,986,000.
     There were 40,157,106 shares of the issuer’s common stock, $.01 par value per share and 871,225 shares of Series A Convertible Preferred Stock, $.01 par value per share, outstanding as of September 14, 2006.
DOCUMENTS INCORPORATED BY REFERENCE
          None.
 
 

 


 

Hypertension Diagnostics, Inc.
Annual Report on Form 10-KSB
For the Year Ended June 30, 2006
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 Deferred Equity Incentive Agreement
 Consent of Independent Registered Public Accounting Firm
 Certification of CEO Pursuant to 13a-14/15d-14
 Certification of CFO Pursuant to 13a-14/15d-14
 Certification Pursuant to 18 U.S.C. Section 1350
 Certification Pursuant to 18 U.S.C. Section 1350
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PART I
Forward-Looking Statements
          This Annual Report and our public documents to which we refer contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. In addition, we may make forward-looking statements orally in the future by or on behalf of the Company. When used, the words “believe,” “expect,” “will,” “can,” “estimate,” “anticipate” and similar expressions are intended to identify forward-looking statements. We caution readers not to place undue reliance on any forward-looking statements and to recognize that the statements are not predictions of actual future results. Actual results could differ materially from those anticipated in the forward-looking statements due to the risks and uncertainties set forth herein under the caption “Risk Factors,” as well as others not now anticipated.
     These risks and uncertainties include, without limitation: our ability to develop a business model to timely generate acceptable levels of revenues; the control exercised by the Schwartz Group; negative effect on our stock price resulting from available securities for sale; our need for additional capital; our dependence on our CVProfilor® DO-2020; the availability of third-party reimbursements for the use of our products; increased market acceptance of our products; our marketing strategy may result in lower revenues; the illiquidity of our securities on the OTC Bulletin Board and the related restrictions on our securities relating to “penny stocks”; potential violations by us of federal and state securities laws; the availability of integral components for our products; our ability to develop distribution channels; increased competition; changes in government regulation; health care reforms; exposure to potential product liability; our ability to protect our proprietary technology; regulatory restrictions pertaining to data privacy issues in utilizing the CDMF; and the ability to manufacture our products on a commercial scale and in compliance with regulatory requirements.
Introduction
          We were incorporated under the laws of the state of Minnesota on July 19, 1988. We are engaged in the design, development, manufacture and marketing of proprietary devices that we believe non-invasively measure both large and small artery elasticity. Vascular compliance or arterial elasticity has been investigated for many years and clinical studies suggest that a lack of arterial elasticity is an early indicator of vascular disease. Our product provides important cardiovascular parameters which we believe provide clinically beneficial information useful in screening patients who may be at risk for future cardiovascular disease, provide assistance to physicians with their diagnosis of patients’ cardiovascular disease, and allow for monitoring the effectiveness of various treatments of patients with diagnosed cardiovascular disease.
ITEM 1. Business
          We are currently marketing three products:
          CVProfilor® DO-2020 CardioVascular Profiling System. The CVProfilor® DO-2020 System has been approved by the FDA, and is being marketed to primary care physicians and other health care professionals within the United States. These physicians and other health care professionals can either rent the CVProfilor® DO-2020 on a “per-patient-tested” rental basis, lease it through a third-party capital lease, or purchase it directly from us.
          Utilizing our Central Data Management Facility, or CDMF, we are able to track utilization of the CVProfilor® DO-2020 System in each physician’s office and medical clinic and to invoice our physician customers based on the number of CardioVascular Profile Reports (CVProfile™ Reports) which they generate each month.
          HDI/PulseWave™CR-2000 Research CardioVascular Profiling System. The CR-2000 Research System is being marketed worldwide “for research purposes only” to clinical research investigators for the purpose of collecting data in cardiovascular studies. Further, because the CR-2000 Research System bears the CE Mark (CE 0123) and meets the European Union Medical Device Directive, physicians may use the CR-2000 Research System with patients in a clinical setting in the European Union.

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          CVProfilor® MD-3000 CardioVascular Profiling System. The CVProfilor® MD-3000 System is the international version of the CVProfilor® DO-2020 System designed for physicians outside the United States. The CVProfilor® MD-3000 System has a CE Mark (CE 0123) that allows it to be marketed within European Union countries.
Background of Business
          Cardiovascular Disease
          Cardiovascular disease is the primary cause of heart attacks and strokes and is the leading cause of death worldwide. Cardiovascular disease can manifest itself in many ways, including: hypertension or high blood pressure, coronary artery disease leading to heart attacks, peripheral artery disease, arteriosclerosis (hardening of the arteries) or atherosclerosis (plaque which progressively blocks arteries), aneurysm, stroke, kidney failure, retinopathy and even sudden death.
          According to the American Heart Association’s (“AHA”) Heart Disease and Stroke Statistics — 2006 Update, in 2003, more than 910,600 Americans died from heart disease-related conditions, such as heart attack, high blood pressure, stroke, heart failure, and congenital heart defects. Heart disease-related illnesses have been the country’s deadliest conditions for more than a century. It’s been the No. 1 cause of death since 1900, except for the year 1918. Today, more than 71 million Americans have heart disease, including 27.4 million people aged 65 or older. That number is expected to skyrocket as the nation ages. By the year 2010, heart disease will affect 40 million Americans aged 65 and older, predicts the AHA. Heart disease kills more than 150,000 Americans per year under the age of 65. Besides the human toll, heart disease is also financially costly. In 2006, heart disease will cost America more than $403 billion in direct and indirect costs, the AHA estimates.
          Hypertension, typically defined as blood pressure measuring 140 mmHg or greater systolic pressure and/or 90 mmHg or greater diastolic pressure, is extremely common. Worldwide, 600 million people with high blood pressure are at risk of heart attack, stroke, and cardiac failure. According to the AHA, approximately 65 million adult Americans (that is, about 32% of the adult population) have high blood pressure. Of those with high blood pressure, 30% are unaware they have it, 34% are on medication and have it controlled, 25% are on medication and do not have their blood pressure controlled, and 14.8% are not on medication and do not have their blood pressure under control. In other words, more than 65% of these individuals are not being properly treated for their high blood pressure and, therefore, face significantly higher increased risk for advanced heart and kidney disease and the occurrence of strokes. In recognition of the health risks posed by high blood pressure, the AHA issued guidelines that classify individuals with systolic blood pressure between 120-139 mmHg or diastolic blood pressure between 80-89 mmHg as “prehypertensive.” The AHA estimates that an additional 59 million American adults over the age of 18 have “prehypertension.” Prehypertensive individuals are believed to be at significant risk for developing hypertension and they have a much greater risk of cardiovascular events or dying from cardiovascular disease within 10 years than people with lower or normal blood pressure levels.
          According to the National Institutes of Health, or NIH, National Heart, Lung, and Blood Institute’s, or NHLBI, Framingham Heart Study, middle-aged and elderly people face a 90% risk of developing hypertension during their remaining years. Moreover, an estimated 73% of the 17 million U.S. adults with diabetes have hypertension or borderline hypertension. Another 16 million American adults have pre-diabetes, a condition that occurs when a person’s blood glucose levels are higher than normal but not high enough for a diagnosis of diabetes. The American Diabetes Association, or ADA, predicts that the number of new U.S. cases of diagnosed diabetes is expected to increase by one million people per year. The ADA believes that people with diabetes are two to four times more likely to have hypertension, two to four times more likely to experience a stroke, and cardiovascular disease is the major cause of diabetes-related deaths. The WHO estimates that 176 million people have diabetes worldwide. India tops the list having 31 million people with diabetes, the largest number of people with diabetes in the world. Overall, hypertension and diabetes are major contributors to cardiovascular death worldwide and continue to grow in size. For example, only one-third of the people over 35 years of age in Beijing and Shanghai, China have normal blood pressure, and 30% of Chinese adults have high blood pressure, one of the highest rates of hypertension in the world.

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          Hypertension can easily go undetected and has been called the “silent killer” because it usually produces no clinical symptoms until after it has already seriously damaged the heart, kidneys, brain and/or other vital organs. Hypertension damages the arteries, leading to pathological changes in the tissues and organs supplied by these damaged arteries. It accelerates the development of atherosclerosis in large blood vessels and in the arteries supplying blood to the brain, heart, kidneys and legs. Artherosclerosis is the formation of plaque and the accumulation of fatty deposits lining the walls of arteries, or endothelium, which affect blood flow. The endothelium helps to maintain the flexibility or elasticity of the artery and normally inhibits the accumulation of lipid and cellular deposits on the wall of the artery. Abnormal function of the endothelium and the associated structural changes in the blood vessel wall result in a progressive loss of elasticity of the arteries. Detection of this loss in elasticity can identify individuals with abnormal arterial structure and function, often long before plaque formation can cause morbid cardiovascular events such as heart attacks or strokes. Further, demonstration of normal arterial structure and function might suggest that an individual does not have early atherosclerosis and therefore may not need aggressive risk factor management, despite poor life styles such as obesity, smoking or inactivity.
          There is no simple, clinically applicable method to detect the presence of atherosclerosis prior to plaque obstruction of the arteries leading to heart attack, stroke, angina and other cardiovascular diseases. There have been widespread, global efforts at identification of individuals exhibiting the risk factors associated with artherosclerosis and intervention through lifestyle modification, medical therapy, surgical procedures and medication. The problem with this approach is two-fold: (a) patients without traditional risk factors will not be identified even though up to half of the atherosclerotic clinical events occur in such individuals; and (b) patients who have one or more risk factors may be subjected to intensive and prolonged therapy even though they may not have the atherosclerotic process which the therapy is designed to inhibit.
          The Clinical Problem
          Cardiovascular specialists spend considerable effort on evaluating heart function, including the clinical use of electrocardiograms (ECGs), echocardiograms and stress tests, but have been unable to assess the functional and structural abnormality of the arteries prior to the late phase of arterial obstruction due to artherosclerosis. In addition, due to the fact that hypertension increases one’s risk for developing cardiovascular disease, physicians put considerable effort into blood pressure measurements even though it, too, is an insensitive and nonspecific means of assessing the underlying condition of the blood vessels. Traditionally, a patient’s arterial blood pressure is obtained clinically by using a sphygmomanometer, that is, an upper-arm blood pressure cuff device. Despite these attempts to identify patients at risk for cardiovascular disease studies show that blood pressure is not necessarily well correlated with actual cardiovascular events. Approximately, 50% of heart attack victims and 75% of stroke victims have normal blood pressure. Therefore, focusing on blood pressure levels alone to determine cardiovascular risk may not catch those with actual disease.
          Although an elevated blood pressure is associated with a higher risk for cardiovascular events, the elevated blood pressure is not the disease, but merely a relatively crude marker for the likelihood of disease. Furthermore, blood pressure itself is highly variable from moment to moment and day to day in almost all individuals. Elevated serum cholesterol levels, especially an increase in the low-density lipoproteins/high-density lipoproteins (LDL/HDL) ratio, also are associated with a higher risk for morbid cardiovascular events, but this measurement does not identify blood vessel disease directly. Instead, a high LDL/HDL ratio is yet another risk factor (such as smoking or lack of exercise) that might increase the risks associated with blood vessel disease. Various medical techniques such as radiology, magnetic resonance imaging (MRI), computerized tomography (CT) scans and ultrasonography also are not useful in obtaining information about the elasticity of small and/or very small arteries, or arterioles, which are the first blood vessels to become altered with hypertension and other cardiovascular diseases.
          The degree of arterial elasticity is related to the condition of the blood vessels, and with declining elasticity comes an increase in the incidence of vascular disease. Declining elasticity in the arterial wall precedes the development of overt coronary artery disease by many months and even years. Therefore, the “premature stiffening” of the small arteries and arterioles appears to be an early and sensitive clinical marker for cardiovascular disease, even in patients who have no clinical evidence of traditional risk factors for vascular disease. Further, clinical research data published globally has shown that patients with heart failure, coronary artery disease, hypertension and diabetes all exhibit a loss or reduction of arterial elasticity.

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          According to the AHA, cardiovascular disease claims more lives each year than the next four causes of death combined, which are cancer, chronic lower respiratory diseases, accidents and diabetes. In addition more women die of cardiovascular disease each year than men. According to the National Institute of Health (“NIH”) Women’s Ischemia Syndrome Evaluation (“WISE”) report released in 2006, Women have a form of heart disease that is fundamentally different and harder to diagnose then in men. Standard cardiovascular disease diagnostic techniques such as treadmill stress tests and coronary angiography designed to show large coronary artery stenosis is not useful in women where the plaque appears more likely to spread evenly through the artery wall. Coronary angiography might be missing a sizeable portion of women in terms of estimating the risk for cardiovascular disease. Half or more of women who present with findings suggesting ischemia have dysfunction at the microvascular level and this dysfunction appears linked to adverse outcomes. Therefore, women appear to be strong candidates for CVProfilor testing.
          Our Answer
          Our products capture blood pressure waveform data produced by the beating heart and analyze it in order to provide an assessment of systemic arterial elasticity for both large and very small arteries.
          Blood pressure waveform data is produced each time the heart cycles through a complete heartbeat. As the heart contracts pushing a volume of blood into the arteries, pressure within the arteries rise. As the aortic valve closes after the heart has ejected this volume of blood, blood pressure within the arteries falls prior to the next heartbeat. The complete cycle forms a pressure curve or waveform, which reflects the degree or amount of arterial elasticity. Subtle changes in arterial elasticity introduce changes within the entire arterial system that are reflected in this blood pressure waveform or shape. This “blood pressure waveform” or “pulse contour analysis” methodology provides an independent assessment of the elasticity or flexibility of the large arteries which expand briefly as they act as conduits for blood ejected by the heart, and of the small arteries and the arterioles which produce oscillations or reflections in response to the pressure wave generated during each heart beat. The degree of arterial elasticity is related to the condition of the blood vessels and with declining elasticity comes an increase in the incidence of cardiovascular disease.
          Incorporating this physiological phenomena associated with blood pressure waveforms, Drs. Jay N. Cohn and Stanley M. Finkelstein, Professors at the University of Minnesota Medical School in Minneapolis and two of our Company’s founders, developed a clinically useful procedure for determining a measure of elasticity for both large and small arteries. Our products use patented and proprietary software programs and algorithms to analyze the contour of the blood pressure waveform so that the arterial elasticity can be determined. The measure of elasticity of the large arteries is called a C1-large artery elasticity index and in the small arteries the measure is called the C2-small artery elasticity index.
          The Products
          We currently have designed, developed and are marketing three products:
-   HDI/PulseWave™ CR-2000 Research CardioVascular Profiling System
-   CVProfilor® DO-2020 CardioVascular Profiling System
-   CVProfilor® MD-3000 CardioVascular Profiling System
          Our products painlessly and non-invasively collect 30 seconds of blood pressure waveform data from the patient. The products analyze this data by means of an embedded computer and then generate a CardioVascular Profile Report or CVProfile™ Report using an external printer. The Report contains several clinically useful parameters, which permit a physician to screen patients for underlying vascular disease. All of our products have four primary components: (a) a custom designed, non-invasive Arterial PulseWave™ Sensor which is positioned over the radial artery at the wrist by means of a special apparatus; (b) an upper-arm blood pressure cuff connected via a hose to an oscillometric blood pressure module within the device; (c) a device enclosure which contains a computer, a high resolution touch-screen display and other electronics and software programs; and (d) an external printer.
          HDI/PulseWave™ CR-2000 Research CardioVascular Profiling System
          The CR-2000 Research System, first promoted during December of 1998, is currently being marketed worldwide. In the European Union, the CR-2000 Research System bears the CE Mark (CE 0123) which allows it to be marketed in the European Union for clinical research purposes. Further, because the CR-2000 Research System

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also meets the European Union Medical Device Directive, physicians may use the CR-2000 Research System with patients in a clinical setting in the European Union. In the U.S., the CR-2000 Research System is not recognized as a medical device and it is being marketed “for research purposes only” to clinical research investigators for the purpose of collecting data in cardiovascular studies. We have not submitted, and do not intend to submit, an application for the CR-2000 Research System to the FDA for clearance to market it as a medical device for use on patients in the U.S.
          The CR-2000 Research System non-invasively collects 30 seconds of blood pressure waveform data, performs an analysis of the digitized blood pressure waveforms, and generates a Research CardioVascular Profile Report that contains 15 cardiovascular parameters (some report parameters are displayed on the screen and the entire report is generated by an external printer). An electronic RS-232 computer output port is standard on all CR-2000 Research Systems so that research scientists and clinical investigators can download the Research CardioVascular Profile Report parameters and waveform data directly to computer systems within their medical centers and research institutions.
          The CR-2000 Research System is being marketed worldwide to pharmaceutical firms, research investigators at academic medical research centers, government institutes conducting a wide range of cardiovascular disease research and, in the European Union, to physicians for use in clinical research.
          Five drug manufacturers have permitted the public disclosure of their use of our HDI/PulseWave™ CR-2000 Research CardioVascular Profiling System in their multi-site clinical research trials: Alteon, Inc.; AstraZeneca, LP; Parke-Davis; Pfizer, Inc. and Solvay Pharmaceuticals, Inc. Pfizer released the results of the AVALON trial in 2005, which showed the benefits of its new drug, Caduet, on improving arterial elasticity in as short as eight weeks. Our CR-2000 Research System was first introduced into the initial 2-year phase of the NHLBI Multi-Ethnic Study of Atherosclerosis, or MESA, research trial in May of 2000. After several years of preparatory efforts, the NHLBI publicly announced the 10-year multicenter study on September 14, 2000. The MESA trial is a prospective clinical study attempting to identify clinically useful markers or parameters for predicting cardiovascular disease before the onset of signs or symptoms. The trial has been designed to be a 10-year investigation of more than 6,000 men and women of many ethnic backgrounds residing throughout the U.S. Each study participant will have his or her C1-large artery elasticity or C-2 small artery elasticity index determined and recorded. Over the remainder of the trial, enrollees will be followed to determine changes in subclinical disease as well as cardiovascular disease morbidity and mortality.
          CVProfilor® DO-2020 CardioVascular Profiling System
          On November 1, 2000, the FDA granted us clearance to market the CVProfilor® DO-2020 System as a medical device in the U.S. The CVProfilor® DO-2020 System is currently being promoted to physicians specializing in internal medicine, general and family practice, cardiology, endocrinology, nephrology and to other primary care physicians throughout the U.S.
          The CVProfilor® DO-2020 System non-invasively collects 30 seconds of blood pressure waveform data, performs an analysis of the digitized blood pressure waveforms, and generates a CVProfile™ Report. The CVProfile™ Report, printed in the physician’s office using the printer provided as part of the System, contains information on blood pressure (systolic, diastolic and mean arterial pressure), heart rate, pulse pressure, body surface area, body mass index, and both C1-large and C2-small artery elasticity indices. A brief medical history of the patient is recorded by the user of the System and an internal modem transmits this history and all of the CVProfile™ Report results to our Central Data Management Facility, or CDMF.
          Reimbursement will always vary considerably by the patient’s medical necessity, by physician, by provider, by geography and by provider coverage plans, making the process of obtaining reimbursement for the CVProfilor® DO-2020 by current physician customers an important component of our product launch.
          CVProfilor® MD-3000 CardioVascular Profiling System
          An international version of our product, the CVProfilor® MD-3000 CardioVascular Profiling System, was introduced at the combined meeting of the 19th Scientific Meeting of the International Society of Hypertension, or ISH, and the 12th European Meeting on Hypertension, or ESH, during June 23-27, 2002 in Prague, Czech Republic. The CVProfilor® MD-3000 System is designed for use in physicians’ offices outside the United States to non-invasively assess the health of patients’ large and small arteries for the early detection and management of vascular disease.

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          Similar to the CVProfilor® DO-2020 System, the CVProfilor® MD-3000 System provides physicians with the ability to immediately print a CVProfile™ Report in their office containing patient specific information on blood pressure (systolic, diastolic and mean arterial pressure), heart rate, pulse pressure, body surface area, body mass index, and both C1-large and C2-small artery elasticity indices. Due to fundamental differences in physician reimbursement, patient data transfer regulations and telephone communication technologies, the CVProfilor® MD-3000 System is being marketed to physicians through distributors as a capital purchase item and does not contain technology which allows the telephonic transmission of data to a Central Data Management Facility.
          CardioVascular Profile (CVProfile™) Report
          The Research CardioVascular Profile Report currently generated by the CR-2000 Research System presents the following parameters:
-   1.5 Second Blood Pressure Waveform Graph — Pulse Pressure — Estimated Stroke Volume Index
-   Large Artery Elasticity Index — Pulse Rate — Estimated Cardiac Output
-   Small Artery Elasticity Index — Estimated Cardiac Ejection Time — Estimated Cardiac Index
-   Systolic Blood Pressure — Estimated Stroke Volume — Total Vascular Impedance
-   Diastolic Blood Pressure — Body Surface Area — Systemic Vascular Resistance
-   Mean Arterial Pressure — Body Mass Index
          The CVProfile™ Report currently generated by the CVProfilor® DO-2020 System and the CVProfilor® MD-3000 System presents the following parameters:
-   1.5 Second Blood Pressure Waveform Graph — Mean Arterial Pressure
-   C1-Large Artery Elasticity Index — Pulse Pressure
-   C2-Small Artery Elasticity Index — Pulse Rate
-   Systolic Blood Pressure — Body Mass Index
-   Diastolic Blood Pressure — Body Surface Area
          The Advantages: Potential Beneficial Medical Outcomes for Patients and Payers
          Basic and applied research findings suggest that the arterial elasticity indices can be used to determine the “clinical age” of the body’s arteries and that these values, when viewed in combination with a medical history, physical examination and/or other tests, may provide a meaningful picture of the vascular health for patients of about 10 years of age and older. The C1-large and C2-small artery elasticity indices are of particular clinical importance in such evaluations. These indices indicate the elasticity or flexibility of the patient’s arteries throughout the body, which we believe to be beneficial in assessing vascular disease. These indices also provide valuable information to physicians in screening patients who may be at risk for underlying vascular disease and thereby may have a potential for future life-threatening cardiovascular events.
          During the last several years, clinical research investigators have evaluated thousands of “normal” subjects, as well as many who have cardiovascular disease. They have summarized their data in order to establish the approximate “reference range” for arterial elasticity and other cardiovascular parameters. Patients with normal blood pressure values have been identified who exhibit “premature stiffening” of their small and very small arteries or arterioles. Without the benefit of a CVProfile™ Report, such patients would be considered “clinically normal and asymptomatic.” Thus, we believe that the CVProfilor® DO-2020 System and the CVProfilor® MD-3000 System may help physicians identify such patients and encourage them to modify their lifestyle and/or intervene therapeutically by prescribing medication much earlier in the progression of cardiovascular disease.
          Further, physicians using our CVProfilor® DO-2020 System have indicated to us that the products are useful in evaluating patients with elevated blood pressure in order to decide who requires immediate and aggressive treatment versus those who might merely need to institute lifestyle changes. This would be an important clinical distinction, which cannot be easily determined in medical practice today.

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          Not only is arterial elasticity becoming an increasingly important clinical parameter in the identification of cardiovascular disease, but also developing and selecting optimal drug therapy. Research suggests that a drug’s effect on arterial elasticity is potentially an important consideration in selecting optimal drug therapy because many cardiovascular drugs exert their primary and secondary effects on blood pressure, vessel size and/or vascular wall integrity. Thus, drugs that favorably impact or enhance arterial elasticity may play a significant clinical role in reducing patient morbidity and mortality.
          Published Articles: Clinical Research Update
          Several scientific articles have been published in peer-reviewed medical journals which utilized either the CR-2000 Research System or the CVProfilor® DO-2020 System. We have over 245 abstracts and articles in our bibliography, all of which generally address our technology, our methodology, the relationship of arterial elasticity to cardiovascular disease, and/or the benefits of blood vessel elasticity assessment. In addition, more than half of these peer-reviewed, published articles and abstracts reference the utilization of the CVProfilor® DO-2020 System or the HDI/PulseWave™ CR-2000 Research System in their data collection. We believe the inclusion of our products in these publications provides credibility to our technology and the utility of our products in screening for cardiovascular disease.

