Filed Pursuant to Rule 424(b)(3)

File No. 333-126510

PROSPECTUS SUPPLEMENT NO. 1

(to Prospectus Dated July 19, 2005)

[Optical Sensors’ Logo]

7,452,361 Shares

Common Stock

This Prospectus Supplement No. 1 to Form SB-2 supplements the prospectus dated July 19, 2005 relating to the 7,452,361 shares of common stock of Optical Sensors Incorporated that may be offered for sale for the account of several stockholders of Optical Sensors, their respective pledgees, donees, transferees or other successors in interest, as stated under the heading “Plan of Distribution” in the original prospectus.

This Prospectus Supplement No. 1 is being filed to update the original prospectus with respect to developments in Optical Sensors’ business that have occurred since the date of the original prospectus and to include in the prospectus Optical Sensors’ financial statements for the quarter ended June 30, 2005. This Prospectus Supplement No. 1 is not complete without, and may not be delivered or utilized except in connection with, the original prospectus. This Prospectus Supplement No. 1 is qualified by reference to the original prospectus, except to the extent that the information contained in this Prospectus Supplement No. 1 supersedes the information contained in the original prospectus.

Recent Developments

Attached hereto and incorporated by reference herein is the Quarterly Report on Form 10-QSB of Optical Sensors Incorporated for the first quarter ended June 30, 2005, as filed with the Securities and Exchange Commission on August 15, 2005.

The common stock offered involves a high degree of risk. We refer you to “Risk Factors,” beginning on page 6 of the original prospectus.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this Prospectus Supplement No. 1 is truthful or complete. Any representation to the contrary is a criminal offense.

The date of this Prospectus Supplement No. 1 is August 15, 2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

(Mark One)

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

For the quarter ended June 30, 2005

or

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

For the transition period from              to             

Commission File Number: 0-27600

OPTICAL SENSORS INCORPORATED

(Exact name of small business issuer as specified in its charter)

Delaware	41-1643592
(State of other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

7615 Golden Triangle Drive, Suite C, Minneapolis, Minnesota	55344-3733
(Address of principal executive offices)	(Zip Code)

Issuer’s telephone number, including area code (952) 944-5857

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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.    x  Yes    ¨  No

As of August 8, 2005, the Issuer had 3,808,289 shares of Common Stock outstanding.

Transitional Small Business Disclosure Format (Check One):    ¨  Yes    x  No

Index

OPTICAL SENSORS INCORPORATED

			Page
Part I.	Financial Information
	Item 1.     Financial Statements (Unaudited)		2
		Balance Sheets – June 30, 2005 and December 31, 2004	2
		Statements of Operations – Three and Six Months ended June 30, 2005 and June 30, 2004	3
		Statements of Cash Flows – Six Months ended June 30, 2005 and June 30, 2004	4
		Notes to Financial Statements	5
	Item 2.     Management’s Discussion and Analysis or Plan of Operation		12
	Item 3.     Controls and Procedures		22
Part II.	Other Information
	Item 5.     Other Information		23
	Item 6.     Exhibits		24

1

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

Optical Sensors Incorporated d/b/a väsamed

Balance Sheet

	June 30, 2005			December 31,2004
	(Unaudited)			(Note)
Assets
Current assets:
Cash	$	111,189		$	8,759
Accounts receivable		176,064			184,963
Inventories		382,995			194,216
Prepaid expenses and other current assets		59,551			10,641
Total current assets		729,799			398,579
Property and equipment:
Leased equipment		1,157,989			1,157,989
Research and development equipment		831,624			831,624
Leasehold improvements		340,802			340,802
Furniture and equipment		339,128			304,754
Production equipment		532,471			518,418
Marketing equipment		19,001			—
		3,221,015			3,153,587
Less accumulated depreciation		(2,982,828	)		(2,951,654	)
		238,187			201,933
Other assets:
Patents, net of accumulated amortization of 2005—$532,209, 2004—$492,031		488,488			410,850
Other assets		9,723			9,723
		498,211			420,573
Total assets	$	1,466,197		$	1,021,085
Liabilities and shareholders’ equity (deficit)
Current liabilities:
Advances from shareholder	$	—		$	4,183,000
Accounts payable		338,243			139,717
Employee compensation		215,768			234,525
Accrued royalties		100,000			100,000
Other liabilities and accrued expenses		10,400			3,920
Accrued interest payable		—			54,849
Obligation under capital lease, current portion		4,500			—
Total current liabilities		668,911			4,716,011
Obligation under capital lease, less current portion		21,074			—
Total Liabilities		689,985			4,716,011
Shareholders’ equity (deficit):
Preferred stock, par value $0.01 per share (Series A, Series B and Series C: 4,333,334, 236,934 and 78,354 shares issued and outstanding, $1,500,000, $3,554,005 and $7,051,860 liquidation preference, respectively)
Authorized shares – 5,000,000
Issued and outstanding shares – 4,648,622		46,486			45,703
Common stock, par value $0.01 per share:
Authorized shares – 30,000,000
Issued and outstanding shares –3,633,289		36,333			36,333
Additional paid-in capital		89,950,066			81,648,978
Accumulated deficit		(89,244,577	)		(85,409,002	)
Unearned compensation		(12,096	)		(16,938	)
Total shareholders’ equity (deficit)		776,212			(3,694,926	)
Total liabilities and shareholders’ equity (deficit)	$	1,466,197		$	1,021,085

Note: The balance sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes.

2

Optical Sensors Incorporated d/b/a väsamed

Statements of Operations

	Three Months Ended June 30						Six Months Ended June 30
	2005			2004			2005			2004
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Revenues:
Sales	$	195,844		$	189,368		$	400,412		$	332,283
Product development fees		—			42,400			6,400			80,648
Royalties		—			2,582			62,500			6,178
Total revenues		195,844			234,350			469,312			419,109
Costs and expenses:
Cost of goods sold		340,683			305,349			687,074			609,914
Cost of product development		—			24,017			1,235			42,493
Research and development expenses		372,017			2,408,520			732,963			2,820,669
Impairment of patents		—			—			3,610			—
Selling, general and administrative expenses		719,342			454,410			1,232,227			937,631
Total costs and expenses		1,432,042			3,192,296			2,657,109			4,410,707
Operating loss		(1,236,198	)		(2,957,946	)		(2,187,797	)		(3,991,598	)
Interest expense		(45,514	)		(46	)		(142,716	)		(72	)
Other income (expense), net		(3,662	)		1			(4,662	)		19,372
		(49,176	)		(45	)		(147,378	)		19,300
Net loss		(1,285,374	)		(2,957,991	)		(2,335,175	)		(3,972,298	)
Imputed preferred stock dividends		(1,500,400	)		—			(1,500,400	)		—
Loss attributable to common shareholders	$	(2,785,774	)	$	(2,957,991	)	$	(3,835,575	)	$	(3,972,298	)
Loss per Share:
Basic and diluted	$	(.35	)	$	(.86	)	$	(.64	)	$	(1.20	)
Loss attributable to common shareholders per share:
Basic and diluted	$	(.77	)	$	(.86	)	$	(1.06	)	$	(1.20	)
Shares used in calculation of net loss per share:
Basic and diluted		3,633,289			3,425,693			3,633,289			3,316,991

See accompanying notes.

3

Optical Sensors Incorporated d/b/a väsamed

Statements of Cash Flows

	Six Months Ended June 30,
	2005			2004
Operating activities
Net loss	$	(2,335,175	)	$	(3,972,298	)
Adjustments to reconcile net loss to net cash used in operating activities:
Purchase of Steorra Technology – recorded as in-process research and development expense		—			1,700,000
Non-cash compensation expense (credit) on stock options		(167,903	)		3,645
Compensation expense related to stock options issued to consultant		4,842			4,842
Imputed interest on advances from shareholder		142,635
Depreciation and amortization		72,449			47,819
Impairment of patents		3,610			—
Changes in operating assets and liabilities net of acquisitions:
Accounts receivable		8,899			16,097
Inventories		(188,779	)		12,765
Prepaid expenses, other current assets and other assets		(48,910	)		(31,213	)
Accounts payable and accrued expenses		186,249			(16,841	)
Net cash used in operating activities		(2,322,083	)		(2,235,184	)
Investing activities
Purchases of property and equipment		(41,854	)		—
Payments for patents		(122,523	)		(32,874	)
Net cash used in investing activities		(164,377	)		(32,874	)
Financing activities
Advances from shareholder		1,539,000			2,314,000
Net proceeds from issuance of preferred stock		1,049,890			—
Net cash provided by financing activities		2,588,890			2,314,000
Increase in cash		102,430			45,942
Cash at beginning of period		8,759			17,321
Cash at end of period	$	111,189		$	63,263
Non-cash investing and financing activity:
Property and equipment acquired via capital lease obligation	$	25,574		$	—
Conversion of advances from shareholder and accrued interest into Series C convertible preferred stock.	$	5,776,849		$	—

See accompanying notes.

4

Optical Sensors Incorporated

Notes to Financial Statements

(Unaudited)

June 30, 2005

Note A – Summary of Significant Accounting Policies

Basis of Presentation:

The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the financial statements and footnotes thereto included in the Optical Sensors Incorporated Annual Report on Form 10-KSB for the year ended December 31, 2004.

Classification:

Certain 2004 operating amounts have been reclassified to conform to the 2005 presentation.

Stock-Based Compensation:

The Company follows Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), and related interpretations in accounting for its stock options. Under APB No. 25, when the exercise price of stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.

5

The following table illustrates the effect on net loss and net loss per shares if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to its stock-based employee compensation for the three and six months ended June 30.

	Three Months Ended June 30						Six Months Ended June 30
	2005			2004			2005			2004
Loss Attributable to common stockholders	$	(2,785,774	)	$	(2,957,991	)	$	(3,835,575	)	$	(3,972,298	)
Add: stock-based compensation (credit) cost included in the determination of net loss as reported		(64,867	)		(14,855	)		(163,061	)		8,487
Less: stock-based compensation that would have been included in the determination of net loss if the fair value method had been applied		(82,493	)		(232,848	)		(175,739	)		(307,809	)
Pro forma net loss	$	(2,933,134	)	$	(3,205,694	)	$	(4,174,375	)	$	(4,271,620	)
Net basic and diluted loss per share:
As reported	$	(.77	)	$	(.86	)	$	(1.06	)	$	(1.20	)
Pro forma	$	(.81	)	$	(.94	)	$	(1.15	)	$	(1.29	)

Net Loss Per Share:

The net loss per share has been computed in accordance with the provisions of the Financial Accounting Standards Board’s Statement No. 128, Earnings Per Share. All potential common shares from stock options and convertible promissory notes have been excluded from the computation of diluted net loss per share for the applicable periods presented because the effect would have been anti-dilutive.

Note B – Research and Development Supplies

At December 31, 2003, research and development supplies with a carrying value of $414,332 consisted of electro-optical modules. These modules were originally a component of the Company’s proprietary SensiCath Arterial Blood Gas System. The Company discontinued sales of the SensiCath product in January of 1999 and subsequently disposed of all related inventories, with the exception of these modules, which the Company utilizes from time to time in prototyping new applications of the Company’s technologies, as components of test equipment, and for use in performing clinical studies. The Company believed these modules were important to the Company’s development of products for itself and other companies by allowing the Company to respond quickly and economically to such needs as they arise. However, in the first three quarters of 2004 the Company experienced declining spending patterns on the part of the Company’s business partners plus lower internal consumption of the modules. In particular, the Company had believed Nellcor would purchase a significant quantity of the modules to be used in test stations in their production of CapnoProbe Sensors. However, in August of 2004, Nellcor experienced a recall of the CapnoProbe product and, at that time, provided no indication as to when, if ever, it would re-launch the product. In addition, towards the end of the third quarter of 2004 the Company made a strategic decision to re-direct the Company’s research and development resources towards the recently acquired Steorra technology and away from contract development work, further limiting the anticipated usage of the

6

modules. The Company concluded at that time that future use of the modules would most likely not be at a level sufficient to consume significant quantities of the modules. Accordingly, the Company recognized an impairment expense of $387,766 in the third quarter of 2004, reducing the carrying value to zero at September 30, 2004.

Note C – Inventories

Inventories consisted of the following:

	June 30, 2005		December 31, 2004
Finished goods	$	150,824	$	70,587
Raw materials		232,171		123,629
	$	382,995	$	194,216

Note D –Exclusive License Agreement

The Company licensed a single application of our tissue capnometry technology, the CapnoProbe^TM Sublingual (SL) System to Nellcor^® Tyco Healthcare in 2001. The application limits the use of the product to its ability to evaluate CO₂ in the gastrointestinal tract in order to alert healthcare providers to pending or actual tissue hypoperfusion and possible organ failure. The license agreement the Company negotiated with Nellcor, made Nellcor the exclusive, worldwide manufacturer and distributor of CapnoProbe and resulted in payments to the Company of over $3 million in license, development and supply fees from 2001 through 2003. Under the license agreement, the Company was entitled to receive royalties on net sales of the disposable components and on aggregate gross margins for the CapnoProbe instrument. On August 24, 2004, Nellcor initiated a voluntary recall of the CapnoProbe Sublingual Sensor. See Note K- Subsequent Events for information relating to the termination of the license agreement.