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MARKETING, SALES AND DISTRIBUTION
          Because of the magnitude and impact cardiovascular disease has on the population, we believe that our products offer a significant opportunity for providing a more accurate, cost-effective and efficient means with which to screen, risk-stratify and manage patients who may have underlying vascular disease and/or who have been diagnosed with cardiovascular disease.
          The Research Market
          The CR-2000 Research System is being marketed worldwide to pharmaceutical firms, research investigators at academic medical research centers, and government institutes conducting clinical research trials relating to cardiovascular disease and treatment. These organizations are in the business of gathering large amounts of cardiovascular data from human research subjects, non-invasively. The CR-2000 Research System has been certified to carry a CE Mark for Europe and it is being marketed for research purposes only to clinical research investigators for the purpose of collecting data in cardiovascular studies. Further, because the CR-2000 Research System also meets the European Union Medical Device Directive, physicians may use the CR-2000 Research System with patients in a clinical setting in the European Union.
          It costs a research-based drug company, on average, $802 million and about 10-15 years to get one new drug from the laboratory to the pharmacist’s shelf. Further, only five in every 5,000 chemical compounds that enter pre- or non-clinical testing are ultimately subjected to human testing, and only one in five of those is ultimately approved for administration to patients. We believe that the CR-2000 Research System provides an innovative means for gathering additional data and information during such critical clinical research endeavors.
          The clinical research market is diverse, with global pharmaceutical companies, the U.S. federal and foreign governments and medical device manufacturers funding the vast majority of these research endeavors. In most cases, the direct costs of physician services and the costs of additional medical care due to these clinical research trials are paid directly to the provider organizations by the pharmaceutical study sponsors.
          Therefore, we pursue the following three markets for the CR-2000 Research System:
          Pharmaceutical Companies. There are approximately 1,200 firms conducting clinical research trials worldwide. Nonetheless, a relatively small number of pharmaceutical firms in the world accounted for the vast majority of all research and development spending. These pharmaceutical firms often seek new ways to gather additional data and information non-invasively from human subjects engaged in clinical research trials and we actively market to pharmaceutical companies for the inclusion of our CR-2000 Research System in their clinical research trials relating to drugs for the treatment of cardiovascular disease.
          Academic Centers. Universities throughout the world conduct clinical research trials, which are financially supported with grants from governmental agencies, disease management foundations and private sponsors including commercial entities and individual or family endowments. Universities with research centers conducting clinical trials in the areas of preventative cardiology, nephrology and epidemiology are a particular target market for our CR-2000 Research System.
          The U.S. Government. The National Institutes of Health, the Veterans’ Affairs Medical Centers, the Agency for Health Care Policy and Research, and the Centers for Disease Control and Prevention often conduct large-scale research projects and clinical trials that represent a significant market opportunity for the CR-2000 Research System.
          As of June 30, 2006, the CR-2000 Research System was being utilized in 25 countries throughout the world and users have contributed many of the articles in our bibliography of 245 published abstracts, articles and presentations that reference either our CR-2000 Research System or our pulse contour methodology. These references not only reinforce the scientific and clinical merit of our arterial waveform analysis methodology, but they broaden the medical community’s understanding of, as well as the clinical application of, employing large and, especially, small artery elasticity indices as early and sensitive markers for the presence of vascular disease in patients.

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          To date, five pharmaceutical firms and the National Institutes of Health/National Heart, Lung, and Blood Institute, the largest governmental clinical research agency, deployed the CR-2000 Research System for use in multi-site clinical trials.
           Alteon, Inc. used the CR-2000 Research System as part of its Advanced Glycosylation End products (A.G.E.) ‘Crosslink Breaker’ ALT-711 drug trial;
           AstraZeneca, LP used the CR-2000 Research System to obtain additional data in its Trial Of Preventing Hypertension, or TROPHY, study which was designed to investigate whether or not early treatment of subjects with high blood pressure can prevent or at least delay the onset of clinically detectable hypertension;
           The National Institutes of Health/National Heart, Lung, and Blood Institute used the CR-2000 Research System as one of the primary investigative clinical endpoints for its Multi-Ethnic Study of Atherosclerosis, or MESA, research trial which is a ten-year, multi-site prospective clinical study involving approximately 6,000 subjects of varied ethnic background in an attempt to identify clinically useful procedures for predicting cardiovascular disease;
           Parke-Davis used the CR-2000 Research System for a multi-site cardiovascular drug research trial as part of their ongoing clinical research investigations;
           Pfizer, Inc. used the CR-2000 Research System for a North American cardiovascular drug research trial, AVALON, to study the arterial elasticity impact of their combination drug, Caduet, a combination of Norvasc and Lipitor; and
           Solvay Pharmaceuticals, Inc. chose the CR-2000 Research System for a multi-site cardiovascular drug research trial.
          The inclusion of the CR-2000 Research System in these important pharmaceutical research trials provide credibility and promote awareness of our blood pressure waveform analysis technology in the global medical marketplace.
          The Practicing Physician Market
          The CVProfilor® DO-2020 CardioVascular Profiling System is designed for use by physicians, other health care professionals and trained medical personnel. As of 2000, American Medical Association estimates indicate that there are more than 813,000 licensed physicians actively working in the U.S., about 250,000 of which are included in our target market as potential users of the CVProfilor® DO-2020 System as follows:
           Approximately 120,000 physicians specializing in internal medicine;
           Approximately 80,000 general and family practice physicians (that is, primary care physicians);
           Approximately 30,000 medical sub-specialty physicians; and
           Approximately 20,000 cardiovascular disease specialists.
          Our current market focus is toward internists, primary care physicians and other health care providers who can use our product for the cardiovascular risk-stratification of their hypertensive and diabetic patients, and who are directly involved in screening patients for potential underlying vascular disease.
          Marketing Strategy
          Our primary objective is to establish the CardioVascular Profiling products as the standard for identifying and monitoring patients with cardiovascular disease.
          HDI/PulseWave™ CR-2000 Research System
          The CR-2000 Research System, originally launched during December of 1998, is currently being marketed worldwide through a small direct sales force in the U.S. and through international distributors outside the U.S. We continue to identify and manage independent medical distribution firms for marketing our technology internationally. As of June 30, 2006, the established end-user price in the U.S. for the CR-2000 Research System was approximately $26,000; however, higher than expected manufacturing, marketing or distribution costs and/or competitive pressures could result in our need to raise or lower this current price.
          The CR-2000 Research System has a CE Mark (CE 0123) which allows it to be marketed throughout the European Union for clinical research purposes. Further, because the CR-2000 Research System also meets the European Union Medical Device Directive, physicians may use the CR-2000 Research System with patients in a clinical setting in the European Union. In the U.S., the CR-2000 Research System is not recognized as a medical device and it is being marketed “for research purposes only” to clinical research investigators for the purpose of collecting data in cardiovascular studies.

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          CVProfilor® DO-2020 System
          On November 1, 2000, we obtained clearance from the FDA to market the CVProfilor® DO-2020 System in the U.S. for use by physicians and other health care providers to non-invasively screen patients for the presence of vascular disease. On March 16, 2001, we announced that a controlled launch of our FDA cleared CVProfilor® DO-2020 System was underway with the objective of validating pricing, marketing and reimbursement expectations within our U.S. target market of internal medicine, family practice and cardiology physicians prior to implementing a nationwide launch.
          As part of our product launch, we have introduced the CVProfilor® DO-2020 System to physicians at several key physician meetings, regionally and nationally. For example, at the 2004 American College of Cardiology (ACC) meeting held in New Orleans, Louisiana and at the 2004 European Society of Hypertension meeting held in Paris, France, we provided CVProfile™ tests to physicians in the booth of Novartis Pharmaceuticals Corporation. In addition to these meetings, we also participated in the 2004 meeting held by the ADA and the 2003 meeting held by the AHA to market our products. In fiscal year 2005, revenue from Novartis Pharmaceuticals Corporation accounted for approximately 13.1% of our total revenue. However, in January 2005, Novartis informed us that they would not be renewing their agreement with HDI.
          In the United States, the CVProfilor® DO-2020 System is being marketed to physicians under four pricing structures. Physicians may:
          - purchase a new CVProfilor® DO-2020 System for $28,500;
          - rent the CVProfilor® DO-2020 System for a period of one year and pay a $45 per-patient-tested fee, subject to a minimum monthly fee of $450.
          - purchase a rented CVProfilor® DO-2020 System for a reduced price dependant upon the amount of cumulative rental payments made to HDI.
          In order to accelerate the rate of acceptance of our CVProfilor® DO-2020 System in the medical marketplace, we have focused our marketing to physicians in the United States on the per-use price structure, which we refer to as the “per-patient-tested” rental basis. We are currently using a small direct sales force to call on key physician opinion leaders. We plan to expand our sales network consistent with our capital availability and revenue growth.
          We believe that a “per-patient-tested” marketing strategy has a number of significant advantages over the more traditional product “sales” strategies. A “per-patient-tested” rental program allows the physician to: conduct a trial use of our arterial elasticity assessment technology without a sizeable upfront capital outlay; obtain positive cash flow and/or a positive margin with their very first use of the CVProfilor® DO-2020 System; generate additional clinic revenues with little or no additional costs; and have access to state-of-the-art cardiovascular screening technology without the risk of product obsolescence, product maintenance or repair, or product down-time. In certain circumstances and based upon their expectations as to utilization, a physician may feel that it may be more cost-effective to purchase a CVProfilor® DO-2020 System. In which case, we also offer the CVProfilor® DO-2020 System for purchase and a portion of their rental payments can be applied to the purchase price. We believe the per-patient-tested marketing approach reduces the economic risk to physicians as compared to a capital acquisition approach or “sales” approach and allows physicians to confirm the clinical value of the product before making a purchase decision. However, the success of any of our marketing strategies will depend in large part on physician acceptance of the CVProfilor® DO-2020.
          The per-patient-tested marketing strategy has one significant drawback for us. This approach delays our cash-flow recovery of product costs. Physician payments for use of the CVProfilor® DO-2020 follow actual utilization by some 60-90 days; utilization in one month is invoiced in the following month and payment is generally received within 30 to 60 days of invoicing. This delay in payment, therefore, requires six to twelve months to fully recover product costs. These cash flow delays mean that we will generate little, if any, cash during the initial placement of the product and will require cash from other sources to support its operations during this period. Despite these disadvantages, we anticipate that this marketing approach will allow us to accelerate the rate of physician acceptance of the product and to eventually generate the majority of our revenue based on CVProfilor® DO-2020 System utilization. The CDMF is able to track product utilization and to invoice physician customers based on the number of CVProfile™ Reports they perform in their medical offices and clinics each month.

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          CVProfilor® MD-3000 System
          Following the introduction of the CVProfilor® MD-3000 System in June 2002, we began introducing the product to our international distributors to market it to cardiovascular specialists, cardiologists and primary care physicians for use in screening, diagnosing and monitoring the treatment of patients with cardiovascular disease within international markets.
          The MD-3000 System is being sold to distributors who re-sell it in their territory. Our distributors have the right to set the selling price of the MD-3000 System within their assigned territory. Distributor appointments are generally based on the distributor’s ability to manage the financial aspects of currency fluctuations, their demonstration of ethical conduct consistent with U.S. business practices, their ability to market to and support key differences in physician practice patterns, and their ability to satisfy government regulations pertaining to use of medical devices that exist within their territory. We prefer distributors to also distribute complementary cardiovascular or general medical products and that have the ability to designate specialist support for marketing the MD-3000 System.
          Engineering
          In April 2001, we acquired certain assets of Solutions Engineering, Inc., or SEI, an external contract engineering firm based in St. Paul, Minnesota, that had been instrumental in the design, development and ongoing technical support of our products, including engineering tools (that is, software programs, electronic instruments and mechanical equipment), special engineering methodology, a unique quality system and basic business assets including office and engineering furniture and supplies. We develop and provide ongoing technical support for our products.
          Production
          We have been producing CR-2000 Research Systems within our manufacturing facility since November 1998 and DO-2020 Physician Systems since March 2001. The design, development and integration of all of the components necessary to fabricate and manufacture our products were undertaken on our behalf by SEI as noted above. According to testing performed at TÜV Product Service, Inc., the CR-2000 Research System has been found to be in full compliance with all electromagnetic immunity and emissions requirements, and with the requirements for displaying the CE Mark. The CVProfilor® DO-2020 System was also evaluated by Underwriters Laboratories, Inc., and the System complies with the UL electrical safety standard.
          On November 30, 1999, we announced that our Quality Assurance System was registered to ISO-9002, EN-46002 and ISO-13488 by TÜV Product Service, Inc. Both our CR-2000 Research CardioVascular Profiling System and our MD-3000 System display the “CE 0123” mark, indicating that they are approved for sale throughout the European Union and that the products comply with applicable electrical and mechanical safety standards.
          Currently, we manufacture all versions of the CardioVascular Profiling System within our facility located in Eagan, Minnesota, in compliance with the FDA’s Quality System Regulations, or QSR. Further, the manufacturing facility is operated using a complete quality system approach, which meets international standards and has been certified as being in compliance with the new ISO-13485 standard. Despite having a small production staff, we believe that we can accommodate current requirements and should be able to meet anticipated future needs to manufacture, test, package and ship all products within our in-house facility.
          Competition
          Competition in the medical device industry is intense and many of our competitors have substantially greater financial, manufacturing, marketing, distribution and technical resources than we do. We compete directly with manufacturers of standard blood pressure cuff devices (called sphygmomanometers), as well as many well-established companies manufacturing more elaborate and complex medical instruments. In addition, we are aware of other companies that are developing products, which provide either a measurement arterial compliance or elasticity or a clinical surrogate for it.

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          We are aware of a number of firms that are developing or have developed products that attempt to measure vascular elasticity (sometimes referred to as vascular stiffness) and which may be viewed to a greater or lesser degree as competitive alternatives to our products. These firms include: ARTECH Medical (formerly Colson/Dupont Medical), Pantin, France; AtCor Medical Pty Ltd. (formerly PWV Medical, Ltd.), based in Sydney, Australia; Colin Medical Instruments Corp., Tokyo, Japan (recently acquired by Omron Healthcare Co. Ltd.); Endothelix, Inc., Houston, Texas; Fukuda Denshi, Tokyo, Japan; Hemonix, Inc., Beverton, Oregon; International Medical Device Partners, or IMDP, Las Vegas, Nevada; Itamar Medical, Ltd., Caesarea, Israel; Meridian Co., Ltd., Seoul, Korea; Micro Medical, Kent, United Kingdom (recently acquired by VIASYS Healthcare Inc.); Novacor, Paris, France; Omron Healthcare, Inc., Bannockburn, Illinois, a subsidiary of Omron Corporation, Kyoto, Japan; Pie Medical Imaging bv, Maastricht, The Netherlands; Pulse Metric, Inc., or PMI, San Diego, California; Specaway Pty. Ltd., St. Pauls, New South Wales, Sydney, Australia; and Vasocor, Inc., Charleston, North Carolina..
          Eight of these companies have products that have been cleared by the FDA.
          AtCor’s Medical Pty Ltd’s, the SphygmoCor System, FDA cleared on February 1, 2002, is indicated for use in those patients where information related to the ascending aortic pressure is desired, but in the opinion of the physician, the risks of an invasive intra-arterial pressure recording procedure are too great. The SphygmoCor System provides a derived ascending aortic blood pressure waveform and a range of central arterial indices.
          Colin Medical Instruments Corp. received FDA clearance on July 9, 2002, for a monitor that is designed to assist in the detection of peripheral vascular diseases. In addition to measuring blood pressure, heart rate, pulse wave and heart sounds, the device is capable of calculating ankle-brachial index and pulse wave velocity. This device is used on adult patients only. Colin Medical Technology, (formerly Colin Medical Instruments Corp), a division of the Carlyle Group, was recently acquired by the Omron Corporation.
          IMDP’s device, the CardioVision MS-2000, requires the purchase of a separate personal computer (and the use of special software), which needs to be connected to the device in order to have a working system. Further, this device only provides an elasticity measurement of the large artery directly under an upper-arm blood pressure cuff.
          Itamar Medical Ltd.’s Endo-PAT 2000, FDA cleared on November 12, 2003, is a non-invasive device intended for use as a diagnostic aid in the detection of coronary artery endothelial dysfunction (positive or negative) using a reactive hyperemia procedure and is not intended to be used as a screening test in the general population.
          Meridian Medical, Inc.’s device, the Digital Pulse Analyzer or DPA, also known as the McPulse, uses an optoelectronic sensor finger probe to observe changes in pressure and heart rate and to provide information on arterial wall stiffness. Meridian Medical, Inc. is the North American distribution office of Meridian Co., Ltd. Located in Seoul, Korea. Meridian received FDA clearance to market the McPulse on February 19, 2003.
          Omron Healthcare, Inc.’s HEM-9000AI analyzes pulse waves derived from the radial artery to produce a measurement of augmentation index, an index that is linked to large artery stiffness, i.e., late stage vascular disease. Omron Healthcare, Inc., the U.S. division of Omron Corporation, Kyoto, Japan, received FDA clearance to market the HEM-900AI on October 28, 2005.
          Pulse Metric, Inc., manufactures the DynaPulse®, a monitor which has only been cleared by the FDA for determining standard blood pressure measurements. However, the device can output blood pressure data to a computer which can then forward the data to PMI’s facilities in San Diego where it is analyzed to determine certain parameters including total or large artery compliance or elasticity. It has been determined that PMI has not been cleared by the FDA to generate these parameters since the FDA does not regulate such centralized computer operations.
          Vasocor, Inc.’s device measures blood pressure values and heart pulse rates based on segmental measurement and provides an indication of arterial compliance. Vasocor, Inc.’s device received FDA clearance on January 23, 2002, however, the company filed for bankruptcy in February 2003.
          Government Regulation
          Medical devices, such as our CVProfilor® DO-2020 System, are subject to strict regulation by state and federal authorities, including the Food and Drug Administration, or FDA, and comparable authorities in certain states. In addition, our sales and marketing practices are subject to regulation by the United States Department of Health and Human Services pursuant to federal anti-kickback laws, and are also subject to similar state laws.

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          Under the Federal Food, Drug and Cosmetic Act, or the FDCA, and its relevant amendments and acts (1976 Medical Device Amendments, 1990 Safe Medical Devices Act, 1992 Medical Device Amendments, 1997 FDA Modernization Act, and 2002 Medical Device User Fee and Modernization Act) and the regulations promulgated thereunder, manufacturers of medical devices are required to comply with rules and regulations concerning the design, testing, manufacturing, packaging, labeling and marketing of medical devices. Medical devices intended for human use are classified into three categories (Classes I, II and III), depending upon the degree of regulatory control to which they will be subject. Our products are considered Class II devices.
          If a Class II device is substantially equivalent to an existing device that has been continuously marketed since the effective date of the 1976 Amendments, FDA requirements may be satisfied through a Premarket Notification Submission (510(k)) under which the applicant provides product information supporting its claim of substantial equivalence. In a 510(k) Submission, the FDA may also require that it be provided with clinical test results demonstrating the safety and efficacy of the device. The process of obtaining clearances or approvals from the FDA and other applicable regulatory authorities can be expensive, uncertain and time consuming, frequently requiring several years from the commencement of clinic trials or submission of data to regulatory acceptance. On November 1, 2000, our 510(k) submission was granted clearance by the FDA to market our CVProfilor® DO-2020 System. Our CVProfilor® DO-2020 System is the only one of our products marketed in the U.S. for the treatment of patients. Our CR-2000 Research System is not marketed in the U.S. for the treatment of patients – it is marketed “for research purposes only” to clinical research investigators for the purpose of collecting data in cardiovascular studies.
          As a manufacturer of a medical device, we are also subject to certain other FDA regulations, and our manufacturing processes and facilities are subject to continuing review by the FDA to ensure compliance with these regulations. We believe that our manufacturing and quality control procedures conform to the requirements of FDA regulations. FDA clearances and approvals often include significant limitations on the intended uses for which a product may be marketed. FDA enforcement policy strictly controls and prohibits the promotion of cleared or approved medical devices for non-approved or “off-label” uses. In addition, product clearances or approvals may be withdrawn for failure to comply with regulatory standards or the occurrence of unforeseen problems following initial marketing.
          Medical device laws are also in effect in many of the countries outside of the United States in which we do business. These laws range from comprehensive device approval and quality system requirements for some or all of our medical device products to simple requests for product data or certifications. The number and scope of these requirements are increasing. In June 1998, the European Union Medical Device Directive became effective. All medical devices must meet the Medical Device Directive standards and receive CE Mark certification to be sold in the European Union. CE Mark certification involves a comprehensive quality system audit and review of product data by the notified body in Europe. Both our CVProfilor® MD-3000 and our CR-2000 Research System have been through this assessment and bear the CE Mark (CE 0123). Other countries have similar requirements based on conformance to quality standards consistent with our ISO-13485 certification and/or the FDA’s Quality System Regulations.
          Federal, state and foreign regulations regarding the manufacture and sale of healthcare products and medical devices are subject to future change. We cannot predict what material impact, if any, these changes might have on our business. Future changes in regulations or enforcement policies could impose more stringent requirements on us, compliance with which could adversely affect our business. These changes may relax certain requirements, which could prove beneficial to our competitors and thus adversely affect our business. In addition, regulations of the FDA and state, federal and foreign laws and regulations depend heavily on administrative interpretations, and we cannot assure that future interpretations made by the FDA, or other regulatory authorities, with possible retroactive effect, will not adversely affect us. In addition to the regulations directly pertaining to us and our products, many of our health care provider customers and potential customers are subject to extensive regulation and governmental oversight. Regulatory changes in the healthcare industry that adversely affect the business of our customers could have a material adverse effect on our business, financial condition and results of operations. Failure to comply with the FDA and any applicable regulatory requirements could result in, among other things, civil and criminal fines, product recalls, detentions, seizures, injunctions and criminal prosecutions. Further, we can give no assurance that we will be able to obtain additional necessary regulatory clearances or approvals in the U.S., or internationally, on a timely basis, if ever. Delays in the receipt of, or failure to receive, these clearances or approvals, or failure to comply with existing or future regulatory requirements would have a material adverse effect on our business, financial condition and results of operations.

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          Reimbursement
          We anticipate that most revenue affiliated with physician use of the CVProfilor® DO-2020 System will ultimately be derived from insurance coverage and third party payers. The payer marketplace includes commercial insurers, Medicare and other federally funded programs, and “self-pay” plans. Each payer establishes its own coverage and payment policies resulting in a range of payments and coverage decisions. Physician reimbursement is an important aspect in the CVProfilor® DO-2020 System’s success. Without adequate levels of reimbursement, physicians may be reluctant to even try the CVProfilor® DO-2020 System. There is no assurance that adequate third party reimbursement for the CVProfilor® DO-2020 System will be sustainable at present, or in the future.
          The Centers for Medicare & Medicaid Services, or CMS, a division of the U.S. Department of Health and Human Services, or HHS, has established three levels of coding for health care products and services as follows:
           Level I, Current Procedural Terminology, or CPT, codes for physicians’ services;
           Level II, National Codes for supplies and certain services; and
           Level III, local codes.
          The coding system applicable to the CVProfilor® DO-2020 System is Level I. Insurers require physicians to report their services using the CPT coding system.
          Having achieved FDA 510(k) clearance to market the CVProfilor® DO-2020 System, we are able to petition the American Medical Association, or AMA, for a recommendation on whether the CVProfilor® DO-2020 System fits within any existing CPT codes or whether it requires a new code application or code revision. In the event the AMA determines that none of the existing CPT codes are appropriate for the CVProfilor® DO-2020 System, we believe that it may take two or more years to obtain a CVProfilor® DO-2020 System technology-specific CPT code. During this time, physicians may be required to use a “miscellaneous” code for patient billing purposes, although the level of reimbursement they receive, if any, will depend on each individual payer’s assessment of the procedure. Our inability to obtain third party reimbursement and/or direct patient payment for the CVProfilor® DO-2020 System would have a material adverse effect on our business.
          Most physicians using the CVProfilor® DO-2020 System are obtaining reimbursement under one of several existing CPT codes. The level of physician reimbursement varies considerably by provider, by patient and by clinic. Reimbursement will always vary considerably by the patient’s medical necessity, by physician, by provider, by geography and by provider coverage plans, making the process of obtaining reimbursement for the CVProfilor® DO-2020 by current physician customers an important component of our product launch.
          Reimbursement associated with physician utilization of our CVProfilor® MD-3000 System will be dependent on the health care policies of the country in which our CVProfilor® MD-3000 System is being used. Each country regulates health care coverage, service delivery and payment for services performed in a different manner. Therefore, we rely on our international distributors to understand the reimbursement policies within their geography and to position the CVProfilor® MD-3000 System consistent with those policies. In most cases, the distributor establishes a base of key opinion-leader physicians to use the CVProfilor® MD-3000 System and advocate for reimbursement with the country’s health care authorities.
          Reimbursement is not a factor in the marketing of our HDI/PulseWave™ CR-2000 Research System as our sales of this product are to firms who do not use it in patient care. Rather, the CR-2000 Research System is purchased by entities that utilize it to measure changes in human research subjects and, therefore, typically fund the acquisition of our CR-2000 Research System as part of the total research study cost.
          Patents and Proprietary Technology
          Our success depends, in part, on our ability to maintain patent protection for our products and processes, to preserve our trade secrets and to operate without infringing the property rights of others. We are the exclusive assignee of eleven issued U.S. patents, six of which expire on March 20, 2018, three of which expire on September 10, 2019, one of which expires on August 1, 2022 and one of which expires on October 23, 2010. As part of an overall strategy to concentrate on protection of key technologies, we have abandoned one patent in Germany, France, Great Britain, and Hong Kong as not being part of our strategic plan, rather than continuing to pay yearly annuity taxes to maintain a patent in these countries.