Note E – Variable Accounting Rules and Compensation Expense

In accordance with the terms of the Securities Purchase Agreement with Circle F Ventures executed in August 2000, all options then held by current employees and current directors were amended so that the exercise price was equal to the average price per share paid by Circle F Ventures, LLC for the Series A preferred stock. Accordingly, the exercise price was reduced to $2.08 per share. This repricing has resulted in the plan being subject to variable accounting. Compensation expenses have been recorded as listed in the table below. Additional compensation charges could be recorded in future periods.

	2005			2004
First Quarter	$	(100,615	)	$	20,921
Second Quarter		(67,288	)		(17,276	)
Third Quarter		n/a			(105,915	)
Fourth Quarter		n/a			(111,717	)

7

Note F – Advances from Shareholder

The Company has been dependent upon cash advances from Circle F Ventures for continued funding of its operations. From December 11, 2003 through May 6, 2005, Circle F had advanced an aggregate of $5,722,000 to the Company in funds on a continuing basis to enable it to continue operations; $150,000 was advanced in December 2003, $4,033,000 was advanced in the 2004 and $1,539,000 through May 6, 2005. These advances bore no interest, were unsecured and contained no conversion features. As a result, the Company had imputed interest on the advances from Circle F at an interest rate of prime plus 2% (8.00% at June 30, 2005) and recorded interest expense of $45,355 and $142,635 for the three and six months ended June 30, 2005, respectively, which was recorded as a contribution to equity as additional paid-in-capital. On May 6, 2005, outstanding advances from Circle F Ventures were converted into Series C preferred stock (See Note I below). Between May 6, 2005 and August 15, 2005, the Company received additional advances from Circle F Ventures of $350,000.

Note G – Purchase of Non-invasive Cardiac Output (NICO) Technology

On May 14, 2004, the Company completed its acquisition from SORBA Medical Systems, Inc. (“SORBA”) of all assets related to SORBA’s Steorra^™ impedance cardiograph device and RTea^™ advanced signal processing technology (the ”Technology”), consisting primarily of intellectual property rights and other ancillary equipment and supplies. The Company did not acquire any cash, receivables or miscellaneous items not related to the Technology. The Company acquired the Technology for consideration consisting of cash in the amount of $300,000 and 425,000 shares of common stock valued at $4.00 per share which was the stock closing price on the date of closing. As part of the agreement, the Company issued 403,750 shares of common stock (95% of the total) on May 14, 2004 and the remaining 21,250 shares of common stock (5% of the total) on September 1, 2004. The Company did not assume any debts or liabilities of SORBA. When the Company acquires technology from another entity, the purchase price is allocated, as applicable, between purchased in-process research and development expense (“IPR&D”), other identifiable intangible assets and net tangible assets. The Company’s policy defines IPR&D as the value assigned to those projects for which related products have not received regulatory approval and have no alternative future use. The Steorra device is an FDA regulated product currently being used in hospitals and clinics. The Company has revised the device’s user interface and aesthetics and is re-launching after receiving CE mark approval and ISO certification. However, the Company has concluded that the Steorra technology does not meet the definition of alternative future use and has classified the Steorra technology purchase as IPR&D and written it off as research and development expense of $2,000,000 during the year ended December 31, 2004. Also, the Company has concluded that the ancillary equipment and supplies purchased with the Steorra technology are not of material value and no value has been assigned to those items.

8

Note H – Patents

Patents are stated at cost and are amortized upon issuance of a patent on a straight-line basis over 60 months. Amortization expense was $22,168 and $12,856 for the three months ended June 30, 2005 and 2004, respectively, and $41,275 and $26,105 for the six months ended June 30, 2005 and 2004, respectively. Estimated amortization expense for the next five years of patents issued as of December 31, 2004 is as follows:

Year ending December 31:
2005	$	82,550
2006		68,487
2007		61,137
2008		44,338
2009		14,424
	$	270,936

Note I - Sale of Preferred Stock and Conversion of Debt to Capital Stock

On May 6, 2005, the Company executed a Stock Purchase Agreement with Circle F Ventures, LLC and its affiliates for the conversion of cash advances, outstanding interest and fees and expenses in the amount of $6,001,849 into 66,686 shares of the Company’s newly designated Series C preferred stock, par value $0.01 per share (the “Series C Preferred Stock”), and with Barth Investment Company II, LP for the private placement of 8,334 shares of Series C Preferred Stock in exchange for an investment of $750,000. The $6,001,849 consisted of cash advances of $5,722,000, $54,849 of interest and $225,000 of fees associated with financing activities on the part of Fleming Securities Inc.

In connection with the issuance of the Series C Preferred Stock, the Company issued Fleming Securities, Inc. a five-year warrant to purchase 300,084 shares of the Company’s common stock, par value $0.01, at a per share exercise price of $2.70, subject to adjustment for issuances of certain other securities below the then current exercise price and in the event of certain capital adjustments or similar transactions, such as a stock split or merger. In addition, with respect to additional purchases of Series C Preferred Stock under the Stock Purchase Agreement, if any, the Company agreed to issue Fleming Securities, Inc. a warrant or warrants for a number of shares of common stock equal to 10% of the shares issuable upon conversion of the Series C Preferred Stock sold through Fleming Securities, Inc. to investors at a per share exercise price of $2.70. If Fleming Securities, Inc. exercises the warrants in full the Company would receive an additional $810,277 in cash proceeds.

On June 15, 2005, the Company executed a Joinder Agreement with Barth Investment Company II, LP for the private placement of 3,334 shares of Series C Preferred Stock in exchange for an investment of $300,000 pursuant to the terms of the Stock Purchase Agreement executed by the parties on May 6, 2005. Each share of Series C Preferred Stock is convertible into 40 shares of common stock at a conversion price of $2.25 per share.

As a result of the conversions and issuance of warrants, Circle F Ventures, LLC and its affiliates, at June 30, 2005, beneficially own 6,502,308 shares of the Company’s common stock on an as converted basis representing a 75.28% ownership interest in the Company. Charles D. Snead, Jr., one of the Company’s directors, is a consultant and attorney for Circle F and Hayden R. Fleming and their affiliates and related companies.