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          We also have obtained an exclusive license to utilize the intellectual property described within several U.S. patents from the Regents of the University of Minnesota. The license for these patents expires concurrently with the expiration date of the last of these patents to expire, which is currently expected to be May 31, 2011, although some of the patents expire December 8, 2010 or October 8, 2008. Additionally, we have obtained an exclusive license from the University of Minnesota with respect to five foreign issued patents: one, issued in Japan, is currently expected to expire August 22, 2009, and one in each of Hong Kong, France, Germany, and the United Kingdom are all currently expected to expire November 21, 2011.
          These twenty-three licensed or assigned patents relate to our blood pressure waveform analysis procedures, our cardiovascular profiling technology and/or the non-invasive determination of cardiac output. Included in these patents are six U.S. issued patents relating to the design, configuration and manufacturing of our Sensor, which is a key component of our products. The Sensor is manufactured for us by Apollo Research Corp., or Apollo.
          In January, 2001, in an effort to secure an alternative manufacturer for the Sensor for which Apollo is our sole supplier and because of the uncertainty of Apollo’s ability to continue to manufacture the Sensors, we obtained from Apollo detailed documentation and technical information required to fabricate and manufacture Sensors in accordance with our specifications and calibration requirements, Sensor production records, history files, test reports and related records.
          One or more patent applications relating to our U.S. issued patents are currently pending in the United States. We can give no assurance that our current patents and licenses will provide a competitive advantage, that the pending applications will result in patents being issued, or that our competitors will not design around any patents or licenses issued to us.
          Besides seeking additional patents, we intend to rely to the fullest extent possible on trade secrets, proprietary “know-how” and our ongoing endeavors involving product improvement and enhancement. We can give no assurance that nondisclosure agreements and invention assignment agreements, which we have or will execute, will protect our proprietary information and know-how or will provide adequate remedies in the event of unauthorized use or disclosure of that information, or that others will not be able to independently develop that information.
          University of Minnesota Research and License Agreement
          On September 23, 1988, we entered into a Research and License Agreement, or the License Agreement, with the University of Minnesota, or the University, pursuant to which the University granted to us an exclusive, worldwide license under the patents that relate to our products for diagnostic, therapeutic, monitoring and related uses. The License Agreement is subject to any rights retained by the U.S. government, pursuant to U.S. law and regulations, in the patents and licensed technologies in connection with any U.S. government funding of the University’s research of the license technology. The License Agreement expires with the last to expire of the patents related to the licensed technology (currently expected to be May 31, 2011). We also have the right to grant sub-licenses under the University’s patents.
          In consideration of the License Agreement, we conducted expanded clinical trials of arterial compliance technology and are continuing to use our best efforts to develop commercial medical devices. We must pay a royalty on revenue from commercialization of our products (or future products, which incorporate the licensed arterial compliance technology), in the amount of three percent (3%) of gross revenue (less certain reductions, such as damaged and returned goods).
          Employees and Consultants
          As of June 30, 2006, we employed 10 full-time employees, 4 of whom are engaged in sales positions and are not based at our corporate headquarters in Eagan, Minnesota. We believe that our employee relations are good.

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          From time to time, we may engage consultants to provide various services. We currently engage consultants and independent contractors and have ongoing consultant relationships with several experts including the following:
           several experts in regulatory affairs and FDA matters; and
           Jay N. Cohn, M.D., as our Chief Medical Consultant;
          We may retain additional consultants as necessary to accommodate our need for experts in selected areas of product-related endeavors and other business matters.
RISK FACTORS
The following are important factors that could cause actual results to differ materially from those anticipated in any forward-looking statements made by or on behalf of the Company.
Risks Related to Our Business
          We are presently generating only minimal revenue. We cannot assure you that we will ever be able to generate significant revenue, attain or maintain profitable operations, or successfully implement our business plan or current development opportunities. As of June 30, 2006, we had an accumulated deficit of $25,978,319 attributable primarily to selling, general and administrative expenses. Until we are able to generate significant revenue from our business activities, we expect to continue to incur operating losses and will need to find sources of significant, immediate additional capital to offset such losses to continue operations.
          We are currently marketing three products: the HDI/PulseWave™ CR-2000 Research CardioVascular Profiling System, the CVProfilor® DO-2020 CardioVascular Profiling System and the CVProfilor® MD-3000 CardioVascular Profiling System. While we expect the CVProfilor® DO-2020 System to generate the majority of our revenue in the future, to date it has generated only minimal revenue. Marketing and distribution activities have commenced in the U.S., as well as internationally, for the CR-2000 Research System, but the revenue we derive from the CR-2000 has been insufficient to make our operations profitable. The CVProfilor® MD-3000 system, the international version of our CVProfilor® DO-2020 System, was released in June 2002 and has generated only minimal revenue.
          The likelihood of our success must be considered in view of the expenses, difficulties and delays we have encountered, and may encounter in the future, as well as the competitive environment in which we operate. Our profitability is dependent in large part on gaining market acceptance of our products, developing distribution channels, maintaining the capacity to manufacture and sell our products efficiently and successfully, and the continuation of third party reimbursement. We cannot assure you that we will successfully meet any or all of these goals.
          We may need additional capital in the future to continue our business. Until such time as our product generates sufficient revenue to fund our operations, we will continue to require additional capital to continue our business, the receipt of which cannot be assured. Currently, we have a monthly burn rate of approximately $70,000. We believe that we have sufficient capital derived from the proceeds of our prior securities offerings and cash flow from existing operations to meet our needs for the next 12 months after June 30, 2006. We do not expect revenue generated by our products to be sufficient to meet our capital needs during the next twelve months. Our ability to execute our business strategy, including marketing of our products, placing equipment in physicians’ offices without charge and establishing and maintaining an inventory of System components, depends to a significant degree on our ability to obtain sufficient and timely future financing. As we grow our business and begin to develop new geographical markets for our products, our current monthly burn rate may increase.
          Our long-term capital needs are subject to our ability to raise additional capital and to generate adequate revenue from our products, neither of which can be assured. We may seek additional funds through an additional offering of our equity securities or by incurring additional indebtedness. We cannot assure you that any additional funds will be available or that sufficient funds will be available to us or that funds will be available in a timely way. Additional funds may not be available on terms acceptable to us or our security holders. Any future capital that is available may be raised on terms that are dilutive to our security holders.

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          Our success is mainly dependent upon a single product, the CVProfilor® DO-2020 System. On November 1, 2000, we obtained FDA approval to market the CVProfilor® DO-2020 System. We have developed a plan for the marketing of the CVProfilor® DO-2020 System and expect the CVProfilor® DO-2020 System to generate the majority of our revenue. However, we cannot assure you that our marketing plan will be successfully implemented or ultimately generate significant revenue, if any. To date, we have generated only minimal sale or rental revenue from the CVProfilor® DO-2020 System. Further, even if we successfully market the product, we must be able to manufacture a reliable product and deliver that product to our distributor or customer in a timely fashion. Because we lack extensive manufacturing and marketing experience with this product, we cannot assure you that we will be successful in producing, marketing or placing the CVProfilor® DO-2020 System. We cannot assure you that physicians will use the CVProfilor® DO-2020 System once it is placed in their offices. Because our revenue is based, in part upon a fee charged per-patient-tested, the failure of physicians to use our CVProfilor® DO-2020 System would result in a material adverse effect on our financial results. Moreover, placements of CVProfilor® DO-2020 Systems, and satisfactory utilization by physicians of those systems placed, has taken more time and resources than originally anticipated due to delays in obtaining market acceptance, consistent and satisfactory levels of third party reimbursements to physicians utilizing the CVProfilor® DO-2020 Systems and delays in integrating the CVProfilor® DO-2020 Systems into the clinic operations in which they are placed. Further, while we charge a fee per-patient-tested for the CVProfilor® DO-2020 System that we believe is competitive in the market, higher than expected manufacturing, marketing and distribution costs, lower than expected reimbursement levels, lower than expected usage by physicians, and/or other competitive forces may require us to raise or lower our fees or alter our pricing or marketing structure in a manner that could have a material and adverse effect on us. In May of 2005, we introduced a rent-to-own program, whereby rental customers (those using the CVProfilor® DO-2020 System on a per-patient-tested basis) could purchase their used equipment at a price lower than the price for purchasing a new System by applying a portion of their collected rental payments toward the buy-down of the used equipment price. The sale of used equipment or conversion of rental customers to owners, while initially strong, has slowed down considerably as new rental customers have not been as interested in converting as previous rental customers and the ability to sell a new customer on purchasing the system outright has proved to be more challenging than originally anticipated.
          Because we have a new product, the uncertainty of market acceptance of our product and/or the clinical application of the technology will affect our business. Our financial performance depends upon the extent to which our products are accepted by research investigators (regarding the CR-2000 Research System) as being useful, and by physicians and other health care providers as being effective, reliable and safe for use in screening patients for underlying vascular disease (regarding the CVProfilor® DO-2020 System) and for use in screening, diagnosing and monitoring the treatment of patients with vascular disease (regarding the CVProfilor® MD-3000 System). Third party reimbursement to physicians is a complex matter and varies region-by-region. If the CVProfilor® DO-2020 System fails to achieve market acceptance due to lack of appropriate third party reimbursement to physicians, the failure of arterial elasticity parameters to be perceived as reliable and clinically beneficial or any other factors which cause a lack of acceptance by physicians, we will likely be forced to cease operations.
          Our marketing strategy may result in lower revenues. We have focused our initial CVProfilor® DO-2020 marketing efforts on a “per-patient-tested” marketing strategy which we believe has a number of significant advantages for physicians over the more traditional product “sales” strategy. Our pricing under this “per-patient-tested” is as follows: a physician leases the CVProfilor® DO-2020 System for a period of one year, paying a $45 per test, subject to minimum monthly fee of $450. The per-patient-tested marketing strategy has one significant drawback for us over the more traditional product capital acquisition or “sales” strategy. This per-patient-tested rental approach delays our cash flow recovery of product costs. Physician payments for use of the CVProfilor® DO-2020 under this pricing follow actual utilization by some 30-90 days; utilization in one month is invoiced in the following month and payment is generally received within 30 to 60 days of invoicing. This delay in payment, therefore, requires six to twelve months to fully recover product costs. These cash flow delays mean that we will generate little, if any, cash during the initial placement of the product and will require cash from other sources to support its operations during this period, the receipt of which cannot be assured. Additionally, we cannot assure you that our marketing strategy will result in greater revenue, immediately or over time, than revenue which would have been realized from the sale of the CVProfilor® DO-2020 System. While we believe that the per-patient-tested method may increase the rate of acceptance for physician customers willing to use the CVProfilor® DO-2020 as compared to a capital acquisition approach or “sales” approach, this may not be true. Additionally, the success of any of our marketing strategies will depend in large part on physician acceptance of the CVProfilor® DO-2020, which cannot be assured.

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          We are unable to predict how quickly or how broadly our products will be accepted by the market, if at all, or if accepted, what the demand for them could be. Achieving market acceptance requires that we educate the marketplace about the anticipated benefits associated with the use of our products and also requires us to obtain and disseminate additional data acceptable to the medical community as evidence of our product’s clinical benefits. Because our products represent a new approach for evaluating vascular disease, there has been a greater reluctance to accept our products than would occur with products utilizing more traditional technologies or methods of diagnosis. This has resulted, and may continue to result, in longer sales cycles and slower revenue growth than anticipated. We cannot assure you that we will be successful in educating the marketplace about our products or that available data concerning these benefits will create a demand by the research or medical community for our products. We cannot assure you that physicians will utilize the CVProfilor® DO-2020 System once installed in their offices, or that our services will be profitable to, or become generally accepted by, these physicians. To date, the rate of physician utilization has developed more slowly than we anticipated and is generally lower than we anticipated. In addition, our products are premised on the medical assumption that a loss of arterial elasticity is an indicator of the early onset of vascular disease. While we believe, based on many clinical research studies and trials, that the loss of arterial elasticity is indeed an indicator for the early onset of vascular disease, we cannot assure you that our claims will be fully accepted by the medical community, if at all.
          Our physician customers are dependent upon the availability of third party reimbursement to the physician and/or direct patient payment. While the cost of our products and services are reimbursed by certain private health coverage insurers and payer organizations, Medicare and certain of the private health coverage insurers and other payer organizations may not consistently provide reimbursement for our products and services. The availability of third party reimbursement for our medical products and services may affect the physician’s decision to use our products and services. As a result, our financial performance may be impacted by the availability of reimbursement, if any, for the cost of our products and services from government health administration authorities, private health coverage insurers and other payer organizations. Our experience has shown that reimbursement for the cost associated with the CVProfilor® DO-2020 System varies significantly by the patient’s medical necessity, by physician, by provider, by geography and by provider coverage plans. Not only must the procedure utilizing our products be recognized as a valid medical diagnostic procedure, the payer must offer coverage for the procedure. Further, even if the payer offers coverage, the amount of reimbursement will vary and may or may not be sufficient to cover the cost of the use of our product by the physician. Because of the complex interactions between these factors, we estimate that consistent reimbursement for the costs associated with our product will not be available for several years. Further, we cannot assure you that adequate third party reimbursement will be available for the CVProfilor® DO-2020 System. If we cannot sustain adequate reimbursement from third parties, we would depend upon direct patient payment for our revenue. We cannot assure you that patients will be willing to pay for our products at prices, which will generate revenue for us, if at all. Our product user’s inability to obtain adequate third party reimbursement and/or direct patient payment for the CVProfilor® DO-2020 System would have a material adverse effect on our business, financial condition and results of operations.
          We have not been successful in growing our sales force. The process of finding qualified sales reps who can convey the clinical and economic value proposition to prospective customers has proved extremely difficult. Additionally, the company has experienced high turnover in its sales force. Our ability to grow our revenues will largely be determined upon the ability of the company to find, hire, train, and retain a competent sales force.
          We operate in an intensely competitive market. Competition from medical devices, or other medical measures, that are used to screen patients for cardiovascular disease is intense and likely to increase. We compete with manufacturers of, for example, non-invasive blood pressure monitoring equipment and instruments, and may compete with manufacturers of other non-invasive devices. In addition, our products will also compete with traditional blood pressure testing by means of a standard sphygmomanometer, which, as a stand-alone product, is substantially less expensive than our products. Many of our competitors and potential competitors have substantially greater capital resources, name recognition, research and development experience, and more extensive regulatory, manufacturing and marketing capabilities than we do. Many of these competitors offer well-established, broad

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product lines and ancillary services that we do not offer. Some of our competitors have long-term or preferential supply arrangements with physicians, medical clinics, pharmaceutical firms, and hospitals, and other purchasing organizations which may act as a barrier to market entry for our products. In addition, other large health care companies or medical instrument firms may enter the non-invasive vascular product market in the future. Competing companies may succeed in developing products that are more efficacious or less costly than any that we may produce, and these companies also may be more successful than we are in producing, marketing or obtaining third party reimbursement for their new or existing products. Competing companies may also introduce competitive pricing pressures that may adversely affect our sales levels and margins. As a result, we cannot assure you that we will be able to compete successfully with existing or new competitors.
          We depend upon sub-assembly contract manufacturers. To date, we have relied on independent contractors for the fabrication of sub-assemblies and major product components used in the production of all versions of our products. For our products to be financially successful, they must be manufactured in accordance with strict regulatory requirements, in commercial quantities, at appropriate quality levels and at acceptable costs. To date, our products have been manufactured in limited quantities and not on a large commercial scale. As a result, we cannot assure you that we will not encounter difficulties in obtaining reliable and affordable contract manufacturing assistance and/or in scaling up our manufacturing capabilities. This may include problems involving production yields, per-unit manufacturing costs, quality control, component supply and shortages of qualified manufacturing personnel. In addition, we cannot assure you that we will not encounter problems relating to integration of components if changes are made in the configuration of the present products. Any of these difficulties, as well as others related to these, could result in our inability to satisfy any customer demand for our products in a cost-effective and efficient manner and therefore would likely have a material adverse effect on our business, financial condition and results of operations.
          We depend upon a limited number of suppliers for several key components; failure to obtain certain key components could materially affect our business. By way of example, we currently obtain our Arterial PulseWave™ Sensor, or the Sensor (which is the subject of six of our U.S. issued patents) through a manufacturing services agreement with Apollo Research Corp., or Apollo, our sole supplier of this component. In January 2001, we were advised by Apollo that they could not assure us that they will continue business operations beyond a month-to-month basis. At that time we placed a large order with Apollo, sufficient to supply our needs for production of approximately 600 of our products, which based upon our current estimates should be sufficient for two years of production. Similarly, we were also advised by Colin Medical Instruments Corp. , our sole supplier of our M1000 Blood Pressure Monitor, that they would be unable to continue to supply us with our M1000 Blood Pressure Monitor. We currently have an inventory of such monitors, which we believe would be sufficient for two years of production. If we exhaust our inventory of the Sensor or the Blood Pressure Monitor for manufacture of our existing products and are not able to obtain supply of this component from an alternative supplier, or if we are not able to timely bring to market the new versions of our products utilizing the new sensor before exhausting our inventory, we may be forced to suspend our manufacture of our products or delay or cancel shipments to customers which would have a material adverse effect upon our business. If the components are not available for our needs, our products may be unavailable to sell to customers, customers may lose confidence in our products and us, and we may need to make new regulatory applications to reflect changes in product manufacturing with a new component, if available. If we are unable to obtain an adequate supply of components meeting our standards of reliability, accuracy and performance, we would be materially adversely affected.
          We lack significant sales and distribution channels. We commenced marketing of the HDI/PulseWave™ CR-2000 Research System in December 1998 and currently have a very limited sales force. We commenced marketing of the CVProfilor® DO-2020 System in March 2001 and have yet to generate any significant revenue based on placements of it. We have not yet developed a nationwide distribution network for our products. We cannot assure you that we will be able to develop an effective sales force with the requisite knowledge and skill to fully exploit the sales potential of our products. We also cannot assure you that our sales force will be able to establish distribution channels to promote market acceptance of, and create demand for, our products. Even as we enter into agreements with distributors, we cannot assure you that the distributors will devote the resources necessary to provide effective sales and promotional support for our products. Our ability to expand product sales will largely depend on our ability to develop relationships with distributors who are willing to devote the resources necessary to provide effective sales and promotional support, and to educate, train and service both a sales force and the medical community in its entirety. We cannot assure you that we will be able to accomplish any or all of these objectives. We also cannot assure you that our financial condition will allow us to withstand sales cycles of the length that may be necessary to assure market acceptance for our CR-2000, DO-2020 or MD-3000 Systems.

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          Our financial results and the market price of our securities are subject to significant fluctuations, which may affect the price of our securities. Our quarterly results and the market price of our securities may be subject to significant fluctuations due to numerous factors, such as variations in our revenue, earnings and cash flow, the ability to meet market expectations, the availability of product components, market acceptance, changes in price, terms or product mix, changes in manufacturing costs or the introduction of new products by us or our competitors. Our inability to successfully market the CVProfilor® DO-2020 System will adversely affect our financial results which may have an adverse effect on the market price of our securities. We cannot assure you that we will ever generate significant revenue or that our revenue or net income will ever improve on a quarterly basis or that any improvements from quarter to quarter will be indicative of future performance. In addition, our expenses are based in part on expectations of future revenue. As a result, expenses may not match revenue on a quarterly basis, and a delay in future revenue would adversely affect our operating results.
          In addition, the stock markets are experiencing significant price and volume fluctuations, resulting from a variety of factors both identifiable and unidentifiable, including general global market conditions, comparative prices of U.S. and foreign currency, changes in the national or global political environment, risk of war or other unrest, public confidence in the stock markets, regulation of or by the stock markets and the performance of certain industries. These significant market price and volume fluctuations result in change in the market prices of the stocks of many companies that may not have been directly related to the operating performance of those companies. These broad market fluctuations may result in the market price of our common stock falling abruptly and significantly or remaining significantly depressed.
          Our thinly traded stock could be under additional pressure as a result of the Chesney settlement. We had appealed the District Court ruling that provided to Chesney, et.al. with approximately $130,000 in cash and 714,286 shares of freely tradeable common stock to the Minnesota Court of Appeals. The Appeals Court ruled against us. The 714,286 shares of our common stock are currently on deposit with the Hennepin County District Court. In the near future, Chesney, et.al. could be in possession of 714,286 shares of our common stock, which represents approximately 57 times the average daily volume. Sales of the 714,286 shares in the open market could severely impact our common stock price of HDII.OB for months to come. Should Chesney decide to liquidate the position more quickly, it could have a more profound impact on the stock price than an orderly liquidation of the block over a six to nine month period.
          If we do not adapt to rapid technological change, our business will suffer. The medical device market is characterized by intensive development efforts and rapidly advancing technology. Our success will largely depend upon our ability to anticipate and keep pace with advancing technology and competitive innovations. We cannot assure you that we will be successful in identifying, developing and marketing new products or in enhancing our existing product. In addition, we cannot assure you that new products or alternative screening and diagnostic techniques will not be developed that will render our current or planned products obsolete or inferior. Rapid technological development by competitors may result in our products becoming obsolete before we recover a significant portion of our research, development and commercialization expenses.
          We are subject to product liability exposure and have limited insurance coverage. We face an inherent business risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in adverse clinical events. We have obtained a general liability insurance policy that covers potential product liability claims up to $1 million per incident and $2 million aggregate per year. We cannot assure you that liability claims will not be excluded from these policies, will not exceed the coverage limits of these policies, or that the insurance will continue to be available on commercially reasonable terms, or at all. Consequently, a product liability claim or other claim with respect to uninsured liabilities or in excess of insured liabilities would have a material adverse effect on our business, financial condition and results of operations.
          Failure to effectively manage the growth of our business would have an adverse effect on our business. In an effort to curtail our expenses and conserve our working capital, we have reduced the number of our employees. The execution of our business plan will likely place increasing demands on our existing management and operations. Our future growth and profitability will depend on our ability to increase our employee base,

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particularly our sales staff. We must successfully attract, train, motivate, manage and retain new employees and continue to improve our operational, financial and management information systems. We cannot assure you that we will be able to effectively manage any expansion of our business. Our inability to effectively manage our growth could have a material adverse effect on our business, financial condition and results of operations.
          We depend upon key personnel and we must hire and retain qualified personnel to be successful. We are highly dependent on a limited number of key management personnel, particularly our Chief Executive Officer and Chairman, Mark N. Schwartz, our President and Secretary, Greg H. Guettler, and our Customer Service Manager, George T. Welisevich. We do not have key-person life insurance on these key personnel. Our future success will depend on our ability to attract and retain highly qualified personnel. The Schwartz Group (a group of investors represented by Alan Stern, Larry Leitner and Mark N. Schwartz) is in control of the Company and therefore will be able to effect changes in the management and other personnel of the Company. We compete for qualified personnel with other companies, academic institutions, government entities and organizations. We cannot assure you that we will be successful in hiring or retaining qualified personnel. We also depend upon consultants for services related to important aspects of our business, such as marketing, regulatory compliance and payer reimbursement. We compete with other companies and organizations for the services of qualified consultants. The loss of key personnel or the availability of consultants, or an inability to hire or retain qualified personnel or consultants, could have a material adverse effect on our business, financial condition and results of operations.
          We have a limited number of personnel and the loss of one or more of them may adversely affect our operations. We currently employ ten employees and engage the services of several consultants. The loss of one or more of our employees, even if they are not key employees, could result in the interruption of our operations and adversely affect our financial condition and results. There is no assurance that we will be able to timely employ replacement personnel or engage the temporary services of consultants in the event that we suffer the loss of one or more of our employees.
          If we are unable to protect our proprietary technology, our business will suffer. Our success depends, in part, on our ability to maintain patent protection for our products and processes, to preserve our trade secrets and to operate without infringing the property rights of others. We are the exclusive assignee of eleven issued U.S. patents, and we have obtained an exclusive license to utilize the intellectual property described within several other U.S. patents from the Regents of the University of Minnesota. Additionally, there are several issued patents which also describe technology involving our products and which may offer us some further protection. Twenty-three patents relate to our blood pressure waveform analysis procedures, our cardiovascular profiling technology, and/or the non-invasive determination of cardiac output.
          The validity and breadth of claims coverage in medical technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. We cannot assure you that our current patents and licenses will provide a competitive advantage, that the pending applications will result in patents being issued, or that our competitors will not design around any patents or licenses issued to us. In addition, we cannot assure you that any agreements with employees or consultants will protect our proprietary information and “know-how” or provide adequate remedies in the event of unauthorized use or disclosure of our information, or that others will not be able to develop this information independently. We cannot assure you that allegations of infringement of the proprietary rights of third parties will not be made, or that if made, the allegations will not be sustained if litigated. There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. Litigation may be necessary to enforce patents issued to us, to protect trade secrets or “know-how” we own, to defend us against claimed infringement of the rights of others or to determine the ownership, scope or validity of our proprietary rights and the rights of others. Any of these claims may require us to incur substantial litigation expenses and to divert substantial time and effort of management personnel. An adverse determination in litigation involving the proprietary rights of others could subject us to significant liabilities to third parties, could require us to seek licenses from third parties, and could prevent us from manufacturing, selling or using our products. The occurrence of this litigation or the effect of an adverse determination in any of this type of litigation could have a material adverse effect on our business, financial condition and results of operations.

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Risks Related to Government Regulation
          Our business and our products are subject to extensive regulation by both U.S. and foreign governments. Our CVProfilor® DO-2020 System, which is classified as a medical device in the U.S., is subject to regulation by U.S. federal and state authorities and by foreign governments in the countries in which we sell this product. Further, our CVProfilor® MD-3000, the international version of our CVProfilor® DO-2020 intended for use by physicians outside of the U.S., is subject to regulation by the foreign governments in the countries in which we sell this product.
          Regulation in the United States. Under various amendments to the Federal Food, Drug and Cosmetic Act, or the FDCA, and related regulations, manufacturers of medical devices are required to comply with very specific rules and regulations concerning the design, testing, manufacturing, packaging, labeling and marketing of medical devices. Failure to comply with the FDCA and any applicable regulatory requirements could result in, among other things, civil and criminal fines, product recalls, detentions, seizures, injunctions and criminal prosecutions.
          Our CVProfilor® DO-2020 System was cleared for marketing in the U.S. by the Food and Drug Administration, or the FDA. FDA enforcement policy strictly prohibits the promotion of cleared or approved medical devices for non-approved or “off-label” uses. In addition, the FDA may withdraw product clearances if the CVProfilor® DO-2020 System fails to comply with regulatory standards or if we encounter unforeseen problems following initial marketing. In order to obtain FDA clearance for our product, the facilities and manner in which we operate and do business must adhere to a quality system and in this regard, we are presently ISO-9001, EN-46001 and ISO-13485 registered. Failure to receive future necessary regulatory clearances or approvals or a lengthy approval process would have a material adverse effect on our business, financial condition and results of operations.
          Our level of revenue and profitability as a medical device company may be affected by the efforts of government and third party payers to contain or reduce the costs of health care through various means. In the U.S., there have been, and we expect that there will continue to be, a number of federal, state and private proposals to control health care costs. These proposals may contain measures intended to control public and private spending on health care as well as to provide universal public access to the health care system. If enacted, these proposals may result in a substantial restructuring of the health care delivery system. Significant changes in the nation’s health care system are likely to have a substantial impact over time on the manner in which we conduct our business and could have a material adverse effect on our business, financial condition and results of operations.
          Regulation by Foreign Governments. As a part of our marketing strategy, we are pursuing commercialization of our products in international markets. Our products are subject to regulations that vary from country to country. Although we believe that the CR-2000 and the MD-3000 products can be exported without us having obtained FDA clearance for the marketing of the products in the U.S., there is no assurance that the FDA may not take a contrary position, in which case we could not export our products without first obtaining FDA clearance of the products for marketing in the U.S., which would be an expensive and time consuming process. Export sales of our products may be subject to general U.S. export regulations.
          We cannot assure you that foreign regulatory clearances or approvals will be granted on a timely basis, if ever, or that we will not be required to incur significant costs in obtaining or maintaining our foreign regulatory clearances or approvals. The process of obtaining foreign regulatory approvals in certain countries can be lengthy and require the expenditure of substantial resources. We cannot assure you that we will be able to meet export requirements or obtain necessary foreign regulatory clearances or approvals for our products on a timely basis or at all.
          In order to obtain a CE Mark for our product, the facilities and manner in which we operate and do business must adhere to a quality system and in this regard, we are presently ISO-13485 registered. Further, because both the HDI/PulseWave™ CR-2000 Research System and the CVProfilor® MD-3000 System display the CE mark, they must conform to European Council Directive 93/42/EEC regarding Medical Devices.
          Delays in receipt of or failure to receive foreign clearances or approvals, or failure to comply with existing or future regulatory requirements and quality system regulations, would have a material adverse effect on our business, financial condition and results of operations.

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          Changes in state and federal laws relating to confidentiality of patient medical records could limit our customers’ ability to use services associated with our product. The Health Insurance Portability and Accountability Act of 1996, or HIPAA, mandates the adoption of national standards for the transmission of certain types of medical information and the data elements used in such transmissions to insure the integrity and confidentiality of such information. On December 20, 2000, the Secretary of Health and Human Services promulgated regulations to protect the privacy of electronically transmitted or maintained, individually identifiable health information. We believe that our products and our CDMF will enable compliance with the regulations under HIPAA and with the final rule under HIPAA adopting standards for electronic healthcare transmissions and code sets to be used in those transmissions. However, we cannot assure you that we will be able to comply with the proposed regulations or final standards in a timely manner or at all. If any of our products or the services associated with those products is subject to those regulations, we may be required to incur additional expenses in order to comply with these requirements. We may not be able to comply with them in a timely manner or at all. In addition, the success of our compliance efforts may also be dependent on the success of healthcare participants in complying with the standards. If we are unable to comply with regulations implementing HIPAA in a timely manner or at all, our marketing strategy, the sale of our products and our business could be harmed.
          Further, some state laws could restrict our ability to transfer patient information gathered from our products. Such restrictions would decrease the value of our applications to our customers, which could materially harm our business. The confidentiality of patient records and the circumstances under which records may be released for inclusion in our CDMF databases are subject to substantial regulation by state governments. These state laws and regulations govern both the disclosure and the use of confidential patient medical record information. In addition to HIPAA, legislation governing the dissemination of medical record information has been proposed at the state level. This legislation may require holders of this information to implement security measures. Such legislation might require us to make substantial expenditures to implement such measures.
          Future regulatory requirements may materially impact our business. Federal, state and foreign regulations regarding the manufacture and sale of healthcare products and diagnostic devices are subject to future change. We cannot predict what material impact, if any, these changes might have on our business. Future changes in regulations or enforcement policies could impose more stringent requirements on us, compliance with which could adversely affect our business. These changes may relax some requirements, which could prove beneficial to our competitors and thus adversely affect our business. In addition, regulations of the FDA and state and foreign laws and regulations depend heavily on administrative interpretations. We cannot assure you that future interpretations made by the FDA, or other regulatory authorities, with possible retroactive effect, will not adversely affect our business, financial condition and results of operations.
          We cannot assure you that we will be able to obtain necessary regulatory clearances or approvals in the United States or internationally on a timely basis, if at all. Delays in the receipt of, or failure to receive, these clearances or approvals, or failure to comply with existing or future regulatory requirements would have a material adverse effect on our business, financial condition and results of operations.
          Regulations extending to our contractors and customers affect the manufacture and sale of our products. We and the design and manufacturing vendors with whom we contract are subject to regulation by the FDA relating to the design and manufacture of the CVProfilor® DO-2020 System. This regulation includes, but is not limited to, required compliance with the FDA’s Quality System Regulation, or QSR, and equivalent state and foreign regulations. Our failure, or the failure of any of these vendors, to comply with applicable regulations may subject us or one or more of the vendors, or the medical device designed and produced for and by us, to regulatory action. A regulatory action could threaten or cut off our source of supply or cause the FDA to order the removal of the CVProfilor® DO-2020 System from the market. While we believe we could locate and qualify other sources to design or manufacture necessary components, supply interruptions in the meantime may have a materially adverse effect on our business, financial condition and results of operations.
     In addition to the regulations directly pertaining to us and our products, many of our potential customers are subject to extensive regulation and governmental oversight. Regulatory changes in the healthcare industry that adversely affect the business of our customers could have a material adverse effect on our business, financial condition and results of operations.

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Other Risks
          We are controlled by the Schwartz Group. We issued shares of Series A Convertible Preferred Stock and common stock to a group of investors represented by Alan Stern, Larry Leitner and Mark N. Schwartz, or the Schwartz Group, in the August 2003 and February 2004 Placements, which resulted in the Schwartz Group (specifically, Mark N. Schwartz pursuant to his irrevocable proxy) beneficially owning approximately 65% of our common stock, in the aggregate, on an as-converted basis as of September 14, 2006. As a result of the voting rights inherent in the Series A Preferred Stock and common stock and certain provisions of the Shareholders’ Agreement, we will be prohibited from making certain changes to our capital structure and business practices. Further, we may not enter into certain transactions without the consent of the holders of a majority of the Series A Preferred Stock purchased in this Offering, of which the Schwartz Group will likely hold the majority, or without the consent of our Board of Directors, of which the Schwartz Group and its designees constitute the majority. As a result, the Schwartz Group not only exercises substantial control over all matters that would require shareholder approval, including electing directors and approving significant corporate transactions, but also exercises control over our operations. In addition, our Articles of Incorporation provide that our Board of Directors is divided into three classes, with each class elected in successive years for a term of three years. This provision of our Articles of Incorporation and the concentration of ownership following the Offering may have the effect of delaying or preventing a change in control of us or changes in our Board of Directors or management.
          Our securities are illiquid and will be subject to rules relating to “penny stocks.” On March 17, 2003, we requested that our securities be withdrawn from The Nasdaq SmallCap Market. Since March 21, 2003, our securities have been quoted on the OTC Bulletin Board under the symbols “HDII.OB” for our common stock and “HDIIZ.OB” for our Redeemable Class B Warrant. There can be no assurance that any market will continue to exist for our securities, or that our securities may be sold without a significant negative impact on the price per share.
     Furthermore, our securities are subject to the rules promulgated under the Securities Exchange Act of 1934 relating to “penny stocks.” These rules require brokers who sell securities that are subject to the rules, and who sell to other than established customers and institutional accredited investors, to complete required documentation, make suitability inquiries of investors and provide investors with information concerning the risks of trading in the security. Consequently, an investor would likely find it more difficult to buy or sell our securities in the open market.
          We may be required to offer rescission of certain sales of our securities and may be subject to actions for violations of securities laws. In connection with an offering of our Redeemable Class A Warrants, or the Class A Warrants, which terminated on November 14, 2002, certain Class A Warrants were exercised resulting in the issuance of 57,400 shares of common stock. The exercise of the Class A Warrants during the offering resulted in gross proceeds of $57,400 to the Company. As a result of the exercise of the Class A Warrants in the offering, we also issued our Redeemable Class B Warrants to purchase 57,400 shares of our common stock. The Class A Warrant offering may have violated certain rules regarding issuer tender offers under the Securities Exchange Act of 1934 and the registration requirements of the Securities Act of 1933, as amended, or the Securities Act. There can be no assurance that the Commission will not bring an action against us for violations of federal securities laws. If an administrative order is entered against us, we could be prohibited from engaging in certain types of securities transactions for a period of time. This may hinder our ability to raise additional working capital through the sale of our securities. Furthermore, we could be required to offer persons who participated in our Class A Warrant offering the right to rescind their exercise of the Class A Warrants and, to the extent these participants exercise this rescission right, we would be required to return to them their aggregate Class A Warrant exercise price. In addition, state securities regulators could bring actions against us for violations of state securities laws and seek additional sanctions against us.
     Our stock prices may be depressed and our shareholders may experience significant dilution upon the exercise of certain outstanding warrants, which may be affected by the actual or perceived sales of a significant number of our securities in the public market. As of September 14, 2006, there were 40,157,106 shares of our common stock issued and outstanding. Of these outstanding shares, 35,250,390 shares are either freely tradeable or eligible for sale under either Rule 144 or Rule 144(k).

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          As of September 14, 2006, we have a total of 24,898,291 shares of common stock, which may be issued upon exercise of the following options or warrants:
  §   3,396,842 shares of our common stock purchasable through the exercise of options granted under our 2003 Stock Plan;
 
  §   365,000 shares of our common stock purchasable through the exercise of options granted under our 1995 Long-Term Incentive and Stock Option Plan;
 
  §   1,103,000 shares of our common stock purchasable through the exercise of options granted under our 1998 Stock Option Plan;
 
  §   1,138,195 shares of our common stock purchasable through the exercise of other outstanding options and warrants, exercisable at per share exercise prices ranging from $0.25 to $3.39; and
 
  §   10,768,974 shares of our common stock issuable upon exercise of the Warrants sold in the August 2003 and February 2004 Placements, and 8,126,280 additional shares of our common stock issuable upon conversion of the Series A Convertible Preferred Stock underlying the Warrants.
          We also have 10,454,700 shares of our common stock issuable upon conversion of our 871,225 outstanding shares of Series A Convertible Preferred Stock.
          Moreover, we have registered all the shares of our common stock issuable through our 1995 Long-Term Incentive and Stock Option Plan and 750,000 shares of our common stock issuable through our 1998 Stock Option Plan. We have also registered 287,500 shares purchasable through the exercise of all other outstanding options and warrants.
          At any time our common stock trades at prices in excess of the exercise or conversion price of the options or warrants, it is possible that the holders of those options or warrants may exercise their conversion or purchase privileges. If any of these events occur, the number of shares of our outstanding common stock could increase substantially. This increase, in turn, could dilute future earnings per share, if any, and could depress the market value of our common stock.
          We cannot predict the extent to which the dilution, the availability of a large amount of shares for sale, and the possibility of additional issuances and sales of our common stock will negatively affect the trading price of our common stock or the liquidity of our common stock.
          We do not intend to pay cash dividends on our common stock. We have never paid cash dividends on our common stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We anticipate that profits, if any, received from operations will be devoted to our future operations.
          We are subject to certain provisions, which could impede takeovers by third parties even if such a change of control might be beneficial to our shareholders. We have established three classes of directors with staggered terms of office, supermajority voting requirements for business combinations, and the right of the Board of Directors to issue, without shareholder approval, preferred stock on terms set by the Board. We are also subject to certain terms of Minnesota law that could have the effect of delaying, deterring or preventing a change of control, including Sections 302A.671 and 302A.673 of the Minnesota Business Corporation Act, which prohibits a Minnesota corporation from engaging in any business combination with any interested shareholder for a period of four years from the date when the person became an interested shareholder unless certain conditions are met.
          Minnesota law and our Articles of Incorporation impose limitations on the liability of our directors to our shareholders. Our Articles of Incorporation provide, among other things, that directors, including a person deemed to be a director under applicable law, are not to be personally liable to us or our shareholders for monetary damages for breach of fiduciary duty as a director, except to the extent provided by applicable law (i) for any breach of the director’s duty of loyalty to us or our shareholders, (ii) for acts or omissions, not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) under Sections 302A.559 or 80A.23 of the Minnesota Business Corporation Act, as amended, (iv) for any transaction from which the director derived an improper personal benefit, or (v) for any act or omission occurring prior to the date that the applicable articles became effective. Our Articles further provide that if the Minnesota Business Corporation Act hereafter is amended to authorize the further elimination or limitation of the liability of directors, then the liability of our directors will be eliminated or limited to the fullest extent permitted by the Minnesota Business Corporation Act, as so amended.

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ITEM 2. Description of Property
          On October 24, 1997, we entered into a non-cancelable operating lease agreement for approximately 6,900 square feet of commercial office and light assembly space at The Waters Business Park in Eagan, Minnesota, a location in close proximity to the Minneapolis/Saint Paul International Airport and within a 20 minute drive to the downtown area of both Saint Paul and Minneapolis. Effective July 31, 2000, the term of this operating lease was extended for thirty-six (36) months, from November 1, 2000 to October 31, 2003. Effective September 16, 2003, the term of this operating lease was extended for thirty-six (36) months, from November 1, 2003 to October 31, 2006. Effective September 1, 2006, the term of this operating lease was extended for forty-eight (48) months from November 1, 2006 to October 31, 2010. The monthly gross rent, including basic operating expenses, is approximately $6,700. We believe that this facility should be adequate for our currently anticipated requirements for the term of the lease.
ITEM 3. Legal Proceedings
          On March 17, 2004, we received a letter from counsel for one of our employees alleging that our reimbursement practices were illegal and unethical and also alleging violation of applicable “whistleblower” statutes. On March 18, 2004, we received a letter from counsel for one of our former employees alleging that we failed to pay for accrued vacation time and also alleging violation of applicable “whistleblower” statutes. On August 25, 2004, we entered into a binding memorandum of understanding with these individuals agreeing to settle these disputes. As settlement in full of these employees’ claims, we agreed to pay the individuals an aggregate amount of $130,000 in cash and to issue unrestricted shares of our common stock with a market value of $100,000. We also retained a reimbursement consultant to investigate the whistleblower claims, and such consultant indicated its belief that such claims lack merit.
          In May 2005, plaintiffs filed a motion to enforce the memorandum of understanding. We filed a counter-motion seeking to enforce the return of property provisions in the memorandum of understanding. On September 9, 2005, the Hennepin County District Court (“the Court”) ruled in favor of plaintiffs. Pursuant to the Order, on September 30, 2005, we provided the Court with a check for deposit in the Court’s account in the amount of $138,382 ($130,000 for the cash portion of the mediated settlement, and $8,382 for court and administrative costs and interest) to secure the judgement pending post-Order motions seeking further relief. We filed a Notice of Appeal of the Court’s decision on November 7, 2005. On December 14, 2005, the Court denied plaintiffs’ motion for a supersedes bond and instead ordered the defendants to deliver to the Hennepin County Court Administrator a stock certificate for 714,286 shares of our common stock. Additionally, the Court ordered that the $138,382 in funds on deposit with the Court for the duration of the parties’ appeal process. On August 8, 2006, the Minnesota State Court of Appeals affirmed the decision of the Hennepin County District Court. The Company has decided not to appeal the Court of Appeals decision to the Minnesota State Supreme Court and has attempted to negotiate a cash settlement in lieu of payment of 714,286 shares of common stock which would now be required to be registered with the U.S. Securities and Exchange Commission.
          We are involved in various other legal actions in the ordinary course of our business. Although the outcome of any such legal actions cannot be predicted, management believes that there is no pending legal proceedings against or involving us for which the outcome is likely to have a material adverse effect upon our financial position or results of operations.
          Except as set forth above, we are not aware of any material pending or threatened legal proceedings, which involve us.
ITEM 4. Submission of Matters to a Vote of Security Holders
     No matters were submitted to a vote of our shareholders during the fourth quarter of the fiscal year ended June 30, 2006.

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PART II
ITEM 5. Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity / Securities
          Since March 21, 2003, our common stock has been traded on the Over-the-Counter Bulletin Board under the symbol “HDII.OB”. Prior to March 21, 2003, our common stock was traded on The Nasdaq SmallCap Market under the ticker symbol “HDII”. As of September 14, 2006, there were: (i) 164 shareholders of record, without giving effect to determining the number of shareholders who hold shares in “street name” or other nominee status; (ii) outstanding options or warrants to purchase 6,003,037 shares of our common stock; (iii) 871,225 outstanding shares of Series A Convertible Preferred Stock which is convertible into 10,454,700 shares of our common stock; and (iv) 40,157,106 outstanding shares of our common stock, of which 35,250,390 shares are either freely tradeable or eligible for sale under Rule 144 or Rule 144(k).
          The following table sets forth, for the fiscal quarters indicated, the high and low closing prices of our common stock as reported by the Over-the-Counter Bulletin Board. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
                 
    Sales Price
    High   Low
Fiscal 2006
               
First Quarter
  $ 0.32     $ 0.16  
Second Quarter
    0.27       0.18  
Third Quarter
    0.34       0.21  
Fourth Quarter
    0.37       0.25  
 
               
Fiscal 2005
               
First Quarter
  $ 0.25     $ 0.13  
Second Quarter
    0.23       0.15  
Third Quarter
    0.43       0.19  
Fourth Quarter
    0.26       0.16  
Dividend Policy
          We have never paid cash dividends and have no plans to do so in the foreseeable future. Our future dividend policy will be determined by our Board of Directors and will depend upon a number of factors, including our financial condition and performance, our cash needs and expansion plans, income tax consequences, and the restrictions that applicable laws and our credit arrangements then impose.
Recent Sales of Unregistered Securities
          Option Grants
          During the fiscal year ended June 30, 2006, we granted options to purchase up to an aggregate of 380,000 shares of common stock to our employees, pursuant to our various Stock Plans. The options vest immediately, and have exercise prices between $0.17 and $0.25 per share.

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ITEM 6. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
     We are engaged in the design, development, manufacture and marketing of proprietary medical devices that we believe non-invasively detect subtle changes in the elasticity of both large and small arteries. We are currently marketing three products: the HDI/PulseWave™ CR-2000 Research CardioVascular Profiling System, the CVProfilor® DO-2020 CardioVascular Profiling System and the CVProfilor® MD-3000 CardioVascular Profiling System.
    The CR-2000 Research System is being marketed worldwide “for research purposes only” to clinical research investigators for the purpose of collecting data in cardiovascular studies. Further, because the CR-2000 Research System bears the CE Mark (CE 0123) and meets the European Union Medical Device Directive, physicians may use the CR-2000 Research System with patients in a clinical setting in the European Union.
 
    In the U.S., the CVProfilor® DO-2020 System is being marketed to primary care physicians and other health care professionals on a “per-patient-tested” rental basis. It can also be purchased or leased. Utilizing our Central Data Management Facility (the “CDMF”), we are able to track utilization of the CVProfilor® DO-2020 System in each physician’s office and medical clinic and to invoice our physician customers on the number of CardioVascular Profile Reports (CVProfile™ Reports) which they generate each month. In the fourth quarter of fiscal year 2005, we implemented a new rent-to-own program that allows rental customers to credit a portion of their payments toward the purchase of their CVProfilor. Acquisition options were enhanced with the assistance of a third-party leasing company, which the physician can use to acquire their CVProfilor.
 
    The CVProfilor® MD-3000 System is being marketed through distributors to physicians outside the United States. These distributors purchase the product from us and then re-sell it to end-user physicians in their territory. The CVProfilor® MD-3000 System has a CE Mark that allows it to be marketed within European Union countries. The CVProfilor® MD-3000 may require certain regulatory approval for it to be marketed in other countries throughout the world.
Critical Accounting Policies
     The financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which requires us to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related footnotes. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. We do not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.
     Revenue Recognition. We recognize revenue in accordance with U.S. Securities and Exchange Commission’s Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition.” Pursuant to SAB No. 104, the Company recognizes revenue from the sale of equipment at the time of shipment to a customer or distributor. Shipment occurs only after receipt of a valid purchase order. Payments from customers and distributors are either made in advance of shipment or within a short time frame after shipment. In the case of sales to distributors, such payment is not contingent upon resale of the product to end users. Shipping and handling costs are included as cost of equipment sales. At the time of shipment, all of the criteria for recognition set forth in SAB No. 104 have been met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.