9

There are no dividend, coupon or redemption rights associated with the preferred stock, however the preferred stock includes a liquidation preference. The Company has agreed to register for resale by the investors the common stock issuable upon conversion of the preferred stock. The preferred stock will not be separately registered or listed on the OTC Bulletin Board. Upon a liquidation, dissolution or winding of the Company, following payment of the preferential amounts required to be paid the holders of the Company’s Series A preferred stock, each holder of Series C preferred stock is entitled to receive $90 per share on a pari passu basis with the preferential amounts required to be paid the holders of the Company’s Series B preferred stock and prior to and in preference over any liquidation payment on the common stock. In addition, it is convertible to common stock at anytime upon the election of the holder, automatically upon either the completion of a private placement of equity securities that yields at least $5,000,000 in gross proceeds or at the Company’s election, in the event the Company’s net sales exceed $5,000,000 in any 12 month period.

In view of the fact that the preferred stock contains an embedded beneficial conversion feature, the Company has recorded a deemed dividend on preferred stock in our financial statements for the quarterly period ended June 30, 2005. This non-cash dividend is to reflect the implied economic value to the preferred stockholders of being able to convert their shares into common stock at a price which is in excess of the fair value of the preferred stock. The fair value allocated to the preferred stock of $6,105,019 together with the original conversion terms were used to calculate the value of the deemed dividend on the preferred stock of $1,500,400 at the date of issuance of the preferred stock. This fair value was calculated using difference between the agreed upon conversion price of the preferred stock into shares of common stock of $2.25 and the fair market value of common stock on the date of the transaction of $2.75, as determined by the closing price as reported by the Over-the-Counter Bulletin Board. This amount has been charged to accumulated deficit with the offsetting credit to additional paid-in-capital. The Company has treated the deemed dividend on preferred stock as a reconciling item on the statement of operations to adjust our reported net loss to “net loss available to common stockholders.”

Note J – Recent Accounting Pronouncements

In June 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections”, a replacement of APB Opinion No. 20 and FASB Statement No. 3. The statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections of errors made occurring in fiscal years beginning after June 1, 2005. The statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this statement. The Company does not expect the adoption of SFAS No. 154 to have a material effect on its financial statements.

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Note K – Subsequent Events

On July 8, 2005, the Company entered into a termination agreement and mutual release with Nellcor to terminate the license agreement and reaffirm the earlier termination of the supply agreement with Nellcor. The termination agreement provides for the transfer of certain tooling and unused monitoring devices from Nellcor to the Company, subject to certain restrictions on their use. Subject to certain exclusions, the parties have also agreed to release each other from any and all claims related to, among other things, the license agreement, the supply agreement and the recall of the CapnoProbe. As consideration for the termination agreement, the Company has agreed to issue 175,000 shares of the Company’s common stock to Nellcor and forgo any additional royalties from Nellcor. The Company received royalty payments from Nellcor of $62,500 in the first quarter of 2005 and $133,747 between 2003 and 2004.

On August 4, 2005, the Company secured $125,000 in financing from a third party investor from the sale of 1,390 shares of Series C preferred stock, at $90 per share, pursuant to the Stock Purchase Agreement dated May 6, 2005. On August 15, 2005, the Company secured an additional $450,000 in financing from a third party investor from the sale of 5,000 shares of Series C preferred stock.

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Item 2. Management’s Discussion and Analysis or Plan of Operation

The following Management’s Discussion and Analysis or Plan of Operation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “may,” “expect,” “believe,” “anticipate,” or “estimate,” identify such forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially from those expressed in such forward-looking statements. Some of the factors that could cause such material differences are identified in “Risk Factors.” We undertake no obligation to correct or update any forward-looking statements, whether as a result of new information, future events, or otherwise. You are advised, however, to consult any future disclosures we make on related subjects in future filings with the SEC.

Overview

Since our initial public offering in 1996, we have evolved from a company focused on arterial blood gas monitoring in the intensive care unit to one that is focused on non-invasive hemodynamic monitors that are useable in hospital point-of-care, office-based physician practices and certain other non-hospital settings. In early 2004 we announced that we would begin doing business as väsamed. We believe the name “väsamed” underscores our mission to provide non-invasive diagnostic tools for a variety of vascular and cardiovascular conditions.

We develop, manufacture and market low-cost, noninvasive peripheral and cardio vascular diagnostic systems for hemodynamic assessment. Currently, we manufacture and sell PV2000 and SensiLase^TM PAD 3000 skin perfusion pressure and pulse volume waveform diagnostic systems for quantitative evaluation of small vessel disease in patients with chronic foot ulcers, diabetes and other peripheral arterial disease. Skin Perfusion Pressure (SPP) is a precise quantitative reading of the pressure at which the blood flow in capillaries overcomes a controlled occlusion. SPP delivers a valuable diagnostic tool by measuring blood flow to capillaries to determine microvascular health. SPP is particularly useful for applications such as wound healing prediction, amputation planning and microvascular assessment. SPP goes beyond traditional diagnostic tools by delivering accurate, reproducible clinical information regardless of vessel calcification, edema, physiology, skin type, or hyperbaric conditioning. As such, it provides unparalleled clinical value across the entire spectrum of patient types and disease states. The core technology for SPP originally came from Vasamedics LLC. In 2002, we acquired PV2000 and other assets related to medical instrumentation for patient monitoring of laser Doppler blood flow (LaserFlo BPM²) and related measurements from Vasamedics. We then developed an improved and fully automated version of PV2000 - the SensiLase PAD 3000 - and received U.S. Food and Drug Administration (FDA) clearance for it in mid-2004. The acquisition also provided us direct sales contact with customers in areas of current and future market interest.