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     Equipment rental revenue, whether from the minimum monthly fee or from the per-patient-tested fee, is recognized when collection is probable, which is currently upon cash receipt. At the time of receipt of rental revenues, all of the criteria for recognition set forth in SAB No. 104 have been met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.
     In the case of either a sale or rental of our product, there are no post-shipment obligations which affect the timing of revenue recognition. Neither customers nor distributors have a right to return or exchange our product. Warranty repairs on all of the above are handled on a repair or replacement basis, at our discretion. Further, there is no installation of our product; it is ready to use when plugged into an electrical outlet and no specialized knowledge is required to ready it for use. For these reasons, we have concluded that our revenue recognition policy is appropriate and in accordance with SAB No. 104.
     Allowance for Doubtful Accounts. Accounts receivable are reviewed to determine the need for an allowance for amounts that may become uncollectible in the future. The necessity of an allowance is based on management’s review of accounts receivable balances and historic write-offs.
     Inventories and Related Allowance for Excess and Obsolete Inventory. Inventories are valued at the lower of cost or market and reviewed to determine the need for an allowance for excess and obsolete inventories. The need for an allowance is based on management’s review of inventories on hand compared to estimated future usage and sales.
     Research and Development. For the fiscal year ended June 30, 2006, we incurred research and development costs of $30,314. We did not incur any research and development costs for the fiscal year ended June 30, 2005.
Results of Operations
     As of June 30, 2006, we had an accumulated deficit of $25,978,319, attributable primarily to selling, general and administrative expenses. Until we are able to generate significant revenue from our activities, we expect to continue to incur operating losses. As of June 30, 2006, we had cash and cash equivalents of $1,722,913. We anticipate that these funds, in conjunction with revenue anticipated to be earned from placements and sales of our CVProfilor® DO-2020 Systems, anticipated sales of our CR-2000 Research Systems, anticipated operating cost reductions, as well as anticipated proceeds from the exercise by holders of stock purchase warrants to purchase our common stock and Series A Preferred Stock, will allow us to pursue our business development strategy for at least the next twelve months following June 30, 2006.
Fiscal Year Ended June 30, 2006 Compared to Fiscal Year Ended June 30, 2005
     The following is a summary of our Revenue and Cost of Sales for the fiscal years ended June 30, 2006 and 2005, respectively:
                                 
    Fiscal Year Ended June 30, 2006  
            Equipment     Equipment     Service/  
    Total     Sales     Rental     Contract  
Revenue
  $ 1,789,546     $ 1,352,486     $ 418,979     $ 18,081  
Cost of Sales
    90,447       2,181       87,796       470  
 
                       
Gross Profit
  $ 1,699,099     $ 1,350,305     $ 331,183     $ 17,611  
 
                       
                                 
    Fiscal Year Ended June 30, 2005  
            Equipment     Equipment     Service/  
    Total     Sales     Rental     Contract  
Revenue
  $ 1,182,005     $ 445,889     $ 560,377     $ 175,739  
Cost of Sales
    184,984       57,262       105,566       22,156  
 
                       
Gross Profit
  $ 997,021     $ 388,627     $ 454,811     $ 153,583  
 
                       

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     Total Equipment Sales Revenue for the fiscal year ended June 30, 2006 was $1,352,486, compared to $445,889 for the fiscal year ended June 30, 2005, a 203% increase. We use the “per-patient-tested” rental model primarily to stimulate trial of the DO-2020 and provide a financial incentive for a renter to convert to a sale by crediting 50% of rental payments for the first three months of rental toward the purchase price of the DO-2020. This results in an increase in equipment sales revenue. Revenue relating to international equipment sales was $261,611 for the fiscal year ended June 30, 2006 and $71,375 for the fiscal year ended June 30, 2005, a 267% increase. This increase was largely due to a $135,000 order in December 2005 from our Chinese distributor.
     Placements of the CVProfilor® DO-2020 System, and satisfactory utilization by physicians of those systems placed, has taken more time and resources than originally anticipated due to delays in obtaining consistent and satisfactory levels of third party reimbursements to physicians utilizing the CVProfilor® DO-2020 System and delays in integrating the CVProfilor® DO-2020 System into the clinic operations in which they are placed. We have commenced focusing our resources on specific regional markets that we believe are more likely to generate higher levels of acceptance of the CVProfilor® DO-2020 System by physicians and a greater amount of reimbursements by third party payors to such physicians. We believe this approach is the most effective method of both increasing placements of the CVProfilor® DO-2020 System and increasing the physician utilizations of such systems placed. Our current marketing strategy focuses on marketing the CVProfilor® DO-2020 System to physicians who treat patients with diabetes and hypertension. We believe these physicians have the greatest interest in, and use for, our product. Therefore, the most critical factor in our ability to increase rental revenue rests in our ability to expand our marketing and distribution network to increase placements and utilization of our CVProfilor® DO-2020 System. We believe there are three ways we could expand our marketing and distribution network: 1) the development of an internal sales force; 2) a strategic partnership with a firm that possesses a distribution network calling on these same physicians; or 3) a combination of the internal sales force and external distribution network methods. We believe this dual method of expansion offers us the greatest opportunity for success. We are pursuing discussions with firms that have an interest in representing our CVProfilor® DO-2020 System nationwide. In the short term, we have also focused on international sales of our CR-2000 Research System and CVProfilor® MD-3000 System as a means of generating cash to support operational expenses.
     Further, the existence, timing and extent of reimbursement of physicians for the use of our CVProfilor® DO-2020 System affects the availability of our working capital. Reimbursement will always vary considerably by the patient’s medical necessity, by physician, by provider, by geography and by provider coverage plans, making the process of obtaining reimbursement for the CVProfilor® DO-2020 System by current physician customers an important component of our product’s success. To the extent that reimbursement is unavailable or inadequate, physicians will be less likely to use the CVProfilor® DO-2020 System.
     In addition, because our CVProfilor® DO-2020 System is being marketed on a per-patient-tested basis, we have a delay in the cost recovery of our working assets. Although our per-patient-tested marketing approach reduces the risk and thereby increases the potential rate of acceptance for physician customers willing to use the CVProfilor® DO-2020 System as compared to a capital acquisition approach, it also delays our cash flow recovery of product costs. Physician payments for use of the CVProfilor® DO-2020 System follow actual utilization by some 60-90 days; utilization in one month is invoiced in the following month and payment is generally received within 30 to 60 days of invoicing. This delay in payment, therefore, requires six to twelve months to fully recover product costs. These cash flow delays mean that we will generate little, if any, cash during the initial placement of the product and will require cash from other sources to support our operations during this period.
     For the fiscal year ended June 30, 2006, we recognized Revenue for the CVProfilor® DO-2020 System “per-patient-tested” rental program of $418,979, compared to $560,377 for the fiscal year ended June 30, 2005, a 25% decrease. As we use the rental model primarily as a means of generating trial with a hopeful move to a sale, renters will not, in the majority of cases, remain in the rental mode as long as previous. This will result in lower rental revenues.
     For the fiscal year ended June 30, 2006, Service/Contract Income was $18,081, compared to $175,739 for the fiscal year ended June 30, 2005, a 90% decrease. None of the $18,081 amount and $154,500 of the $175,739 amount represent contract income pertaining to an agreement with a pharmaceutical company to attend certain hypertension and cardiology meetings in both the U.S. and internationally. This agreement expired in December

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2004 and was not renewed, which accounted for the decline in this component of Service/Contract Income from $154,500 in fiscal year 2005 to zero in fiscal year 2006, representing a 86% decline or $154,500. Under this agreement, we provided our CardioVascular Profiling Systems and certain employees who tested visitors to the pharmaceutical company’s exhibition booth.
     At June 30, 2003, inventory which principally consists of raw materials had been written down to estimated net realizable value to account for quantities in excess of those expected to be sold currently. The results of operations for the fiscal year ended June 30, 2003 included a corresponding charge to Cost of Sales of $850,000 related to this write-down. As inventory is sold relating to Equipment Sales Revenue, a portion of this Inventory Reserve Allowance is recorded as an offset to Cost of Sales pertaining to these sales. As of June 30, 2006, the Inventory Reserve Allowance balance is $665,505. The following table shows the effect of this adjustment for the periods indicated:
                 
    Fiscal Year Ended June 30  
    2006     2005  
Cost of Sales
  $ 188,936     $ 270,990  
Inventory Reserve Adjustment
    (98,489 )     (86,006 )
 
           
Cost of Sales, as reported
  $ 90,447     $ 184,984  
 
           
     Total selling, general and administrative expenses for the fiscal year ended June 30, 2006 were $3,018,624 compared to $2,484,606 for the fiscal year ended June 30, 2005, a 21% increase. The following is a summary of the major categories included in selling, general and administrative expenses:
                 
    Fiscal Year Ended June 30,  
    2006     2005  
Wages, related expenses and benefits
  $ 1,093,018     $ 727,319  
Patents and related expenses
    3,177       6,057  
Outside consultants
    180,182       362,568  
Rent (building/equipment) and utilities
    100,846       97,128  
Insurance-general and directors/officers liability
    61,841       76,177  
Selling, marketing and promotion, including applicable wages
    1,060,564       771,391  
Legal and audit/accounting fees
    168,585       221,682  
Royalties
    53,129       30,188  
Depreciation and amortization
    34,511       57,633  
Research and development
    30,314        
Accelerated vesting of stock options
    24,025        
Other-general and administrative
    208,432       134,463  
 
           
Total selling, general and administrative expenses
  $ 3,018,624     $ 2,484,606  
 
           
     Wages, related expenses and benefits increased from $727,319 to $1,093,018 for the fiscal years ended June 30, 2005 and June 30, 2006, respectively, a 50% increase. Included in the $1,093,018 expense amount for the fiscal year ended June 30, 2006 is an accrued compensation non-cash charge of $395,250 that relates to the estimated amount due our chief executive officer as part of his compensation for services provided to us. Included in the $727,319 expense amount for the fiscal year ended June 30, 2005 is an accrued compensation non-cash charge of $127,500 that relates to the estimated amount due our chief executive officer as part of his compensation for services provided to us.
     Outside consultants expense decreased from $362,568 for the fiscal year ended June 30, 2005 to $180,182 for the fiscal year ended June 30, 2006, a 50% decrease. Included in the $180,182 expense amount for the fiscal year ended June 30, 2006 is $80,175 that relates to services provided by outside service consultants in support of the

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Company’s quality systems pertaining to manufacturing, certification and marketing of its medical devices both domestically and internationally, as well as support of regulatory affairs matters. In fiscal year 2005, we decided to outsource our quality systems and regulatory affairs functions.
     Selling, marketing and promotion expense increased from $771,391 for the fiscal year ended June 30, 2005 to $1,060,564 for the fiscal year ended June 30, 2006, a 37% increase. This category includes wages and commissions paid by us relating to our sales and marketing efforts, as well as travel and convention expenses.
     Legal and audit/accounting fees decreased from $221,682 to $168,585 for the fiscal years ended June 30, 2005 and 2006, respectively, a 24% decrease. This decrease was a result of lower legal fees associated with the Chesney matter.
     Interest income was $46,783 and $32,357 for the fiscal years ended June 30, 2006 and 2005, respectively.
     Net loss was $1,272,742 and $1,455,228 for the fiscal years ended June 30, 2006 and 2005, respectively. For the fiscal year ended June 30, 2006, basic and diluted net loss per share was $(.04), based on weighted average shares outstanding of 35,219,474. For the fiscal year ended June 30, 2005, basic and diluted net loss per share was $(.05), based on weighted average shares outstanding of 28,505,982.
Liquidity and Capital Resources
     Cash and cash equivalents had a net increase of $197,048 and $147,572 for the years ended June 30, 2006 and June 30, 2005, respectively. The significant elements of these changes were as follows:
                         
            Fiscal Year Ended June 30  
            2006     2005  
Net cash used in operating activities:                
  net loss, as adjusted for non-cash items (expenses associated with depreciation, amortization, stock options)   $ (998,486 )   $ (1,262,715 )
 
                       
— (increase) decrease in accounts receivable:     (85,068 )   (A) 115,118  
– (A)
      One of our contract income customers as of June 30, 2004 did not renew their agreement during fiscal year 2005. This customer had a $107,000 accounts receivable balance at June 30, 2004 and a $-0- balance at June 30, 2005.                
 
                       
— (increase) in inventory:     (12,685 )   (B) (97,454 )
– (B)
      In September 2004, we purchased 300 units of a certain inventory part from one vendor amounting to $161,192.                
 
                       
— increase in accrued payroll and payroll taxes:   (C) 343,670     (C) 338,567  
– (C)
      $127,500 of the $338,567 and $267,750 of the $343,670 amounts, respectively, relate to the estimated amount due our chief executive officer as part of his compensation for services provided to us.                

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            Fiscal Year Ended June 30  
            2006     2005  
Net cash provided by financing activities:                
— issuance of preferred stock and common stock:   (D) 973,976     (E) 1,030,101  
– (D)
      $973,976 of this amount pertains to the exercise by holders of warrants to purchase preferred stock and common stock.                
 
                       
– (E)
      $1,014,021 of this amount pertains to the exercise by holders of warrants to purchase preferred stock and common stock.                
     We have incurred operating losses and have not generated positive cash flow from operations. As of June 30, 2006, we had an accumulated deficit of $25,978,319.
     As of June 30, 2006, we had cash and cash equivalents of $1,722,913 and anticipate that these funds, in conjunction with revenue anticipated to be earned from placements and sales of our CVProfilor® DO-2020 Systems, anticipated sales of our CR-2000 Research Systems, anticipated operating cost reductions, as well as anticipated proceeds from the exercise by holders of stock purchase warrants to purchase our common stock and Series A Preferred Stock, will allow us to pursue our business development strategy for at least the next twelve months following June 30, 2006.
     Our current marketing strategy focuses on marketing the CVProfilor® DO-2020 System to physicians who treat patients with diabetes and hypertension. We believe these physicians have the greatest interest in, and use for, our product. Therefore, the most critical factor in our ability to increase rental revenue rests in our ability to expand our marketing and distribution network to increase placements, sales and utilization of our CVProfilor® DO-2020 System. We believe there are three ways we could expand our marketing and distribution network: 1) the development of an internal sales force; 2) a strategic partnership with a firm that possesses a distribution network calling on these same physicians; or 3) a combination of the internal sales force and external distribution network methods. We believe this dual method of expansion offers us the greatest opportunity for success. We are pursuing discussions with firms that have an interest in representing our CVProfilor® DO-2020 System nationwide. In the short term, we have also focused on international sales of our CR-2000 Research System and CVProfilor® MD-3000 System as a means of generating cash to support operational expenses.
     Further, the existence, timing and extent of reimbursement of physicians for the use of our CVProfilor® DO-2020 affects the availability of our working capital. Reimbursement will always vary considerably by the patient’s medical necessity, by physician, by provider, by geography and by provider coverage plans, making the process of obtaining reimbursement for the CVProfilor® DO-2020 by current physician customers an important component of our product’s success. To the extent that reimbursement is unavailable or inadequate, physicians will be less likely to use the CVProfilor® DO-2020.
     No assurance can be given that additional working capital will be obtained in a timely manner or on terms and conditions acceptable to us or our shareholders. Our financing needs are based upon management estimates as to future revenue and expense. Our business plan and our financing needs are also subject to change based upon, among other factors, market conditions, and our ability to materially increase the revenue generated by our CVProfilor® DO-2020 System and other cash flow from operations. Our efforts to raise additional funds may be hampered by the fact that our securities are quoted on the OTC Bulletin Board, are illiquid and are subject to the rules relating to penny stocks.
     We have historically obtained working capital from the issuance of our securities. On August 28, 2003, we completed the private placement offering (the “August Placement”) of 585,980 units to a group of investors led by Mark N. Schwartz, our Chief Executive Officer. Gross proceeds from this offering were $2,289,001 and net proceeds were $1,873,383. On February 9, 2004, we completed an additional private placement offering (the “February Placement”) of 118,113 units to a group of investors. Gross proceeds from this offering were $461,370 and net proceeds were $413,121. In June 2004, we issued 1,580,623 shares of common stock and 99,391 shares of Series A Preferred Stock, to holders of warrants to purchase common stock and Series A Preferred Stock, resulting

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in gross proceeds of $471,464. In July 2004, we issued 643,007 shares of common stock and 40,433 shares of Series A Preferred Stock, to holders of warrants to purchase common stock and Series A Preferred Stock, resulting in gross proceeds of $191,794. In March and April 2005, we issued 2,756,534 shares of common stock and 173,341 shares of Series A Preferred Stock, to holders of warrants to purchase common stock and Series A Preferred Stock, resulting in gross proceeds of $822,227. During the period January through June 2006, we issued 2,807,549 shares of common stock and 155,163 shares of Series A Preferred Stock, to holders of warrants to purchase common stock and Series A Preferred Stock, resulting in gross proceeds of $973,976.
          In December 2004, FASB issued SFAS No. 123 (revised 2004) (“123R”), “Share-Based Payment”, that focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This statement replaces SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Beginning with the first quarter of fiscal year 2007, the Company will be required to expense the fair value of employee stock options and similar awards. As a public company, the Company is allowed to select from two alternative transition methods, each having different reporting implications. The impact of SFAS No. 123R has not been determined at this time.
          The Financial Accounting Standards Board has published FASB Interpretation (FIN) No. 48 (FIN No. 48), Accounting for Uncertainty in Income Taxes, to address the non-comparability in reporting tax assets and liabilities resulting from a lack of specific guidance in FASB Statement of Financial Accounting Standards (SFAS) No. 109 (SFAS No. 109), Accounting for Income Taxes, on the uncertainty in income taxes recognized in an enterprise’s financial statements. Specifically, FIN No. 48 prescribes (a) a consistent recognition threshold and (b) a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides related guidance on de-recognition, classification, interest, and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 will apply to fiscal years beginning after December 15, 2006. The impact of FIN No. 48 has not been determined at this time.

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ITEM 7. Financial Statements
Financial Statements
Hypertension Diagnostics, Inc.
Years Ended June 30, 2006 and 2005

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Hypertension Diagnostics, Inc.
Financial Statements
Years Ended June 30, 2006 and 2005
Contents
         
    37  
 
       
Audited Financial Statements
       
    38  
    39  
    40  
    41  
    42  

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee, Shareholders and Board of Directors of
Hypertension Diagnostics, Inc.
     We have audited the accompanying balance sheets of Hypertension Diagnostics, Inc. (the “Company”) as of June 30, 2006 and 2005, and the related statements of operations, shareholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
     We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amount and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
     In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company at June 30, 2006 and 2005, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ Virchow, Krause & Company, LLP
Minneapolis, Minnesota
August 17, 2006

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Hypertension Diagnostics, Inc.
Balance Sheets
                 
    June 30,  
    2006     2005  
Assets
               
Current Assets:
               
Cash and cash equivalents
  $ 1,722,913     $ 1,525,865  
Accounts receivable
    177,660       92,592  
Inventory
    334,963       322,278  
Prepaids and other current assets
    21,854       22,012  
 
           
Total Current Assets
    2,257,390       1,962,747  
 
               
Property and Equipment:
               
Leasehold improvements
    17,202       17,202  
Furniture and equipment
    1,193,807       1,272,763  
Less accumulated depreciation and amortization
    (1,128,980 )     (1,065,376 )
 
           
 
    82,029       224,589  
 
               
Other Assets
    6,530       6,530  
 
           
Total Assets
  $ 2,345,949     $ 2,193,866  
 
           
 
               
Liabilities and Shareholders’ Equity
               
Current Liabilities:
               
Accounts payable
  $ 58,895     $ 85,958  
Accrued payroll and payroll taxes
    398,101       459,431  
Deferred revenue
    12,454       5,255  
Other accrued expenses
    19,631       24,027  
 
           
Total Current Liabilities
    489,081       574,671  
 
               
Deferred Revenue, less current portion
    16,454       15,658  
 
               
Shareholders’ Equity:
               
Series A Convertible Preferred Stock, $.01 par value:
               
Authorized shares—5,000,000
               
Issued and outstanding shares—871,225 and 915,411 at June 30, 2006 and 2005, respectively; each share of preferred stock convertible into 12 shares of common stock at the option of the holder (aggregate liquidation preference $2,391,218 and $2,114,515 at June 30, 2006 and 2005, respectively)
    8,712       9,154  
Common Stock, $.01 par value:
               
Authorized shares—150,000,000
               
Issued and outstanding shares— 40,157,106 and 32,743,083 at June 30, 2006 and 2005, respectively
    401,571       327,431  
Additional paid-in capital
    27,408,450       25,972,529  
Accumulated deficit
    (25,978,319 )     (24,705,577 )
 
           
Total Shareholders’ Equity
    1,840,414       1,603,537  
 
           
Total Liabilities and Shareholders’ Equity
  $ 2,345,949     $ 2,193,866  
 
           
See accompanying notes.

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Hypertension Diagnostics, Inc.
Statements of Operations
                 
    Year Ended June 30,  
    2006     2005  
Revenue:
               
Equipment sales
  $ 1,352,486     $ 445,889  
Equipment rental
    418,979       560,377  
Service/contract income
    18,081       175,739  
 
           
 
    1,789,546       1,182,005  
Cost of Sales
    90,447       184,984  
 
           
Gross Profit
    1,699,099       997,021  
 
               
Expenses:
               
Selling, general and administrative
    3,018,624       2,484,606  
 
           
Total Expenses
    3,018,624       2,484,606  
 
           
Operating Loss
    (1,319,525 )     (1,487,585 )
 
               
Other Income:
               
Interest income
    46,783       32,357  
 
           
 
    46,783       32,357  
 
           
Net Loss
  $ (1,272,742 )   $ (1,455,228 )
 
           
 
               
Basic and Diluted Net Loss per Share
  $ (.04 )   $ (.05 )
Weighted Average Shares Outstanding
    35,219,474       28,505,982  
See accompanying notes.

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Hypertension Diagnostics, Inc.
Statement of Shareholders’ Equity
                                                         
                                    Additional              
    Preferred Stock     Common Stock     Paid-in     Accumulated        
    Shares     Amount     Shares     Amount     Capital     Deficit     Total  
Balance at June 30, 2004
    803,484     $ 8,035       26,449,378     $ 264,494     $ 24,585,206     $ (23,250,349 )   $ 1,607,386  
Value of stock options and Common Stock issued in lieu of cash
                1,600,000       16,000       405,278             421,278  
Conversion of Preferred Stock into Common Stock
    (101,847 )     (1,019 )     1,222,164       12,222       (11,203 )            
Warrants exercised
    213,774       2,138       3,399,541       33,995       977,888             1,014,021  
Stock options exercised
                72,000       720       15,360             16,080  
Net loss
                                  (1,455,228 )     (1,455,228 )
 
                                         
Balance at June 30, 2005
    915,411       9,154       32,743,083       327,431       25,972,529       (24,705,577 )     1,603,537  
Value of Common Stock issued in lieu of cash
                2,214,286       22,143       489,475             511,618  
Conversion of Preferred Stock into Common Stock
    (199,349 )     (1,994 )     2,392,188       23,922       (21,928 )            
Warrants exercised
    155,163       1,552       2,807,549       28,075       944,349             973,976  
Accelerated vesting of outstanding stock options
                            24,025             24,025  
Net loss
                                  (1,272,742 )     (1,272,742 )
 
                                         
Balance at June 30, 2006
    871,225     $ 8,712       40,157,106     $ 401,571     $ 27,408,450     $ (25,978,319 )   $ 1,840,414  
 
                                         
See accompanying notes.

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Hypertension Diagnostics, Inc.
Statements of Cash Flows
                 
    Year Ended June 30,  
    2006     2005  
Operating Activities:
               
Net loss
  $ (1,272,742 )   $ (1,455,228 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Value of stock options, Common Stock and warrants issued in lieu of cash
    292,500       21,278  
Depreciation
    122,307       163,199  
Net book value of sale of property and equipment
    21,306       8,036  
Accelerated vesting of outstanding stock options
    24,025        
Change in operating assets and liabilities:
               
Accounts receivable
    (85,068 )     115,118  
Interest receivable
          8,920  
Inventory
    (12,685 )     (97,454 )
Prepaids and other assets
    158       33,485  
Accounts payable
    (27,063 )     1,156  
Accrued payroll and payroll taxes
    157,788       338,567  
Deferred revenue
    7,995       16,113  
Other accrued expenses
    (4,396 )     (2,027 )
 
           
Net cash used in operating activities
    (775,875 )     (848,837 )
 
               
Investing Activities:
               
Purchase of property and equipment
    (1,053 )     (33,692 )
 
           
Net cash used in investing activities
    (1,053 )     (33,692 )
 
               
Financing Activities:
               
Issuance of Preferred Stock and Common Stock
    973,976       1,030,101  
 
           
Net cash provided by financing activities
    973,976       1,030,101  
 
           
Net increase in cash and cash equivalents
    197,048       147,572  
Cash and cash equivalents at beginning of period
    1,525,865       1,378,293  
 
           
Cash and cash equivalents at end of period
  $ 1,722,913     $ 1,525,865  
 
           
 
               
Supplemental Schedule of Noncash Investing and Financing Activities:
               
Conversion of accrued payroll into Common Stock
  $ 420,000     $ 400,000  
Value of stock issued for accrued lawsuit
  $ 91,618     $  
See accompanying notes.

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
1. Organization and Significant Accounting Policies
Description of Business
     Hypertension Diagnostics, Inc. (the “Company”) was formed on July 19, 1988 to develop, design and market a cardiovascular profiling system. The Company’s chief operating decision maker does not review financial information in a disaggregated manner, and as a result the Company does not report separate segments.
Cash Equivalents
     The Company considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. At June 30, 2006 and 2005, the Company’s cash equivalents are carried at amortized cost which approximated market value, with no resulting unrealized gains and losses recognized. The Company maintains cash in high quality financial institutions. The balances, at times, may exceed federally insured limits.
Accounts Receivable
     The Company reviews customers’ credit history before extending unsecured credit. Accounts receivable are reviewed to determine the need for an allowance for amounts that may become uncollectible in the future. The necessity of an allowance is based on management’s review of accounts receivable balances and historic write-offs. Invoice terms can vary from at date of shipment to net 30 days. The Company does not accrue interest on past due accounts receivable. The Company writes off receivables when they are deemed uncollectible after all collection attempts have failed. The Company has determined that an allowance for doubtful accounts is not necessary as of June 30, 2006 and 2005.
Property and Equipment
     Property and equipment are stated at cost. Improvements are capitalized, while repair and maintenance costs are charged to operations when incurred. Depreciation is computed principally using the straight-line method. Estimated useful lives for leasehold improvements are the shorter of the lease term or estimated useful life and 5-7 years for furniture and equipment.
Use of Estimates
     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Fair Value of Financial Instruments
     The Company’s financial instruments are recorded on its balance sheet. The carrying amounts for cash, accounts receivable, accounts payable, and accrued expenses approximate fair value due to the immediate or short-term maturity of these financial instruments.
Impairment of Long-Lived Assets
     The Company will record impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted future cash flows estimated to be generated by those assets are less than the assets’ carrying amount. To date, no such losses have been recognized.

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
1. Organization and Significant Accounting Policies (Continued)
Shipping and Handling Costs
     The Company records all amounts billed to customers in a sales transaction related to shipping and handling as sales. The Company records costs related to shipping and handling in cost of sales.
Legal Costs
     The Company expenses legal costs related to lawsuits as incurred.
Revenue Recognition
     Equipment Sales Revenue is recognized at the time of shipment to a customer or distributor. Shipment occurs only after receipt of a valid purchase order. Payments from customers and distributors are either received in advance of shipment or within a short time frame after shipment. In the case of sales to distributors, such payment is not contingent upon resale of the product to end users. Shipping and handling costs are included as cost of equipment sales. At the time of shipment, all of the criteria for recognition set forth in Staff Accounting Bulletin (SAB) No. 104 have been met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.
     Equipment Rental Revenue, whether from the minimum monthly fee or from the per-patient-tested fee, is recognized when collection is probable, which is currently upon cash receipt.
     In the case of either a sale or rental of the Company’s product, there are no post-shipment obligations which affect the timing of revenue recognition. Neither customers nor distributors have a right to return or exchange product. Warranty repairs on all of the above are handled on a repair or replacement basis, at the Company’s discretion. Further, there is no installation of the product; it is ready to use when plugged into an electrical outlet and no specialized knowledge is required to ready it for use. For these reasons, the Company believes its revenue recognition policy is appropriate and in accordance with SAB No. 104.
Research and Development Costs
     All research and development costs are charged to expense as incurred. The Company incurred $30,314 in research and development costs for the fiscal year ended June 30, 2006. There were no research and development costs incurred in the fiscal year ended June 30, 2005.
Income Taxes
     Income taxes are accounted for under the liability method. Deferred income taxes are provided for temporary differences between the financial reporting and tax bases of assets and liabilities.
Inventory
     Inventories are valued at the lower of cost (first-in, first-out method) or market and principally consist of raw materials.
Net Loss Per Share
     Basic net loss per share is computed using the weighted average number of common shares outstanding during each period. Diluted net loss per share would normally include the dilutive effect of common shares potentially

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
1. Organization and Significant Accounting Policies (Continued)
issuable upon the exercise of stock options, warrants, or the conversion of preferred stock. However, since the Company reported losses for all periods presented, all potential common shares have been excluded from the calculation of diluted net loss per share, as the effect would have been anti-dilutive.
Stock-Based Compensation
     The Company accounts for stock-based transactions under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. As permitted by SFAS No. 123, the Company has elected to continue following the guidance of APB Opinion No. 25 (as interpreted by FIN 44) for measurement and recognition of stock-based transactions with employees and non-employee directors. Because stock options have been granted at exercise prices at least equal to the fair market value of the stock at grant date, no compensation cost has been recognized for stock options issued to employees and non-employee directors under the stock option plans, unless the options were modified after the grant date. Stock-based transactions with non-employees are accounted for in accordance with SFAS No. 123 and related interpretations.
     The Company uses the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for employee stock options. Under the intrinsic value method, compensation expense is recorded only to the extent that the market price of the common stock exceeds the exercise price of the stock option on the date of grant.
     In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 is an amendment to SFAS No. 123 providing alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and also provides required additional disclosures about the method of accounting for stock-based employee compensation. The Company adopted the annual disclosure provision of SFAS No. 148 during the year ended June 30, 2003. The Company chose to not adopt the voluntary change to the fair value method of accounting for stock-based employee compensation, pursuant to SFAS No. 148.
     In order to reward employees and board members for their outstanding service over a term of many years, in November 2005, the Board of Directors approved the acceleration of the vesting of all of the then outstanding options under the 1995, 1998 and 2003 Stock Option Plans. This action resulted in the exercisability of all outstanding options being accelerated and fully vested. At the date of the acceleration of the vesting, since the exercise price(s) of some of the outstanding options were less than the market price of the common stock (“in the money” options), compensation expense in the amount of $24,025 was recorded under the intrinsic value method. This acceleration resulted in an additional $208,427 of net compensation expense being included in the following tables for the year ended June 30, 2006. If compensation cost for the Company’s stock option plans had been determined based on the fair value at the grant dates, consistent with the method provided in SFAS No. 123, net loss and net loss per share would have been as follows:

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
1. Organization and Significant Accounting Policies (Continued)
                 
    Year Ended June 30  
    2006     2005  
Net Loss:
               
As Reported
  $ (1,272,742 )   $ (1,455,228 )
Fair value compensation expense
    (304,245 )     (338,453 )
 
           
Pro forma
  $ (1,576,987 )   $ (1,793,681 )
 
           
 
               
Basic and Diluted Net Loss per Share:
               
As Reported
  $ (0.04 )   $ (0.05 )
Fair value compensation expense
    (0.01 )     (0.01 )
 
           
Pro forma
  $ (0.05 )   $ (0.06 )
 
           
 
               
Stock Based Compensation:
               
As Reported
  $ 24,025     $  
Fair value compensation expense
    (328,270 )     (338,453 )
 
           
Pro forma
  $ (304,245 )   $ (338,453 )
 
           
     Pro forma information regarding net loss is required by SFAS No. 123, and has been determined as if the Company had accounted for its stock options under the fair value method of that Statement. The fair value of these options granted during fiscal year 2006 and fiscal year 2005 was estimated using the Black-Scholes option pricing model with the following weighted average assumptions:
                                 
            Expected              
    Risk-Free     Dividend     Expected     Expected  
Fiscal Year Ended   Interest Rate     Yield     Life     Volatility  
June 30, 2006
    4.25% - 4.50 %   None   5 years     1.120  
June 30, 2005
    3.75 %   None   5 years     1.060 - 1.120  
     In December 2004, FASB issued SFAS No. 123 (revised 2004) (“123R”), “Share-Based Payment”, that focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This statement replaces SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Beginning with the first quarter of fiscal year 2007, the Company will be required to expense the fair value of employee stock options and similar awards. As a public company, the Company is allowed to select from two alternative transition methods, each having different reporting implications. The impact of SFAS No. 123R has not been determined at this time.
     The Financial Accounting Standards Board has published FASB Interpretation (FIN) No. 48 (FIN No. 48), Accounting for Uncertainty in Income Taxes, to address the non-comparability in reporting tax assets and liabilities resulting from a lack of specific guidance in FASB Statement of Financial Accounting Standards (SFAS) No. 109 (SFAS No. 109), Accounting for Income Taxes, on the uncertainty in income taxes recognized in an enterprise’s financial statements. Specifically, FIN No. 48 prescribes (a) a consistent recognition threshold and (b) a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides related guidance on de-recognition, classification, interest, and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 will apply to fiscal years beginning after December 15, 2006. The impact of FIN No. 48 has not been determined at this time.

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
2. Income Taxes
     Reconciliation of the statutory federal income tax rate to the Company’s effective tax rate is as follows:
                 
    2006   2005
Tax at statutory rate
    (34.0 )%     (34.0 )%
State income taxes
    (6.0 )     (6.0 )
Change in valuation allowance
    40.0       40.0  
 
               
Effective income tax rate
    %     %
 
               
     At June 30, 2006, the Company has net operating loss carry forwards totaling approximately $20,792,000 that may be offset against future taxable income. If not used, the carry forwards will expire as follows:
         
2010
  $ 548,000  
2011
    364,000  
2012
    772,000  
2013
    1,109,000  
2019
    2,124,000  
2020
    3,253,000  
2021
    2,132,000  
2022
    3,607,000  
2023
    3,223,000  
2024
    1,764,000  
2025
    1,042,000  
2026
    854,000  
 
     
 
  $ 20,792,000  
 
     
     No benefit has been recorded for such carryforwards, and utilization in future years may be limited under Section 382 of the Internal Revenue Code if significant ownership changes have occurred.
     Components of deferred tax assets are as follows:
                 
    June 30  
    2006     2005  
Loss carry forwards
  $ 8,050,798     $ 7,669,403  
Inventory Reserve
    266,202       305,597  
Less valuation allowance
    (8,317,000 )     (7,975,000 )
 
           
Net deferred tax assets
  $     $  
 
           

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
3. Shareholders’ Equity
     Description of Series A Preferred Stock
     On August 28, 2003, the Company designated 4,177,275 shares of the Company’s 5,000,000 authorized shares of preferred stock as Series A Convertible Preferred Stock (the “Series A Preferred Stock”) pursuant to a Certificate of Designation, Preferences and Rights with respect to the Series A Preferred Stock (the “Certificate of Designation”). Each share of the Series A Preferred Stock is initially convertible into twelve (12) shares of the Company’s common stock, subject to adjustment as provided in the Certificate of Designation for customary anti-dilution adjustments and issuances below the conversion price in effect, initially $0.14 per share. The Series A Preferred Stock is convertible into shares of the Company’s common stock at any time. Further, the Series A Preferred Stock will automatically be converted into the Company’s common stock upon sale of all or substantially all of the Company’s assets, a consolidation or merger. Each share of the Series A Preferred Stock shall entitle its holder to vote on all matters voted on by holders of the Company’s common stock on an as-if converted basis.
     In addition, so long as any shares of the Series A Preferred Stock are outstanding, the Company may not, without the approval of the majority of the holders of the Series A Preferred Stock then outstanding, take certain corporate actions, as described in the Certificate of Designation. Upon any liquidation, the holders of the Series A Preferred Stock are entitled to receive out of the Company’s assets a liquidation preference equal to an internal rate of return on the adjusted stated value of the Series A Preferred Stock equal to 20%. Any assets remaining after this initial distribution shall be distributed to the holders of the Company’s common stock and the Series A Preferred Stock on an as-if converted basis.
     Stock Options and Common Stock Issued in Lieu of Cash
     On August 28, 2003, the Company entered into an employment agreement with its CEO, Mark N. Schwartz, whereby the Company granted 100,000 shares of its common stock to its CEO for every month of employment for the period September 2003 through December 2004. In accordance with this agreement, on March 31, 2005, the Company issued 1,600,000 shares of its common stock to its CEO. The fair market value of the shares at that date was $400,000.
     On January 13, 2005, the Company entered into an another employment agreement with its CEO whereby the Company agreed to grant 125,000 shares of its common stock to its CEO for every month of employment for the period January 1, 2005 through December 31, 2005. Accordingly, the Company has accrued a compensation liability of $127,500 at June 30, 2005, which is the fair market value of 750,000 shares relating to this provision. In accordance with this agreement, on March 31, 2006, the Company issued 1,500,000 shares of its common stock to its CEO for the calendar year 2005 period. The fair market value of the shares at that date was $420,000.
     On June 5, 2006, the Company entered into another employment agreement for the period January 1, 2006 through December 31, 2006, whereby it will accrue 175,000 phantom shares of its common stock per month payable to its CEO. A cash payment will be made to the CEO equal to the price per share of the Company’s common stock times the number of phantom shares accrued at the earliest of certain Event Dates (as defined). Accordingly, the Company has accrued a compensation liability of $267,750 at June 30, 2006, which is the fair market value of 1,050,000 shares relating to this provision.
     During the fiscal year ended June 30, 2005, the Company entered into various consulting agreements with different individuals. All of these agreements related to providing services to the Company regarding the development of the market for the Company’s CVProfilor® DO-2020 CardioVascular Profiling System. In consideration for the consulting services, the Company agreed to pay certain consulting fees and granted certain stock options. The fair value of the options granted was determined utilizing the Black-Scholes pricing model and the total fair value was amortized / expensed in accordance with the term of each consulting agreement. The total amount expensed regarding these consulting agreements during the fiscal years ended June 30, 2006 and 2005 was $0 and $21,278, respectively.

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Table of Contents

Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
3. Shareholders’ Equity (Continued)
     In connection with certain litigation (see Note 12), in December 2005, the Company issued a stock certificate for 714,286 shares of the Company’s common stock to the Hennepin County Court Administrator. The fair market value of the shares at that date was $91,618.
     Conversion of Preferred Stock into Common Stock
     During the fiscal years ended June 30, 2006 and 2005, certain holders of the Company’s Series A Convertible Preferred Stock elected to convert their shares into shares of the Company’s common stock at a conversion rate of twelve (12) shares of common stock for each share of Series A Convertible Preferred Stock. An aggregate o 199,349 shares of Series A Convertible Preferred Stock were converted into an aggregate of 2,392,188 shares of common stock for the fiscal year ended June 30, 2006 and an aggregate of 101,847 shares of Series A Convertible Preferred Stock were converted into an aggregate of 1,222,164 shares of common stock for the fiscal year ended June 30, 2005.
     Exercise of Warrants and Options
     The following is a summary of preferred stock and common stock purchase warrants that were exercised:
                                 
    Preferred Stock     Common Stock  
    Shares     Amount     Shares     Amount  
FISCAL YEAR ENDED JUNE 30, 2006
                               
 
                               
August 28, 2003 Placement
Warrant B (Preferred — $2.64/share;
    Common — $0.22/share)
    116,956     $ 308,757       1,859,927     $ 409,180  
 
                               
February 9, 2004 Placement
Warrant A (Preferred — $2.04/share;
     Common — $0.17/share)
    38,207       77,942       607,611       103,294  
 
                               
Publicly Traded Warrants
Redeemable Class B Warrants
     (Common — $0.22/share)
    N/A       N/A       340,011       74,803  
 
                       
     TOTAL
    155,163     $ 386,699       2,807,549     $ 587,277  
 
                       
 
                               
FISCAL YEAR ENDED JUNE 30, 2005
                               
 
                               
August 28, 2003 Placement
Warrant A (Preferred — $2.04/share;
     Common — $0.17/share)
    152,710     $ 311,528       2,428,564     $ 412,856  
 
                               
February 9, 2004 Placement
Warrant A (Preferred — $2.04/share;
     Common — $0.17/share)
    61,064       124,571       970,977       165,066  
 
                       
     TOTAL
    213,774     $ 436,099       3,399,541     $ 577,922  
 
                       

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
3. Shareholders’ Equity (Continued)
     During the fiscal year ended June 30, 2005, certain stock options totaling 72,000 shares of common stock were exercised resulting in total proceeds to the Company of $16,080.
     The following is a summary of the outstanding stock purchase warrants as of June 30, 2006:
                                                 
    Warrant A     Warrant B     Warrant C  
    Preferred     Common     Preferred     Common     Preferred     Common  
    $2.04     $.17     $2.64     $.22     $3.60     $.30  
August 2003 Placement
    585,980       9,318,866       468,797       7,455,114       410,198       6,523,233  
 
                                               
Exercised during fiscal 2004
    (99,391 )     (1,580,623 )                        
Exercised during fiscal 2005
    (152,710 )     (2,428,564 )                        
Expired during fiscal 2005
    (333,879 )     (5,309,679 )                        
 
                                   
 
                                               
Outstanding Balance, June 30, 2005
                468,797       7,455,114       410,198       6,523,233  
 
Exercised during fiscal 2006
                (116,956 )     (1,859,927 )            
Expired during fiscal 2006
                (262,031 )     (4,167,016 )            
 
                                   
 
                                               
Outstanding Balance, June 30, 2006
                89,810       1,428,171       410,198       6,523,233  
 
                                               
Expiration Date
                12/15/06       12/15/06       8/28/08       8/28/08  
 
                                               
February 2004 Placement
    118,113       1,878,365       94,496       1,502,702       82,686       1,314,868  
 
                                               
Exercised during fiscal 2005
    (61,064 )     (970,977 )                        
Expired during fiscal 2005
    (18,842 )     (299,777 )                        
 
                                   
 
                                               
Outstanding Balance, June 30, 2005
    38,207       607,611       94,496       1,502,702       82,686       1,314,868  
 
                                               
Exercised during fiscal 2006
    (38,207 )     (607,611 )                        
Expired during fiscal 2006
                                   
 
                                   
 
                                               
Outstanding Balance, June 30, 2006
                94,496       1,502,702       82,686       1,314,868  
 
                                               
Expiration Date
                12/15/06       12/15/06       2/9/09       2/9/09  

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
4. Stock Options and Warrants
During 1995, the Company adopted the Hypertension Diagnostics, Inc. 1995 Long-Term Incentive and Stock Option Plan (“the 1995 Option Plan”) that includes both incentive stock options and nonqualified stock options to be granted to employees, directors, officers, consultants and advisors of the Company. The maximum number of shares reserved under the Plan is 400,000 shares. The Board of Directors establishes the terms and conditions of all stock option grants, subject to the 1995 Option Plan and applicable provisions of the Internal Revenue Code. Incentive stock options must be granted at an exercise price not less than the fair market value of the common stock on the grant date. The options granted to participants owning more than 10% of the Company’s outstanding voting common stock must be granted at an exercise price not less than 110% of fair market value of the common stock on the grant date. The options expire on the date determined by the Board of Directors but may not extend more than ten years from the grant date while incentive stock options granted to participants owning more than 10% of the Company’s outstanding voting stock expire five years from the grant date. At September 22, 2005, the 1995 Option Plan terminated, at which time there were 2,500 shares available for grant.
     A summary of outstanding options under the 1995 Option Plan is as follows:
                         
                    Weighted  
                    Average  
    Shares             Exercise  
    Available     Options     Price  
    for Grant     Outstanding     per Share  
Balance at June 30, 2004
    29,000       346,000     $ 2.04  
Granted
    (287,000 )     287,000       0.16  
Exercised
                 
Canceled/forfeited
    260,500       (260,500 )     2.06  
 
                   
Balance at June 30, 2005
    2,500       372,500       0.58  
Granted
                 
Exercised
                 
Canceled/forfeited
    (2,500 )     (7,500 )     2.20  
 
                   
Balance at June 30, 2006
          365,000       0.54  
 
                   
At June 30, 2006, there were 365,000 options outstanding having exercise prices between $0.15 and $2.20 that had been granted under the 1995 Option Plan. The outstanding options had a weighted average remaining contractual life of 6.70 years. The number of options exercisable as of June 30, 2006 and 2005 were 365,000 and 354,200, respectively, at weighted average exercise prices of $0.54 and $0.59 per share, respectively. The weighted average fair value of options granted under the 1995 Option Plan during the year ended June 30, 2005 was $0.13 per share.
     On May 1, 1998, the Board of Directors approved the 1998 Stock Option Plan (the “1998 Option Plan”), under which stock options may be granted to employees, consultants and independent directors of the Company, up to a maximum of 750,000 shares. Stock options may be either qualified or nonqualified for income tax purposes. On December 10, 2001, shareholders of the Company approved an amendment to the Company’s 1998 Option Plan to increase the number of shares reserved under the 1998 Option Plan from 750,000 to 1,250,000. Under the terms of the 1998 Option Plan, incentive stock options must be granted at an exercise price not less than the fair market value of the common stock on the grant date. The options granted to participants owning more than 10% of the Company’s outstanding voting common stock must be granted at an exercise price not less than 110% of the fair

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
4. Stock Options and Warrants (Continued)
market value of the common stock on the grant date. The options expire on the date determined by the Board of Directors but may not extend more than ten years from the grant date while incentive stock options granted to participants owning more than 10% of the Company’s outstanding voting stock expire five years from the grant date. The 1998 Option Plan is administered in a similar manner to the 1995 Option Plan.
     A summary of outstanding options under the 1998 Option Plan is as follows:
                         
                    Weighted  
                    Average  
    Shares             Exercise  
    Available     Options     Price  
    for Grant     Outstanding     per Share  
Balance at June 30, 2004
    34,620       1,141,380     $ 1.84  
Granted
    (202,572 )     202,572       0.17  
Exercised
          (72,000 )     0.22  
Canceled/forfeited
    168,952       (168,952 )     3.59  
 
                   
Balance at June 30, 2005
    1,000       1,103,000       1.37  
Granted
    (45,000 )     45,000       0.25  
Exercised
                 
Canceled/forfeited
    45,000       (45,000 )     0.17  
 
                   
Balance at June 30, 2006
    1,000       1,103,000       1.37  
 
                   
     At June 30, 2006, there were 1,103,000 options outstanding having exercise prices between $0.165 and $6.12 that had been granted under the 1998 Option Plan. The outstanding options had a weighted average remaining contractual life of 5.93 years. The number of options exercisable as of June 30, 2006 and 2005 were 1,103,000 and 1,028,000, respectively, at weighted average exercise prices of $1.37 and $1.45 per share, respectively. The weighted average fair value of options granted under the 1998 Option Plan during the years ended June 30, 2006 and 2005 was $0.20 and $0.13 per share, respectively.
     On October 31, 2003, the Board of Directors approved the 2003 Stock Plan (the “2003 Option Plan”), under which stock options, stock appreciation rights, restricted stock and deferred stock may be granted to employees, consultants and independent directors of the Company. On November 10, 2005, the Board of Directors approved the following amendments to the 2003 Option Plan: 1) changed the definition of the term “Stock” to exclude Series A Convertible Preferred Stock; 2) changed the Shares Reserved for Issuance to exclude six million (6,000,000) shares of Series A Convertible Preferred Stock; and 3) eliminated the annual automatic grant of stock options to non-employee directors. Stock options granted may be either qualified or nonqualified for income tax purposes. Up to a maximum of 4,000,000 shares of common stock may be issued under the 2003 Option Plan. Under the terms of the 2003 Option Plan, incentive stock options must be granted at an exercise price not less than the fair market value of the common stock on the grant date. The options granted to participants owning more than 10% of the Company’s outstanding voting stock must be granted at an exercise price not less than 110% of the fair market value of the common stock on the grant date. The options expire on the date determined by the Board of Directors but may not extend more than ten years from the grant date while incentive stock options granted to participants owning more than 10% of the Company’s outstanding voting stock expire five years from the grant date. The 2003 Option Plan is administered in a similar manner to the 1995 and 1998 Option Plans.