We acquired R-wave triggered ensemble averaging (Rtea^™) Impedance Cardiography (ICG) in 2004. This clinically proven ICG platform, originally referred to as Steorra^TM, is a non-invasive monitoring platform that provides the hemodynamic data required to better assess and direct the treatment of advanced heart failure, hypertension and other cardiovascular diseases. The product has been re-named AcQtrac^™ ICG and has been re-configured to provide the configuration and mobility options that are required for the multiple call points where this technology will be used. Completely non-invasive, we believe that AcQtrac ICG, augmented by other non-invasive technologies that we are developing, will provide reliable information for optimal diagnosis and drug therapy management. We believe AcQtrac ICG will be a welcome addition within hospitals because non-invasive monitors are believed to be safer, more efficient and cost-effective to use than invasive counterparts. Outside the hospital setting, clinicians have limited information available to them when treating cardiovascular and vascular disease patients, so we believe

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AcQtrac ICG will be readily incorporated into the familiar physical assessment routine of blood pressure and heart rate monitoring found in most doctors’ offices. We have improved AcQtrac user aesthetics and have obtained CE Mark status. We are in the process of securing distributors to begin commercial launch of the product in the third quarter of 2005. Our approach to ICG monitoring is intended to represent an important step in defining the next generation of ICG monitoring principally due to the future inclusion of our tissue capnometry technology. Tissue capnometry enables the determination of tissue health and viability. Our technology has broad patent protection and versatile utility. We are developing applications of this tissue capnometry that are specifically relevant to cardiac function and we will use it to position our AcQtrac platform as one of the most effective ICG platforms available.

We licensed a single application of our tissue capnometry technology, the CapnoProbe^TM Sublingual (SL) System to Nellcor^® Tyco Healthcare in 2001. The application limits the use of the product to its ability to evaluate CO₂ in the gastrointestinal tract in order to alert healthcare providers to pending or actual tissue hypoperfusion and possible organ failure. The license agreement we negotiated with Nellcor, made Nellcor the exclusive, worldwide manufacturer and distributor of CapnoProbe and resulted in payments to us of over $3 million in license, development and supply fees from 2001 through 2003. In late 2003, we transferred CapnoProbe manufacturing to Nellcor’s manufacturing facility in Mexico. Under the license agreement, we were entitled to receive royalties on net sales of the disposable components and on aggregate gross margins for the CapnoProbe instrument. On August 24, 2004, Nellcor initiated a voluntary recall of the CapnoProbe Sublingual Sensor. On July 8, 2005, we entered into a termination agreement and mutual release with Nellcor to terminate the license agreement and reaffirm the earlier termination of the supply agreement with Nellcor. The termination agreement provides for the transfer of certain tooling and unused monitoring devices from Nellcor to us, subject to certain restrictions on their use. Subject to certain exclusions, the parties have also agreed to release each other from any and all claims related to, among other things, the license agreement, the supply agreement and the recall of the CapnoProbe. As consideration for the termination agreement, we have agreed to issue 175,000 shares of our common stock to Nellcor and forgo any additional royalties from Nellcor. We received royalty payments from Nellcor of $62,500 in the first quarter of 2005 and $133,747 between 2003 and 2004.

Our current cash balances, anticipated revenues from net sales are insufficient to fund our operations on a short-term and long-term basis. We will need to obtain additional loans or equity funding in order to continue to fund operations on both a short-term and long-term basis.

As of August 15, 2005, we estimate our projected remaining cash needs through the end of 2005 to be approximately $1,000,000. This takes into account $1,539,000 in advances received from Circle F, which have been converted to preferred stock, $350,000 in advances received from Circle F subsequent to June 30, 2005 and $1,625,000 received from the sale of preferred stock in private placement transactions. We sometimes collectively refer to Circle F Ventures, LLC, Circle F Ventures II, LLC and their affiliates as “Circle F”, and they beneficially own approximately 75.28% of our common stock. These projected total cash needs include expenditures for enhancements to and marketing of the AcQtrac ICG plus continued promotion of the SensiLase product. We often do not have funds available to pay current obligations without receiving advances from Circle F or securing funds through other investors Although we believe that Circle F will continue to provide financing to us in order to obtain a return on its significant investment to date, there can be no assurance that Circle F will continue to do so. Furthermore, there can be no assurance that we will be able to obtain additional loans or equity funding. If we are unable to obtain additional financing and revenues when needed, we will likely be forced to cease operations. Our projected total cash needs for 2005 have increased $1,000,000 from our prior projections of $3,500,000. This increase is primarily the result of the forgoing of future royalties pursuant to the termination of the Nellcor license agreement, difficulty in securing suitable distribution partners and higher legal fees associated with our foreign patents and the negotiation of certain agreements.

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We do not expect to incur any significant liabilities for equipment, real estate or leasehold improvements during 2005 nor do we plan to significantly increase or decrease our current number of employees. We do expect to increase spending for patent filings in major countries around the world and for sales activities related to our SensiLase product and for development and market launch of our AcQtrac ICG product.

Critical Accounting Policies and Estimates

General

The following discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to bad debts, inventories, income taxes, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We recognize revenue in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101, or SAB 101, “Revenue Recognition in Financial Statements”, as amended by SAB 104. SAB 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an agreement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Revenues from our business activities are recognized from net sales of manufactured products upon delivery to the customer. The determination of SAB 104 criteria (3) and (4) for each source of revenue is based on our judgments regarding the fixed nature and collectibility of each source of revenue. Revenue recognized for any reporting period could be adversely affected should changes in conditions cause us to determine that these criteria are not met for certain future transactions.

Research and Development Supplies

At December 31, 2003, research and development supplies with a carrying value of $414,332 consisted of electro-optical modules. These modules were originally a component of our proprietary SensiCath Arterial Blood Gas System. We discontinued sales of the SensiCath product in January of 1999 and subsequently disposed of all related inventories, with the exception of these modules, which we utilize from time to time in prototyping new applications of our technologies, as components of test equipment, and for use in performing clinical studies. We believed these modules were important to our development of products for ourselves and other companies by allowing us to respond quickly and economically to such needs as they arise. However, in the first three quarters of 2004 we experienced declining spending patterns on the part of our business partners plus lower internal consumption of the modules. In particular, we had believed Nellcor would purchase a significant quantity of the modules to be used in test stations in their production of CapnoProbe Sensors. However, in August of 2004, Nellcor experienced a recall of the

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CapnoProbe product and, at that time, provided no indication as to when, if ever, it would re-launch the product. In addition, towards the end of the third quarter of 2004 we made a strategic decision to re-direct our research and development resources towards the recently acquired Steorra technology and away from contract development work, further limiting the anticipated usage of the modules. We concluded at that time that future use of the modules would most likely not be at a level sufficient to consume significant quantities of the modules. Accordingly, we recognized an impairment expense of $387,766 in the third quarter of 2004. We have assigned no value to research and development supplies since the third quarter of 2004 and have since entered into a termination agreement and mutual release with Nellcor to terminate the license agreement.