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
4. Stock Options and Warrants (Continued)
     A summary of outstanding options under the 2003 Option Plan is as follows:
                         
                    Weighted  
                    Average  
    Shares             Exercise  
    Available     Options     Price  
    for Grant     Outstanding     per Share  
Balance at June 30, 2004
    1,586,500       2,413,500     $ 0.21  
Granted
    (1,298,728 )     1,298,728       0.16  
Exercised
                 
Canceled/forfeited
    135,000       (135,000 )     0.19  
 
                   
Balance at June 30, 2005
    422,772       3,577,228       0.19  
Granted
    (380,000 )     380,000       0.20  
Exercised
                 
Canceled/forfeited
    560,386       (560,386 )     0.20  
 
                   
Balance at June 30, 2006
    603,158       3,396,842       0.19  
 
                   
     At June 30, 2006, there were 3,396,842 options outstanding having exercise prices between $0.15 and $0.35 that had been granted under the 2003 Option Plan. The outstanding options had a weighted average remaining contractual life of 7.79 years. The number of options exercisable as of June 30, 2006 and 2005 were 3,396,842 and 1,400,227, respectively, at weighted average exercise prices of $0.19 and $0.19 per share, respectively. The weighted average fair value of options granted under the 2003 Option Plan during the year ended June 30, 2006 and 2005 was $0.16 and $0.13 per share, respectively.
     On November 10, 2005, the Board of Directors approved the 2005 Stock Plan (the “2005 Option Plan”), under which stock options, stock appreciation rights, restricted stock and deferred stock may be granted to employees, consultants and independent directors of the Company. Stock options granted will be nonqualified for income tax purposes. Up to a maximum of 6,000,000 shares of common stock may be issued under the 2005 Option Plan. The options granted to participants owning more than 10% of the Company’s outstanding voting stock must be granted at an exercise price not less than 110% of the fair market value of the common stock on the grant date. The options expire on the date determined by the Board of Directors but may not extend more than ten years from the grant date. The 2005 Option Plan is administered in a similar manner to the 1995, 1998 and 2003 Option Plans. There were no 2005 Option Plan options granted during the year ended June 30, 2006.
     At June 30, 2006, the Company had also granted a total of 37,500 options outside the 1995 Option Plan, the 1998 Option Plan, the 2003 Option Plan and the 2005 Option Plan. These options have exercise prices between $2.00 and $3.70 and a weighted average remaining contractual life of 3.52 years. These options were granted at an exercise price not less than the fair market value of the common stock on the date of grant. Of the 37,500 options granted, 12,500 were granted July 1, 1997 to a certain officer of the Company, under which no compensation cost was recognized. The remainder, 25,000 options, were granted for consulting services provided to the Company. The fair value of these services were estimated using the Black-Scholes option pricing model and were expensed as services were provided. The number of non-Plan options exercisable at June 30, 2006 and 2005 were 37,500 and 1,046,257, respectively, at weighted average exercise prices of $3.13 and $1.77, respectively. There were no non-Plan options granted during the years ended June 30, 2006 and 2005, respectively.

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
4. Stock Options and Warrants (Continued)
     During fiscal year 2002, the Company issued a total of 670,000 warrants, of which 250,000 remain outstanding at June 30, 2006. During fiscal year 2003, the Company issued a total of 100,000 warrants which expired in December 2005. During fiscal year 2004, the Company issued a total of 850,695 warrants which remain outstanding at June 30, 2006. All of the above outstanding warrants have exercise prices between $.25 and $3.39 and expire as follows: March 2007 – 250,000; August 2008 – 850,695.
5. License Agreement
     In September 1988, the Company entered into a license agreement with the Regents of the University of Minnesota (the “Regents”), whereby the Company was granted a license to utilize certain technology developed by the Regents. Under the license agreement, the Company is required to pay royalties on net product revenue containing the technology licensed from the Regents. In the first two years after execution of the agreement, royalties were 1% of net revenue, and for the third and fourth years were 1.5% of net revenue. Beginning in the fifth year, and continuing through the termination of the agreement, royalties were 2% of net revenue, and 3% if the Regents obtained a United States patent on any of the technology covered under the agreement, which occurred. Termination occurs with the expiration of the last patent, or ten years after the date of the first commercial product revenue, if no patent exists. Royalties expense was $53,129 and $30,188 in fiscal years 2006 and 2005, respectively.
6. Employee Benefit Plan
     The Company maintains a Simplified 401(k) qualified retirement plan, which is funded by elective salary deferrals by employees. The Plan covers substantially all employees meeting minimum eligibility requirements. The Plan requires mandatory contributions by the Company. The Company makes contributions on behalf of qualifying contributing participants making elective deferrals in an amount equal to 100% of the elective deferral, not to exceed 3% of employee’s compensation. The matching contributions expense amounted to $28,852 and $18,970 in fiscal years 2006 and 2005, respectively.
7. Commitments
     Subsequent to June 30, 1997, the Company entered into a non-cancelable operating lease agreement for approximately 6,900 square feet of office/warehouse space. Effective September 16, 2003, the term of this operating lease was extended for thirty-six (36) months from November 1, 2003 to October 31, 2006. Effective August 11, 2006, the term of this operating lease was extended for forty-eight (48) months from November 1, 2006 to October 31, 2010. Rent expense was $90,042 and $87,195 in fiscal years 2006 and 2005, respectively.
     The following is a schedule of future minimum lease payments due as of June 30, 2006:
         
Year ending June 30:
       
2007
  $ 80,867  
2008
    77,733  
2009
    76,046  
2010
    78,825  
2011
    26,584  
 
     
 
  $ 340,055  
 
     

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
8. Significant Customers and Credit Risk
     Revenue from the Company’s products is concentrated among specific customers in the same industry. The Company generally does not require collateral.
     Customers that accounted for more than 10% of total revenue are as follows:
                 
    Year Ended June 30
    2006   2005
Customer A
    0%       13.1%  
9. Quarterly Financial Data (unaudited, in thousands, except per share data)
                                 
    First     Second     Third     Fourth  
Fiscal Year Ended   Quarter     Quarter     Quarter     Quarter  
June 30, 2006:
                               
Revenue
  $ 381     $ 541     $ 572     $ 296  
Gross Profit
    348       511       546       294  
Net (Loss)
    (337 )     (284 )     (276 )     (376 )
Basic and Diluted
                               
Net (Loss) per Share
    (.01 )     (.01 )     (.01 )     (.01 )
 
                               
June 30, 2005:
                               
Revenue
  $ 254     $ 292     $ 215     $ 421  
Gross Profit
    206       240       188       363  
Net (Loss)
    (434 )     (440 )     (356 )     (225 )
Basic and Diluted
                               
Net (Loss) per Share
    (.01 )     (.02 )     (.01 )     (.01 )
10. Litigation
     On March 17, 2004, the Company received a letter from counsel for one of its employees alleging that the Company’s reimbursement practices were illegal and unethical and also alleging violation of applicable “whistleblower” statutes. On March 18, 2004, the Company received a letter from counsel for one of its former employees alleging that the Company failed to pay for accrued vacation time and also alleging violation of applicable “whistleblower” statutes. On August 25, 2004, the Company entered into a binding memorandum of understanding with these individuals agreeing to settle these disputes. As settlement in full of these employees’ claims, the Company agreed to pay the individuals an aggregate amount of $130,000 in cash and to issue shares of unrestricted Company common stock with a market value of $100,000. The Company also retained a reimbursement consultant to investigate the whistleblower claims, and such consultant indicated its belief that such claims lack merit.
     In May 2005, plaintiffs filed a motion to enforce the memorandum of understanding. The Company filed a counter-motion seeking to enforce the return of property provisions in the memorandum of understanding. On September 9, 2005, the Hennepin County District Court (“the Court”) ruled in favor of plaintiffs. Pursuant to the Order, on September 30, 2005, the Company provided the Court with a check for deposit in the Court’s account in

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Hypertension Diagnostics, Inc.
Notes to Financial Statements
June 30, 2006 and 2005
10. Litigation (Continued)
the amount of $138,382 ($130,000 for the cash portion of the mediated settlement, and $8,382 for court and administrative costs and interest) to secure the judgement pending post-Order motions seeking further relief. The Company filed a Notice of Appeal of the Court’s decision on November 7, 2005. On December 14, 2005, the Court denied plaintiffs’ motion for a supersedes bond and instead ordered the defendants to deliver to the Hennepin County Court Administrator a stock certificate for 714,286 shares of the Company’s common stock. Additionally, the Court ordered that the $138,382 in funds on deposit with the Court shall remain on deposit with the Court for the duration of the parties’ appeal process. On August 8, 2006, the Minnesota State Court of Appeals affirmed the decision of the Hennepin County District Court. The Company has decided not to appeal the Court of Appeals decision to the Minnesota State Supreme Court and has attempted to negotiate a cash settlement in lieu of payment of 714,286 shares of common stock which would now be required to be registered with the U.S. Securities and Exchange Commission. As of June 30, 2005, $230,000 had been accrued as accrued payroll regarding this matter. As of June 30, 2006, there is no amount accrued regarding this matter.
     The Company is involved in various other legal actions in the ordinary course of its business. Although the outcome of any such legal actions cannot be predicted, management believes that there are no pending legal proceedings against or involving the Company for which the outcome is likely to have a material adverse effect upon the Company’s financial position or results of operations.

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ITEM 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
     None.
ITEM 8A. Controls and Procedures
     (a) Evaluation of Disclosure Controls and Procedures
     Under the supervision and with the participation of our management, including our Chief Executive Officer, Mark N. Schwartz, and Manager of Finance and Accounting, Kellie D. Nelsen, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based upon that review, our Chief Executive Officer and Manager of Finance and Accounting have concluded that, as of the evaluation date, our disclosure controls and procedures were not operating effectively with respect to the matters referred to in paragraph (b) below, but were otherwise effective for gathering, analyzing and disclosing the information that we are required to disclose in the reports we file under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms.
     (b) Changes in Internal Control Over Financial Reporting
     During the course of their audit of our financial statements for June 30, 2006, our independent registered public accounting firm, Virchow, Krause & Company, LLP, advised management and the Audit Committee that our internal controls had allowed an error in revenue recognition and inventory. The revenue recognition error had two pieces. One caused an increase in revenue of approximately $24,000, the other caused a decrease in revenue of approximately $24,500 for the year ended June 30, 2006. The inventory error caused a reduction in cost of sales of approximately $25,000. As a result of this experience, we revised our procedures regarding revenue recognition and inventory control. They also noted potential issues regarding a lack of segregation of duties. We have determined the benefit related to correcting these issues is not cost effective for us.
     There have been no significant changes in our internal control over financial reporting that occurred during the fiscal period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
     We are in the process of complying with the mandates of Section 404 of the Sarbanes-Oxley Act of 2002. The U.S. Securities and Exchange Commission (“SEC”) recently adopted rules that delay our schedule for compliance with Section 404 until our fiscal year ending June 30, 2008. The regulatory agencies are continuing to study the issues surrounding compliance, particularly as it relates to smaller public companies. We have done due diligence to understand the requirements and corresponding work necessary to successfully document our system of internal control to the standards and satisfaction of third parties. The potential cost of compliance with Section 404 to our shareholders in relation to the benefits may be significant. In considering our compliance efforts, we believe that these additional costs and expenses will confirm the existence of an effective and functioning internal control system.
     We intend to diligently pursue implementation and compliance with Section 404 requirements. We do not believe it is in our shareholders’ best interests to incur unnecessary outsized costs in this effort, as we have an existing system of centralized review and controls. Consequently, we will make every effort to comply with Section 404 requirements, but also will attempt to minimize the expense of this effort. As a result of this cautioned approach and the complexity of compliance, there is a risk that, notwithstanding our best efforts, we may fail to demonstrate a compliance program that fully meets the standards of Section 404 as interpreted by our independent accountants.

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PART III
ITEM 9. Directors and Executive Officers of the Registrant
     Our Articles of Incorporation and Bylaws provide that the Board of Directors is classified into three classes, Class I, II and III, with the members of each class to serve (after an initial transition period) for a staggered term of three years. As the term of each class expires, the directors (or their successors) in that class will be elected for an additional term of three years. As Class III directors, the terms of Mr. Brimmer and Dr. Cohn expire after fiscal year 2007. Mr. Schwartz was designated as a Class III director with a term expiring after fiscal year 2007. Mr. Guettler and Dr. Gerber were designated as Class II directors with terms expiring after fiscal year 2006. Messrs. Leitner and Stern were each designated as a Class I director with terms expiring after fiscal year 2008.
                     
Name   Age   Position   Director Since
Larry Leitner (1) (2)
    53     Director     2003  
Alan Stern (2)
    51     Director     2003  
Steven Gerber, M.D. (1)
    52     Director     2003  
Greg H. Guettler
    52     President, Secretary and Director     1997  
Mark N. Schwartz
    50     Chief Executive Officer and Chairman of the Board of Directors     2003  
Kenneth W. Brimmer(1) (2)
    51     Director     1995  
Jay N. Cohn, M.D.
    76     Director     1988  
James S. Murphy (3)
    62     Senior Vice President, Finance and Administration and Chief Financial Officer        
 
(1)   Member of the Audit Committee
 
(2)   Member of the Compensation Committee
 
(3)   Effective June 30, 2006, Mr. Murphy resigned from the Company. Effective July 1, 2006, his duties and responsibilities have been transitioned to Kellie D. Nelsen, Manager of Finance and Accounting. Ms. Nelsen will serve as principal financial officer and principal accounting officer for the Company.
     Larry Leitner – Mr. Leitner is a founding partner of Specialty Commodities, Inc., an international commodities importing, trading, and distribution company established in 1987 with offices and warehouses in Los Angeles, California and Fargo, North Dakota. Specialty Commodities, Inc. is one of the largest importers and distributors of nuts, dried fruits, seeds, and grains, supplying the snack food, health, food, bakery and bird food industries in North America and Europe. Since March 2001, Mr. Leitner has also been a partner in Suntree, LLC, a California manufacturer, roaster and packager of nuts and dried fruits established in 1996, supplying major supermarkets and club stores in the United States. He received his Bachelor of Science degree from North Dakota State University.
     Alan Stern – Mr. Stern is a founding partner of Specialty Commodities, Inc., an international commodities importing, trading, and distribution company established in 1987 with offices and warehouses in Los Angeles, California and Fargo, North Dakota. Specialty Commodities, Inc. is one of the largest importers and distributors of nuts, dried fruits, seeds and grains, supplying the snack food, health food, bakery and bird food industries in the North America and Europe. Since March 2001, Mr. Stern has also been a partner in Suntree, LLC, a California manufacturer, roaster and packager of nuts and dried fruits established in 1996, supplying major supermarkets and club stores in the United States. He received his Bachelor of Arts degree from the City of London School of Business Studies (City University).
     Steven Gerber, M.D. – Since January 2004, Dr. Gerber has served as Managing Director and Director of Research for Wedbush Morgan Securities. From 1997 to 2002, he was Managing Director and Head of Healthcare Research for CIBC World Markets. Dr. Gerber received an MBA from UCLA, an M.D. from Tufts University and

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a B.A. from Brandeis University. He is also a diplomate of the American Boards of Internal Medicine and Cardiovascular Disease. Dr. Gerber is a member of the Board of Overseers of Tufts University School of Medicine, and a medical expert for the Social Security Administration. He serves on the Boards of Directors of HemaCare Corporation, a publicly-held blood services company, Conor Medsystems, Inc., a publicly-held medical devices company and Immusol, Inc., a privately-held biotechnology company.
     Greg H. Guettler – Mr. Guettler has been our President and a Director since September 1997. Mr. Guettler has more than 25 years of experience in sales, marketing and management positions within the medical industry. Prior to joining us, from May 1983 to September 1997, Mr. Guettler was a senior manager at Universal Hospital Services, Inc., or UHS, a nationwide provider of medical devices and “per-use” device management services to the health care industry. During his 14 years at UHS, Mr. Guettler held positions as Director of National and Strategic Accounts where he led a national accounts sales team, as Director of Alternate Care and Specialty Product Promotions where he was responsible for the development of UHS’s alternate care business unit and the nationwide distribution of new medical products, and as Marketing Manager where he was responsible for company-wide marketing and planning. Additionally, Mr. Guettler has held territory, sales, sales management, product management, marketing and business development positions for the American Red Cross Blood Services. Mr. Guettler holds a Bachelor of Arts degree from the University of St. Thomas in St. Paul, Minnesota (1977) and a Master of Business Administration degree (M.B.A.) from the University of St. Thomas Graduate School of Management in St. Paul, Minnesota (1983).
     Mark N. Schwartz – Mr. Schwartz has been our Chief Executive Officer and Chairman of our Board since September 2003. From November 1999 to August 2003, Mr. Schwartz was Chief Financial Officer and served on the Board of Directors of DDD Group plc, a digital media company focused on developing 3D technology for the corporate and consumer markets, which is publicly traded on the London Stock Exchange’s Alternative Investment Market, or AIM. While at DDD, Mr. Schwartz was responsible for arranging the listing and initial public offering of DDD on AIM. Previously, he founded and was Chief Financial Officer of Bodega Latina Corporation, a Latino oriented grocery retailer operating warehouse supermarkets in the Los Angeles area with sales of approximately $200 million. From 1982 to 1985, Mr. Schwartz was an investment banker at Credit Suisse First Boston and Donaldson Lufkin & Jenrette, where he secured, structured and negotiated the first round of institutional financing for Starbucks Coffee and also served on their Board of Directors. He received a Bachelor of Arts degree in economics and political science from Claremont McKenna College and a Masters of Business Administration degree with honors from Harvard Business School.
     Kenneth W. Brimmer – Mr. Brimmer was elected to our Board of Directors in November 1995, and served as the Chairman of our Board from June 5, 2000 to August 28, 2003. Since 1998, Mr. Brimmer has served as a director, and since February 2000 has served as the Chairman of the Board of Directors, of STEN Corporation, a publicly-traded, diversified business and as the CEO of the company since October 2003. Since December 2001, Mr. Brimmer has also served as Chief Manager of Brimmer Company, LLC. From April 2002 until June 2003, he served as Chairman and Director of Active IQ Technologies, Inc. and was Chief Executive Officer from April 2000 until December 2001. Previously, Mr. Brimmer was President of Rainforest Cafe, Inc. from April 1997 until April 2000 and was Treasurer of Rainforest Café from its inception during 1995 until April 2000. Mr. Brimmer was employed by Grand Casinos, Inc. and its predecessor from October 1990 until April 1997. Mr. Brimmer currently serves as a member of the Board of Directors of New York Stock Exchange listed Landry’s Restaurants, Inc. Mr. Brimmer is a member of the Board of Directors of Vioquest Pharmaceuticals, Inc. and Entrx Corporation and is Chairman of the Board of Directors of Spectre Gaming, Inc. Mr. Brimmer holds a Bachelor of Arts degree in accounting from Saint John’s University in Collegeville, Minnesota (1977).
     Jay N. Cohn, M.D. – Dr. Cohn has served as a member of our Board of Directors since our inception in July 1988. Since 1974, Dr. Cohn has been employed by the University of Minnesota Medical School as a Professor of Medicine and he was Head of its Cardiovascular Division from 1974 through 1997. Dr. Cohn discovered that arterial elasticity indices could be determined from blood pressure waveforms in the late 1970’s and he is a co-inventor of the pulse contour analysis technology used in our CardioVascular Profiling System Products. Dr. Cohn is our Chief Medical Consultant and has been a consultant to several pharmaceutical firms both in the U.S. and overseas. He became the Chairman of our Scientific and Clinical Advisory Board during 1996. Dr. Cohn is a past President of the American Society of Hypertension, the International Society of Hypertension and the Heart Failure Society of America, and is a member of some 17 professional societies. He is immediate past editor-in-chief of the

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Journal of Cardiac Failure, has authored more than 600 scientific articles, is a member of the editorial board of 15 professional journals and is co-editor of the textbook, Cardiovascular Medicine. Dr. Cohn also serves as Chairman of the Board of Directors of Cohn Prevention Centers (CPC), a development stage company intending to create a nationwide network of clinics providing cardiovascular health assessment. Dr. Cohn received his M.D. degree from Cornell University (1956).
     James S. Murphy – From March 2000 to June 30, 2006, Mr. Murphy served as our Senior Vice President, Finance and Administration and Chief Financial Officer. Mr. Murphy joined us as Vice President of Finance and Chief Financial Officer in May 1996 and served in that capacity until March 2000. Mr. Murphy was Controller of Gaming Corporation of America from December 1992 through November 1995. From 1978 to 1988, he was a tax partner with Fox, McCue and Murphy, a certified public accounting firm located in Eden Prairie, Minnesota. From 1970 to 1978, Mr. Murphy was employed by Ernst & Ernst (currently named Ernst & Young LLP) with both audit (six years) and tax (two years) experience. Mr. Murphy currently serves on the Board of Directors of Lightning Rod Software, Inc. Mr. Murphy is a member of the American Institute of Certified Public Accountants as well as the Minnesota Society of CPAs. He holds a Bachelor of Science degree from Saint John’s University in Collegeville, Minnesota (1966) and a Master of Business Administration degree (M.B.A.) from the University of Minnesota (1968).
     Kellie D. Nelsen – Ms. Nelsen joined the company in May 2006 as manager of finance and accounting. Ms. Nelsen was a senior accountant with Carlson Companies from April 2004 to May 2006. From November 2001 to April 2004, Ms. Nelsen was a senior accountant in the Business Services Group for Wipfli, LLP, a certified public accounting firm. From June 2000 to November 2001, Ms. Nelsen was a staff accountant for Larson Allen Weisher, a certified public accounting firm. Ms. Nelsen is a member of the American Institute of Certified Public Accountants as well as the Minnesota Society of CPAs. She holds a Bachelor of Science degree from Delaware Valley College in Doylestown, Pennsylvania (2000).
     (a) Significant Employees
     Other than our officers and George T. Welisevich, our Customer Service Manager, there are no employees who are expected to make a significant contribution to our corporation.
     George T. Welisevich – Mr. Welisevich joined the company in October 2004 as our Customer Service Manager. Mr. Welisevich brings more than 20 years of experience in the medical device industry with various roles in Customer Service, Sales Support, Distribution and Operations. From February 1983 to October 2004, Mr. Welisevich was with the company know known as Smiths Medical, a medical device manufacturer located in St. Paul, MN. He held numerous management positions and most recently was the Customer Service and Sales Support Manager for the start up Diabetes Division which was launched in 2002.
     (b) Family Relationships
     There are no family relationships among any of our directors and executive officers. There are no family relationships among our officers, directors, or persons nominated for such positions.
     (c) Legal Proceedings
     No officer, director, or persons nominated for these positions, and no promoter or significant employee of our corporation has been involved in legal proceedings that would be material to an evaluation of our management.
     (d) Audit Committee
     The Board of Directors has an Audit Committee currently comprised of Kenneth W. Brimmer, Larry Leitner and Steven Gerber, M.D. Kenneth W. Brimmer is serving on our audit committee as an audit committee financial expert. The Audit Committee operates under an Audit Committee Charter, adopted effective June 5, 2000, and amended and restated on October 31, 2003. Each of the members of the Audit Committee is an independent director as defined by The Nasdaq Stock Market, Inc. listing standards. The Audit Committee of the Board of Directors is responsible for the selection and approving the compensation of the independent auditors, providing

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independent, objective oversight of our financial reporting system by overseeing and monitoring management’s and the independent auditors’ participation in the financial reporting process.
     (e) Compensation Committee
     The Board of Directors has a Compensation Committee currently comprised of Kenneth W. Brimmer, Larry Leitner and Alan Stern. Each of the members of the Compensation Committee is an independent director as defined by The Nasdaq Stock Market, Inc. listing standards. The Compensation Committee of the Board of Directors is responsible for recommending compensation programs for our executive management and equity-based compensation for employees, officers, and consultants.
     Code of Ethics
     We adopted a code of ethics that applies to our principal chief executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions (the “Code of Ethics”). A copy of the Code of Ethics can be obtained, and will be provided to any person without charge, upon written request to the Company’s Secretary at the Company’s headquarters address. The code of ethics is available on our website.
     Compliance with Section 16 of the Securities Exchange Act of 1934
     Section 16(a) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) requires our directors and executive officers and beneficial holders of more than 10% of our common stock to file with the Commission initial reports of ownership and reports of changes in ownership of our equity securities. As of the date of this Report, we believe that all reports needed to be filed, with the exception of reports to be filed in connection with certain acquisitions of derivative and non-derivative securities by the following officers/directors (Mark N. Schwartz – February, March and April 2006; Jay N. Cohn – June, 2006; Larry Leitner – March, 2006; Alan Stern – March, 2006) (which we believe were filed late), have been filed in a timely manner for the year ended June 30, 2006. In making this statement, we have relied solely on copies of any reporting forms received by us, and upon any written representations received from reporting persons that no Form 5 (Annual Statement of Changes in Beneficial Ownership) was required to be filed under applicable rules of the Commission.
ITEM 10. Executive Compensation
     The following table sets forth the cash and non-cash compensation for the years indicated earned by or awarded to Mark N. Schwartz, our Chief Executive Officer, and our only other executive officers and employees whose total cash compensation exceeded $100,000, or the Named Executive Officers and employees, in fiscal year 2006.
Summary Compensation Table
                                         
                            Long-Term        
            Annual Compensation     Compensation Awards        
    Fiscal Year             Bonus /             All Other  
Name and Principal Position   Ended June 30     Salary     Commission     Securities Underlying Options     Compensation  
Mark N. Schwartz
    2006     $ 88,308     $ 10,096             (A) $687,750  
Chief Executive Officer
    2005       76,428                   (B) $400,000  
 
    2004       58,858                      
 
                                       
Greg H. Guettler
    2006       168,000       47,280              
President and Secretary
    2005       158,343       13,000       659,809        
 
    2004       152,413             400,000        
 
                                       
James S. Murphy
    2006       147,271                    
Senior Vice President,
    2005       147,634             399,105        
Finance and Administration and Chief
    2004       142,464             150,000        
Financial Officer
                                       
 
                                       
William R. Sotka
    2006       57,572       32,922              
Managing Director-Sales
    2005       102,151       84,344       315,386        
 
    2004       108,110             200,000        
 
         
Note (A)
  - -   A bonus of 1,500,000 shares of our common stock was issued on March 31, 2006. The fair market value of those shares was $420,000. For the period January 1, 2006 through June 30, 2006, we have accrued a compensation liability of $267,750, which is the fair market value of 1,050,000 phantom shares of our common stock payable to Mr. Schwartz.
 
       
Note (B)
  - -   A bonus of 1,600,000 shares of our common stock was issued on March 31, 2005. The fair market value of those shares was $400,000.

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     No stock options were granted to named executive officers during the fiscal year ended June 30, 2006. The following table summarizes stock option exercises during the fiscal year ended June 30, 2006 and the total number of options held as of June 30, 2006 by the Named Executive Officers and employees.
Aggregated Option Exercises in Fiscal Year 2006 and
Fiscal Year End Option Values
                                                 
                    Number of Securities     Value of Unexercised  
    Shares             Underlying Unexercised     In-the-Money Options  
    Acquired     Value     Options at June 30, 2006     at June 30, 2006(1)  
Name   on Exercise     Realized     Exercisable     Unexercisable     Exercisable     Unexercisable  
Mark N. Schwartz
                          $     $  
Greg H. Guettler
                1,234,809             98,683        
James S. Murphy
                724,105             58,915        
William R. Sotka
                                   
 
(1)   The values have been calculated based on the closing sale price for our common stock as of June 30, 2006 of $0.26 per share (before payment of applicable income taxes).
Employment Agreement
     In connection with the August 2003 Private Placement, we entered into an employment agreement dated August 28, 2003 with Mr. Schwartz to serve as our Chief Executive Officer and Chairman of the Board. Pursuant to such employment agreement, Mr. Schwartz was provided a monthly salary of $6,000 cash. Effective March 1, 2005, the Compensation Committee of the Board of Directors approved an increase in the monthly cash salary from $6,000 to $7,000. Effective March 27, 2006, the Compensation Committee approved an increase in the monthly cash salary from $7,000 to $8,333. In addition, the employment agreement provides that a bonus or incentive compensation to be paid in shares of our common stock shall be approved by the Compensation Committee. Effective January 3, 2005, the Compensation Committee approved a bonus of 1,600,000 shares of our common stock to Mr. Schwartz for the period September 2003 to December 2004. They also approved a monthly bonus of 125,000 shares of our common stock to Mr. Schwartz for the months of January 2005 through December 2005, respectively.
     On June 5, 2006, we entered into a Deferred Equity Incentive Agreement (the “Agreement”) with Mr. Schwartz. The effective date of this Agreement is January 1, 2006. Under the terms and conditions of this Agreement, we intend to grant to Mr. Schwartz certain equity incentive compensation units (“Units”) that would: (1) have a current value related to the net value of our voting common stock; (2) increase or decrease with any future

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changes in the value of that stock; and (3) be payable in cash only upon certain events. For the period January 1, 2006 through December 31, 2006, we will grant to Mr. Schwartz one hundred seventy-five thousand (175,000) Units per month.
Compensation of Directors
     Members of our Board of Directors receive no cash compensation for such service. In December 2003, each of the following directors had been granted nonqualified options to purchase 300,000 shares of our common stock at an exercise price of $0.20 per share: Kenneth W. Brimmer; Jay N. Cohn; Alan Stern; Larry Leitner; and Steven Gerber.
     Pursuant to our 2003 Stock Option Plan, each non-employee director was to be granted a non-qualified five-year stock option to purchase 100,000 shares of our common stock for each year of service. Under the terms of this plan, each option will be granted at the commencement of each year and will vest in full on the first anniversary of the date of grant, provided that the director continues to serve as our director on such date. Following the August Placement, we granted each of Messrs. Brimmer, Cohn, Stern, Leitner and Gerber, our directors, an option to purchase 300,000 shares of our common stock (for an aggregate of options to purchase 1,500,000 shares of our common stock) at an exercise price of $0.25 per share, which would vest annually in equal increments over a three-year period in accordance with the terms of our 2003 Stock option Plan. On December 18, 2003, each director agreed to waive their rights to receive such options and agreed to accept new options to acquire 300,000 shares of our common stock at an exercise price of $0.20 per share, which options would vest annually in equal increments over a three-year period and expire after a period of ten years. The exercise price of future stock option grants will be determined by our Board of Directors.
ITEM 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
     Equity Compensation Plan Information
                                 
                            Number of securities  
                            remaining available  
                            for future issuance  
                            under equity  
    Number of securities to be     Weighted-average     compensation plans  
    issued upon exercise of     exercise price of     (excluding securities  
    outstanding options, warrants     outstanding options,     reflected in column  
Plan Category   and rights             warrants and rights     (a))  
 
  (a)     (b)     (c)  
Equity compensation plans approved by shareholders
  1995 Plan:     365,000     $ 0.54       0  
 
  1998 Plan:     1,103,000     $ 1.37       1,000  
 
  2003 Plan:     3,396,842     $ 0.19       603,158  
 
                               
Equity compensation plans not approved by shareholders
  2005 Plan:     0     $ 0.00       6,000,000  
 
  Other:     37,500     $ 3.13       N/A  
 
  2003 Plan:                        
 
                         
Total
  2003 Plan:     4,902,342     $ 0.50       6,604,158  
 
                         
Of the 37,500 shares of our common stock to be issued upon exercise of options granted pursuant to equity compensation plans not approved by shareholders, options to purchase up to an aggregate of 12,500 shares were granted to one of our officers prior to our initial public offering, with the option granted on July 1, 1997. This

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option is fully vested as of June 30, 2006 and expires 10 years from the date of grant. The remaining 25,000 shares were granted on April 12, 2001 as non-qualified stock options to individuals providing services to us at fair market value as of the date of grant. These options also expire 10 years from the date of grant and are fully vested.
     Security Ownership — Certain Beneficial Owners
     Beneficial ownership is shown as of September 14, 2006 for shares held by (i) each person or entity known to us to be the beneficial owner of more than 5% of our issued and outstanding shares of common stock based solely upon a review of filings made with the Commission and our knowledge of the issuances by us, (ii) each of our directors, (iii) our Chief Executive Officer and our two other most highly compensated officers whose compensation exceeded $100,000 during the fiscal year ended June 30, 2006, or the Named Executive Officers, and (iv) all of our current directors and executive officers as a group. Unless otherwise indicated, the persons listed below have sole voting and investment power with respect to the shares and may be reached at 2915 Waters Road, Suite 108, Eagan, Minnesota 55121.
                                         
                    Shares Presently           Percentage of Class
                    Acquirable           Beneficially
Beneficial Owner   Class     Shares   Within 60 Days(1)     Total   Owned
A Group Granting Proxies to Mark N. Schwartz (2)
  Common     19,023,133       10,768,974       29,792,107       58.5 %
 
  Preferred     1,172,421       677,190       1,849,611       100.0  
 
  Combined     33,092,185       18,895,254       51,987,439       74.5  
 
                                       
Mark N. Schwartz (3)(5)
  Common     5,290,483  (4)     606,606       5,897,089       14.5  
 
  Preferred      (4)     38,145       38,145       4.2  
 
  Combined     5,290,483  (4)     1,064,346       6,354,829       12.3  
 
                                       
Larry Leitner (3)
  Common     1,297,082  (4)     747,829       2,044,911       5.0  
 
  Preferred     61,440  (4)     28,160       89,600       10.0  
 
  Combined     2,034,362  (4)     1,085,749       3,120,111       6.0  
 
                                       
Alan Stern (3)
  Common     1,159,559  (4)     882,161       2,041,720       5.0  
 
  Preferred     60,294  (4)     36,608       96,902       10.7  
 
  Combined     1,883,087  (4)     1,321,457       3,204,544       6.2  
 
                                       
Steven Gerber (3)
  Common     152,670  (4)     371,246       523,916       1.3  
 
  Preferred     9,600  (4)     4,480       14,080       1.6  
 
  Combined     267,870  (4)     425,006       692,876       1.4  
 
                                       
Greg H. Guettler (3) (5)
  Common     45,356       1,265,344       1,310,700       3.2  
 
  Preferred     1,280       1,920       3,200       *  
 
  Combined     60,716       1,288,384       1,349,100       2.6  
 
                                       
James S. Murphy (5)
  Common     392,412  (6)     823,850       1,216,262       3.0  
 
  Preferred           6,272       6,272       1.0  
 
  Combined     392,412  (6)     899,114       1,291,526       2.5  
 
                                       
Jay N. Cohn (3)
  Common     1,198,764  (7)     702,737       1,901,501       4.7  
 
  Preferred     68,829       13,440       82,269       9.3  
 
  Combined     2,024,712  (7)     864,017       2,888,729       5.6  
 
                                       
Kenneth W. Brimmer (3)
  Common     196,992  (8)     454,245       651,237       1.6  
 
  Preferred     8,960       6,272       15,232       1.7  
 
  Combined     304,512  (8)     529,509       834,021       1.6  
 
                                       
All Officers and Directors as a Group (8 persons)
  Common     9,733,318  (9)     5,854,018       15,587,336       33.9  
 
  Preferred     210,403  (9)     135,297       345,700       34.3  
 
  Combined     12,258,154  (9)     7,477,582       19,735,736       34.0  

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All shares in each class noted below are also included in the shares shown as beneficially owned by “A Group Grantings Proxies to Mark N. Schwartz”
                                         
                    Shares Presently           Percentage of Class
                    Acquirable           Beneficially
Beneficial Owner   Class     Shares   Within 60 Days(1)     Total   Owned
Beljam Holdings, Ltd.
  Common     712,455       610,676       1,323,131       3.2  
8665 Wilshire Blvd., Ste. 200
  Preferred     44,800       38,400       83,200       9.1  
Beverly Hills, CA 90211
  Combined     1,250,055       1,071,476       2,321,531       4.5  
 
                                       
Jonathan Gross
  Common     295,162       264,628       559,790       1.4  
15 Rockwood Lane
  Preferred     18,560       16,640       35,200       4.0  
Suffern, NY 10901
  Combined     517,882       464,308       982,190       1.9  
 
                                       
Marten S. Hoekstra
  Common     2,370,723       712,433       3,083,156       7.5  
Zellerstrasse 62
  Preferred     149,082       44,799       193,881       21.2  
8038 Zurich
Switzerland
  Combined     4,159,707       1,250,021       5,409,728       10.4  
 
                                       
Roland Isaacson
  Common     587,039       319,169       906,208       2.2  
P.O. Box 542
  Preferred     36,914       20,070       56,984       6.4  
Big Lake, MN 55309
  Combined     1,030,007       560,009       1,590,016       3.1  
 
                                       
Michael Kest
  Common     814,235       284,982       1,099,217       2.7  
5150 Overland Avenue
  Preferred     51,200       17,920       69,120       7.8  
Culver City, CA 90230
  Combined     1,428,635       500,022       1,928,657       3.8  
 
                                       
James K. Cummings
  Common     488,543       223,916       712,459       1.8  
Living Trust
  Preferred     30,720       14,080       44,800       5.1  
16043 Temecula Street
  Combined     857,183       392,876       1,250,059       2.5  
Pacific Palisades, CA 90272
 
 
                                       
Weinstein Family Trust
  Common     488,543       223,916       712,459       1.8  
1640 - 5th Street, Suite 112
  Preferred     30,720       14,080       44,800       5.1  
Santa Monica, CA 90401
  Combined     857,183       392,876       1,250,059       2.5  
 
*   Less than 1%.
 
(1)   Shares of common stock subject to options and warrants that are currently exercisable or exercisable within 60 days are deemed to be beneficially owned by the person holding the options and warrants for computing such person’s percentage, but are not treated as outstanding for computing the percentage of any other person.
 
(2)   Irrevocable proxies representing the 18,644,933 shares of our common stock and 1,172,421 shares of our Series A Convertible Preferred Stock issued in the August 2003 and February 2004 Unit Placements and the exercise of warrants have been given to Mark N. Schwartz and will be voted in the manner described above under “Voting Agreement and Proxies.”
 
(3)   Director.
 
(4)   Except as noted with respect to 220,000 shares of common stock held by Mr. Leitner and 158,200 shares of common stock held by Mr. Stern (which shares are also represented in the Combined shares of each person), all amounts are also shown as beneficially owned by “A Group Granting Proxies to Mark N. Schwartz.”

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(5)   Named Executive Officer.
 
(6)   142,492 of these shares beneficially owned by Mr. Murphy are also included in shares shown as beneficially owned by “A Group Granting Proxies to Mark N. Schwartz.”
 
(7)   1,056,183 of these shares beneficially owned by Dr. Cohn are also included in shares shown as beneficially owned by “A Group Granting proxies to Mark N. Schwartz.”
 
(8)   142,492 of these shares beneficially owned by Mr. Brimmer are also included in shares shown as beneficially owned by “A Group Granting Proxies to Mark N. Schwartz.”
 
(9)   Shares shown are included in the amounts beneficially owned by “A Group Granting Proxies to Mark N. Schwartz” by class as follows: 9,495,644 shares of common stock, 210,403 shares of Series A Convertible Preferred Stock, and 12,020,480 shares of our common stock and Series A Convertible Preferred Stock, together as a class.
ITEM 12. Certain Relationships and Related Transactions
None.
ITEM 13. Exhibits and Reports on Form 8-K
  (a)   Exhibits
         
3.1
  Articles of Incorporation   Exhibit 3.1 of the Company’s Registration Statement on Form SB-2 (File No. 333-53025) filed on May 19, 1998, or the 1998 Registration Statement
 
       
3.2
  Bylaws   Exhibit 3.2 of the Company’s 1998 Registration Statement.
 
       
3.3
  Articles of Amendment of Incorporation dated June 2, 1998   Exhibit 3.3 of the Company’s 1998 Registration Statement.
 
       
4.1
  Specimen of common stock Certificate   Exhibit 4.1 of the Company’s 1998 Registration Statement.
 
       
4.2
  Specimen of Redeemable Class B Warrant Certificate   Exhibit 4.6 of Registration Statement on Form S-3 (File No. 333-53200) as dated January 4, 2001 and as subsequently amended.
 
       
4.3
  Amended and Restated Class B Warrant Agreement dated as of September 27, 2002 by and between Hypertension Diagnostics, Inc. and Mellon Investor Service, LLC as Warrant Agent.   Exhibit 4.1 of the Current Report on Form 8-K dated September 27, 2002.
 
       
4.4
  Amendment No. 1 dated October 17, 2002 to Amended and Restated Class B Warrant Agreement between Hypertension Diagnostics, Inc. and Mellon Investor Services, LLC.   Exhibit 4.2 of Current Report on Form 8-K dated October 17, 2002.
 
       
4.8
  Form of Common Stock Purchase Warrant issued dated March 27, 2002.   Exhibit 10.3 of the Current Report on Form 8-K dated March 27, 2002.
 
       
4.11
  Certificate of Designation, Preferences and Rights of Series A Convertible Preferred Stock   Exhibit 4.1 of the Company’s Current Report on Form 8-K dated August 28, 2003, or the August 8-K
 
       
4.12
  Form of Securities Purchase Agreement dated as of August 28, 2003 among Hypertension Diagnostics, Inc. and the Unit Investor parties thereto.   Exhibit 4.2 of the August 8-K.

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4.13
  Form of Common Stock Warrant originally issued August 28, 2003.   Exhibit 4.7 of the August 8-K.
 
       
4.14
  Form of Preferred Stock Purchase Warrant originally issued August 28, 2003.   Exhibit 4.6 of the August 8-K.
 
       
4.15
  Registration Rights Agreement dated as of August 28, 2003 among Hypertension Diagnostics, Inc. and the Purchaser parties thereto.   Exhibit 4.4 of the August 8-K.
 
       
4.16
  Shareholders’ Agreement dated as of August 28, 2003 by and among Hypertension Diagnostics, Inc. and the holders of Hypertension Diagnostics, Inc. Series A Convertible Preferred Stock.   Exhibit 4.5 of the August 8-K.
 
       
4.17
  Form of Irrevocable Proxy executed in connection with the Securities Purchase Agreement dated as of August 28, 2003.   Exhibit 4.8 of the August 8-K.
 
       
4.18
  Form of Irrevocable Proxy dated August 4, 2003 executed by Messrs. Brimmer, Cohn, Guettler, Murphy and Dr. Chesney.   Exhibit 4.10 of the August 8-K.
 
       
9.1
  Voting Agreement dated as of August 28, 2003 by and among the holders of Hypertension Diagnostics, Inc. Series A Convertible Preferred Stock.   Exhibit 4.3 of the August 8-K.
 
       
10.1
  1995 Long-Term Incentive and Stock Option Plan *   Exhibit 10.1 of the Company’s 1998 Registration Statement.
 
       
10.2
  1998 Stock Option Plan *   Exhibit 10.2 of the Company’s 1998 Registration Statement.
 
       
10.3
  Form of Stock Option Agreement for 1998 Stock Option Plan *   Exhibit 10.3 of the Company’s 1998 Registration Statement.
 
       
10.5
  Research and License Agreement between the Company and the Regents of the University of Minnesota, dated September 23, 1998   Exhibit 10.4 of the Company’s 1998 Registration Statement.
 
       
10.8
  Manufacturing Services Agreement between Apollo Research Corporation and the Company, dated May 14, 1998   Exhibit 10.13 of the Company’s 1998 Registration Statement.
 
       
10.15
  Letter Agreement dated February 21, 2001 by and between Hypertension Diagnostics, Inc. and Apollo Research Corporation, M. Terry Riggs and Randy Thorton   Exhibit 10.14 of the Company’s Annual Report on Form 10-KSB for the year ended June 30, 2003.
 
       
10.16
  Employment Agreement between Mark Schwartz and the Company, dated August 28, 2003*   Exhibit 10.16 of the Company’s Annual Report on Form 10-KSB for the year ended June 30, 2004
 
       
10.17
  Deferred Equity Incentive Agreement between Mark N. Schwartz and the Company, dated June 5, 2006*   Filed Herewith.
 
       
10.18
  2003 Stock Option Plan*   Exhibit 10.1 of the Company’s 2006 Form S-8 Registration Statement

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10.19
  2005 Stock Option Plan*   Exhibit 10.2 of the Company’s 2006 Form S-8 Registration Statement
 
       
23.1
  Consent of Independent Registered Public Accounting Firm   Filed Herewith.
 
       
31.1
  Certification of Chief Executive Officer pursuant to 13a-14 and 15d-14 of the Exchange Act   Filed Herewith.
 
       
31.2
  Certification of Chief Financial Officer pursuant to 13a-14 and 15d-14 of the Exchange Act   Filed Herewith.
 
       
32.1
  Certificate pursuant to 18 U.S.C. § 1350   Filed Herewith.
 
       
32.2
  Certificate pursuant to 18 U.S.C. § 1350   Filed Herewith.
 
*   Indicates a management contract or compensatory plan or arrangement
(b)   Reports on Form 8-K
 
    None
ITEM 14. Principal Accountant Fees and Services
     The following is a summary of the fees billed to us by Virchow, Krause & Company, LLP (“VK”) for professional services rendered for the years ended June 30, 2006 and 2005:
                 
    2006     2005  
Service   VK     VK  
Audit Fees
  $ 57,175     $ 45,200  
Audit Related Fees
    -0-       -0-  
Tax Fees
    -0-       -0-  
All other Fees
    -0-       -0-  
 
           
TOTAL
  $ 57,175     $ 45,200  
 
           
          Audit fees consist of the aggregate fees billed for professional services rendered for the audit of our annual financial statements, the reviews of the financial statements included in our Forms 10-QSB and for any other services that are normally provided by VK in connection with our statutory and regulatory filings or engagements.
          Audit related fees consist of the aggregate fees billed for professional services rendered for assurance and related services that were reasonably related to the performance of the audit or review of our financial statements that were not otherwise included in Audit Fees.
          Tax fees consist of the aggregate fees billed for professional services rendered for tax compliance, tax advice and tax planning. These services include assistance regarding federal, state and local tax compliance and consultation in connection with various transactions and acquisitions.

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          All other fees consist of the aggregate fees billed for products and services provided by VK and not otherwise included in Audit Fees, Audit Related fees or Tax Fees.
          The policy of our Audit Committee is to review and pre-approve both audit and non-audit services to be provided by the independent auditors (other than with de minimis exceptions permitted by the Sarbanes-Oxley Act of 2002). This duty may be delegated to one or more designated members of the Audit Committee with any such approval reported to the committee at its next regularly scheduled meeting. Approval of non-audit services shall be disclosed to investors in periodic reports required by section 13(a) of the Securities Exchange Act of 1934, as amended. All of the fees paid to VK were pre-approved by the audit committee.
          No services in connection with appraisal or valuation services, fairness opinions or contribution-in-kind reports were rendered by VK. Furthermore, no work of VK with respect to its services rendered to us was performed by anyone other than VK.

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SIGNATURES
     In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  HYPERTENSION DIAGNOSTICS, INC.
 
 
  /s/ MARK N. SCHWARTZ    
  MARK N. SCHWARTZ, Chief Executive Officer   
  (Principal executive officer)   
 
Dated: September 28, 2006
     In accordance with the requirements of the Exchange Act, this report has been signed below on behalf of the registrant and in the capacities indicated on September 28, 2006.
     Each person whose signature appears below constitutes and appoints Mark N. Schwartz and Kellie D. Nelsen as his true and lawful attorneys-in-fact and agents, each acting alone, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-KSB and to file the same, with all exhibits thereto, and other documents in connection therewith, with the U.S. Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, each acting alone, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all said attorneys-in-fact and agents, each acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof.
         
Signature       Title
 
       
/s/ MARK N. SCHWARTZ
      Chairman of the Board of Directors, Chief
 
Mark N. Schwartz
      Executive Officer (Principal executive officer)
 
       
/s/ LARRY LEITNER
 
      Director
Larry Leitner
       
 
       
/s/ ALAN STERN
 
Alan Stern
      Director
 
       
/s/ STEVEN GERBER
 
      Director
Steven Gerber
       
 
       
/s/ KENNETH W. BRIMMER
 
      Director
Kenneth W. Brimmer
       
 
       
/s/ GREG H. GUETTLER
 
      President, Secretary, and Director
Greg H. Guettler
       
 
       
/s/ JAY N. COHN
 
      Director
Jay N. Cohn
       
 
       
/s/ KELLIE D. NELSEN
      Manager of Finance and Accounting
 
Kellie D. Nelsen
      (Principal financial officer)

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