Patents and Impairment Review

At June 30, 2005, we reported patents on our balance sheet, net of amortization, of $488,488. Accumulated amortization was $532,209 at June 30, 2005. After an individual patent is issued, we amortize the accumulated costs on a straight-line basis over an estimated average useful life of 60 months. Periodically we evaluate each patent as to whether it enhances or helps secure our overall intellectual property portfolio. Whenever events or changes in circumstances indicate impairment has occurred, values are adjusted appropriately. Should we not achieve our expectations of the net realizable value of our investment in patents, potential future losses may occur to the extent of the carrying value at June 30, 2005 of $488,488. In October of 2004 and again in April of 2005, we decided to abandon certain foreign patent applications and issued patents. As a result, we recognized patent impairment expenses of $151,657 in the third quarter of 2004 and $3,610 in the first quarter of 2005.

Variable Accounting Rules and Compensation Expense

Certain stock options issued by us have been re-priced thereby resulting in our option plan being subject to variable accounting rules. Application of these rules results in recognizing compensation expense or reductions to compensation expense whenever the market price of our stock varies from that of the prior quarter-end. Additional compensation charges and credits will most likely be recorded in future periods. We are unable to predict the extent of these charges and credits.

Purchased In-Process Research and Development (IPR&D)

When we acquire technology from another entity, the purchase price is allocated, as applicable, between purchased in-process research and development expense (“IPR&D”), other identifiable intangible assets and net tangible assets. Our policy defines IPR&D as the value assigned to those projects for which related products have not received regulatory approval and have no alternative future use. Determining the portion of the purchase price allocated to IPR&D requires us to make significant estimates. The amount of the purchase price allocated to IPR&D is determined in accordance with accepted valuation methods, and includes consideration of the assessed risk of the project not being developed to a stage of commercial feasibility.

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Results of Operations

Our revenues consist of sales, product development fees and royalties. Beginning in the third quarter of 2005, we do not anticipate ongoing revenues from product development fees.

Net sales for the second quarter of 2005 increased $6,476 to $195,844, or 3%, from $189,368 in the second quarter of 2004. Net sales for the six month period ended June 30, 2005 increased $68,129 to $400,412 from $332,283, or 21%, for the six month period ended June 30, 2004. We expect that sales for our products will increase further as we expand sales of our enhanced Skin Peripheral Perfusion product, the SensiLase and introduce our AcQtrac non-invasive cardiac monitor product in the second half of 2005.

Net Sales

	Three Months Ended June 30				Six Months Ended June 30
	2005		2004		2005		2004
CapnoProbe sales to Nellcor	$	—	$	32,768	$	—	$	32,768
VÄSAMED product sales		195,844		156,600		400,412		299,515
	$	195,844	$	189,368	$	400,412	$	332,283

Product development fee revenues for the second quarter of 2005 decreased from $42,400 in the second quarter of 2004 to $0. Product development fee revenues for the six month period ended June 30, 2005 decreased $74,248 to $6,400 from $80,648, or 92%, for the six month period ended June 30, 2004. Because we continue to shift our efforts away from third party development to our own technologies, we do not expect to earn significant development fee revenues in 2005.

We recognized royalty revenues of $62,500 in the first half of 2005, under our CapnoProbe licensing agreement with Nellcor, as compared to $6,178 in the first half of 2004. As a result of the termination of the Nellcor license, we will not receive any further royalty payments from Nellcor. We received royalty payments from Nellcor of $62,500 in the first quarter of 2005 and $133,747 between 2003 and 2004.

Cost of goods sold for the three and six month periods ended June 30, 2005 were $340,683 and $687,074, respectively, as compared to $305,349 and $609,914, respectively, for the three and six month periods ended June 30, 2004. Cost of goods sold for the first two quarters of 2005 and the first two quarters of 2004, each included $100,000 in minimum royalty payments to ICCM. Under our license agreement with ICCM, we are required to pay ICCM a royalty based on sales of the CapnoProbe-type products. We are required under the license agreement to pay ICCM an annual minimum royalty of $400,000 through 2005, after which we may elect to continue to pay an annual minimum royalty of $400,000 for an exclusive license or to forego the minimum royalty payment and retain the license on a non-exclusive basis. Cost of goods sold exceeded sales and royalty revenues in the first halves of 2005 and 2004 because volumes were below that necessary to cover fixed costs and minimum royalty payments to ICCM. We expect margins will improve towards the end of 2005 as sales of the Sensilase product improve and we launch our AcQtrac non-invasive cardiac output monitor in the second half of 2005.

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Cost of product development decreased $41,258 to $1,235, or 97%, in the first half of 2005 compared to $42,493 in the first half of 2004. The decrease in cost of product development revenues between the first halves of 2005 and 2004 were a result of lower product development revenues.

Research and development costs decreased $2,036,503, or 85%, from $2,408,520 in the second quarter of 2004 to $372,017 for the second quarter of 2005. Research and development costs decreased $2,087,706 from $2,820,669, or 74%, for the six month period ended June 30, 2004 to $732,963 for the six month period ended June 30, 2005. Two million dollars of the decrease related to the purchase of the Steorra non-invasive cardiac output technology, which was recorded as purchased in-process research and development expense in the second quarter of 2004. Efforts in the first half of 2005 were directed towards development of our AcQtrac product whereas research and development efforts in the first half of 2004 were directed towards the SensiLase product. We do not expect our research and development costs to decrease materially in the foreseeable future as we continue to direct our efforts to our existing products and new product applications of our technologies.

The following table sets forth the principal components of research and development expenses for the periods indicated:

Research and Development Expenses

	Three Months Ended June 30				Six Months Ended June 30
	2005		2004		2005		2004
Compensation and Benefits	$	215,059	$	246,927	$	434,306	$	493,865
Third party engineering firms, consultants and other professional fees		60,778		64,644		108,350		135,609
Materials and supplies consumed in development projects		38,660		35,245		75,295		84,023
Purchased In-Process Research and Development (IPR&D) expense		—		2,000,000		—		2,000,000
All other costs of research and development		57,520		61,704		115,012		107,172
	$	372,017	$	2,408,520	$	732,963	$	2,820,669

In October of 2004, we completed our strategic planning process for 2005 and years thereafter. In conjunction with this process we reviewed future anticipated costs related to in process patent applications and in support of existing issued patents as compared to anticipated future revenues. We decided to not pursue certain foreign patent applications and to not support certain foreign patents having a total carrying value of $151,657. In addition, we decided to re-direct additional resources away from third party development projects, resulting in a decline in future anticipated usage of research and development supplies valued at $387,766. Also, we concluded that an August 2004 recall of Nellcor’s CapnoProbe product would impair our ability to sell instruments to Nellcor for use in their CapnoProbe manufacturing test equipment. As a result, we recognized impairment expense totaling $539,423 in the third quarter of 2004. In the first quarter of 2005, we recognized additional write-offs of patent costs of $3,610.

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Impairment Costs

	Three Months Ended June 30				Six Months Ended June 30
	2005		2004		2005		2004
Impairment of research and development supplies	$	—	$	—	$	—	$	—
Impairment of patent costs		—		—		3,610		—
	$	0	$	0	$	3,610	$	0

Selling, general and administrative expenses increased $264,932, or 58%, from $454,410 in the second quarter of 2004 to $719,342 for the second quarter of 2005. Selling, general and administrative expenses increased $294,596 from $937,631, or 31%, for the six month period ended June 30, 2004 to $1,232,227 for the six month period ended June 30, 2005. Excluding non-cash compensation credits and charges, the increase in selling, general and administrative expenses in the second quarter of 2005 as compared to the second quarter of 2004 was primarily due to increased sales and marketing compensation and consulting costs, promotional expenses related to increased marketing of our SensiLase and AcQtrac products and legal fees related to contract negotiations between the Company and ICCM and Nellcor. The first quarter of 2004 included costs of SEC staff reviews of prior filings and legal fees related to the acquisition of the AcQtrac technology. We expect selling expenses to increase through 2005 as we continue our promotion of the SensiLase product and launch the AcQtrac product. We expect administrative expenses for 2005 to be approximately the same as 2004 levels.

The following table sets forth the principal components of selling, general and administrative expenses for the periods indicated:

Selling, General and Administrative Expenses

	Three Months Ended June 30						Six Months Ended June 30
	2005			2004			2005			2004
Compensation and Benefits	$	296,814		$	179,965		$	579,543		$	350,089
Professional and consulting fees		220,917			139,231			286,896			333,436
Marketing promotional activities		113,972			52,010			231,452			74,852
Travel and Entertainment		91,054			31,447			146,453			51,401
All other SG&A costs		61,452			66,612			150,944			119,366
		784,209			469,265			1,395,288			929,144
Non-cash compensation (credit) related to options		(64,867	)		(14,855	)		(163,061	)		8,487
	$	719,342		$	454,410		$	1,232,227		$	937,631

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Interest expense for the three and six months ended June 30, 2005 included imputed interest of $45,355 and $142,635, respectively, related to advances from Circle F. Other income in the first quarter of 2004 consisted of gains from the recovery of expensed expenditures from prior years.

Since our inception, we have experienced significant operating losses. We incurred a net loss of $2,335,175 in the first half of 2005 compared to a net loss of $3,972,298 in the first half of 2004. We also recorded deemed preferred stock dividends in the second quarter of 2005 related to the beneficial conversion value of the Series C preferred stock on May 6, 2005, the date when the Series C preferred stock was issued. The deemed preferred stock dividend resulted in the transfer of $1,500,400 from retained earnings to additional paid in capital. As of June 30, 2005, we had an accumulated deficit of $89,244,577. We anticipate that our operating losses will continue for the foreseeable future. Except for historical information contained herein, the disclosures in this report are forward looking statements. See “Risk Factors.”

Liquidity and Capital Resources

Through June 30, 2005, we have financed our operations primarily through the sale of equity and debt securities. From inception through June 30, 2005, we have raised a cumulative total of approximately $83,450,000 from the sale of our equity securities, including the conversion of promissory notes into equity securities. From March of 2000 through June 30, 2005, Circle F has provided $12,965,005 of capital to fund ongoing operations through a series of equity financings, bridge loans and cash advances. Circle F beneficially owns approximately 75.28% of our outstanding common stock, including shares of Series A preferred stock, Series B preferred stock and Series C preferred stock which are convertible into common stock

In the first half of 2005 Circle F advanced us $1,539,000, which was converted into preferred stock in May of 2005. Subsequent to June 30, 2005 and through August 15, 2005, we received additional advances from Circle F of $350,000. In May and June of 2005 we received $1,050,000 for the sale of preferred stock in private placement transactions. On August 4, 2005 and August 15, 2005, we received an additional $125,000 and $450,000, respectively, for the sale of preferred stock in private placement transactions.

Our current assets, not including cash, were $618,610 at June 30, 2005 as compared to $389,820 at December 31, 2004, an increase of $228,790. The increase was caused primarily by increased inventories in anticipation of the launch of the AcQtrac product in the second half of 2005.

Our current liabilities, not including advances from shareholders, were $668,911 at June 30, 2005 as compared to $533,011 at December 31, 2004, an increase of $135,900. The increase reflects normal operating fluctuations between trade payables, employee compensation and other accrued liability accounts.

Our cash was $111,189 at June 30, 2005 and $8,759 at December 31, 2004. Net cash of $2,322,083 was used in operations and $164,377 for capital expenditures in the first half of 2005. These expenditures were funded through advances from Circle F of $1,539,000 and the sale of $1,050,000 of preferred stock to other third parties in private placement transactions in the first half of 2005. On May 6, 2005, the aggregate outstanding balance of cash advances from Circle F of $5,722,000 was converted into Series C preferred stock.

As of August 15, 2005, we estimate our projected remaining cash needs through the end of 2005 to be approximately $1,000,000. This takes into account $1,539,000 in advances received from Circle F, which have been converted to preferred stock, $350,000 in advances received from Circle F subsequent to June

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30, 2005 and $1,625,000 received from the sale of preferred stock in private placement transactions. These projected total cash needs include expenditures for enhancements to and marketing of the AcQtrac ICG plus continued sales launch of the SensiLase product. We often do not have funds available to pay current obligations without receiving advances from Circle F or securing funds through other investors Although we believe that Circle F will continue to provide financing to us in order to obtain a return on its significant investment to date, there can be no assurance that Circle F will continue to do so. Furthermore, there can be no assurance that we will be able to obtain additional loans, equity funding or development fees from other sources. If we are unable to obtain additional financing and revenues when needed, we will likely be forced to cease operations. Our projected total cash needs for 2005 have increased $1,000,000 from our prior projections of $3,500,000. This increase is primarily the result of the forgoing of future royalties pursuant to the termination of the Nellcor license agreement, difficulty in securing suitable distribution partners and higher legal fees associated with our foreign patents and the negotiation of certain agreements.

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Risk Factors

In addition to the factors identified above, there are several factors that could cause our actual results to differ materially from those anticipated by us or which are reflected in any forward-looking statements. These factors, and their impact on the success of our operations and our ability to achieve our goals, include the following:

Need for Additional Financing (which has resulted in the report of our independent registered accounting firm on our 2004 financial statements containing an explanatory paragraph regarding our ability to continue as a going concern). The report of the independent registered public accounting firm on our 2004 financial statements contains an explanatory paragraph regarding our ability to continue as a going concern. We currently have limited revenue from operations that is supplemented in large part by equity infusions, loans and cash advances from Circle F, our largest stockholder. From March of 2000 through August 15, 2005, Circle F has provided $13,315,005 of capital to fund ongoing operations through a series of equity financings, bridge loans and cash advances. As of August 15, 2005, we estimate our projected remaining cash needs through the end of 2005 to be approximately $1,000,000. We believe that will be able to raise additional equity investments and, if need be, Circle F will continue to advance sufficient funds to us to enable us to continue operations and product development in order for Circle F to obtain a return on its significant investment to date. However, there can be no assurance that Circle F will do so. There can be no assurance that we will be able to obtain sufficient product sales, royalty revenues, contract development fees from other sources and additional funding. If we are unable to obtain additional financing and revenues when needed, we will likely be forced to cease operations.

Successful Marketing of the Tissue Capnometry Technology.

Our approach to ICG monitoring is intended to represent an important step in defining the next generation of ICG monitoring principally due to the future inclusion of our tissue capnometry technology. Tissue capnometry enables the determination of tissue health and viability. We are developing applications of this tissue capnometry that are specifically relevant to cardiac function and we will use it to position our AcQtrac platform as one of the most effective ICG platforms available. There can be no assurance that we will be able to develop our planned applications of tissue capnometry or that we will be able to successfully market these application enhancements to our AcQtrac product.

Successful Marketing of the SPP System for Wound Healing Management and AcQtrac ICG for Hemodynamic Monitoring. We currently distribute the PV2000 and SensiLase PAD 3000 Systems through a combination of direct sales and dealer and distributor representatives. The distribution for AcQtrac ICG will rely on some of the same representatives as well as new dealers and distributors. Current dealer and distributor channels are under usual and customary contracts with us and as such, failure to perform is not immediately rectifiable. There can be no assurance that the product sales will meet our forecasted expectations in 2005 or beyond.

Regulatory Approvals. Our ability to market our current products and any products that we may develop in the future requires clearances or approvals from the FDA and other governmental agencies, including, in some instances, foreign and state agencies. The process for maintaining and obtaining necessary regulatory clearances and approvals can be expensive and time consuming. There can be no assurance that we will be able to maintain or obtain necessary regulatory approvals and clearances in the future.

OTC Bulletin Board. Our common stock is traded on the Over-The-Counter (“OTC”) Bulletin Board. Consequently, the liquidity of our common stock is impaired, not only in the number of shares that are bought and sold, but also through delays in the timing of transactions, and coverage by security analysts and the news media, if any, of our company. As a result, prices for shares of our common stock may be lower than might otherwise prevail if our common stock was traded on Nasdaq or a national securities exchange.

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Competition. Competition among medical device companies is intense and increasing. There can be no assurance that our competitors will not succeed in developing or marketing technologies and products that are more effective or less expensive than our products or that would render our products obsolete or non-competitive.

Key Employees. Our success is substantially dependent on the ability, experience and performance of our senior management and other key personnel, including, in particular, Paulita M. LaPlante, our President and Chief Executive Officer. We cannot guarantee that she will remain employed with us. If we lose one or more of the members of our senior management or other key employees, our business could suffer.

Item 3. Controls and Procedures

As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities and Exchange Act of 1934 (the “Exchange Act”)). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There were no significant changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the Company’s most recently completed quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

The Company has a limited number of employees and is not able to have proper segregation of duties based on the cost benefit of hiring additional employees solely to address the segregation of duties issue. The Company determined the risks associated with the lack of segregation of duties are insignificant based on the close involvement of management in day-to-day operations (i.e. tone at the top, corporate governance, officer oversight and involvement with daily activities, and other company level controls).

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PART II. OTHER INFORMATION

Item 5. Other Information

Sale of Series C Preferred Stock

On August 4, 2005, the Company sold 1,390 shares of Series C Preferred Stock for $125,000 pursuant to the terms of the Stock Purchase Agreement executed by certain investors on May 6, 2005. On August 15, 2005, the Company secured an additional $450,000 in financing from a third party investor from the sale of 5,000 shares of Series C preferred stock. Each share of Series C Preferred Stock is convertible into 40 shares of common stock at a conversion price of $2.25 per share.

In connection with the above issuances of the Series C Preferred Stock, the Company issued Fleming Securities, Inc. five-year warrants to purchase 25,560 shares of the Company’s common stock, par value $0.01, at a per share exercise price of $2.70, subject to adjustment for issuances of certain other securities below the then current exercise price and in the event of certain capital adjustments or similar transactions, such as a stock split or merger.

No underwriting commissions or discounts were paid with respect to the sales of the Series C Preferred Stock and warrant. The Series C Preferred Stock and warrant were offered and sold in a private placement transaction made in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933 and Regulation D promulgated thereunder. The investors are accredited investors as defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933. Pursuant to the terms of the Stock Purchase Agreement, the Company has agreed to use its best efforts to effect qualification and registration of the Company’s common stock underlying the Series C Preferred under the Securities Act of 1933 upon the written request of investors holding at least 50% of the outstanding Series C Preferred Stock.

Election of Director

Effective August 10, 2005, in accordance with its Bylaws, the Company’s Board of Directors expanded the membership of its Board of Directors from three to four members and elected Dr. Andrew Jay to fill the newly created directorship.

There is no arrangement or other understanding between Dr. Jay and any other person pursuant to which Dr. Jay was elected, and there are no related party transactions reportable under Item 404(a) of Regulation S-B for Dr. Jay. Dr. Jay has been appointed a member of the Audit Committee of the Board of Director. In connection with Dr. Jay’s election to the Board, the Company’s Board of Directors granted him a fully vested option to purchase 15,000 shares of the Company’s common stock at a per share exercise price of $2.25.

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Item 6. Exhibits

Item No.	Description	Method of Filing
10.1	Termination Agreement and Mutual Release, dated as of July 8, 2005, between the Company and Nellcor Puritan Bennett Incorporated (1)	Filed electronically herewith.
10.2	Eighth Amendment to Lease Agreement dated June 30, 2005 between First Industrial L.P. and the Company	Filed electronically herewith.
10.3	Joinder Agreement to Stock Purchase Agreement by and between Optical Sensors Incorporated and Barth Investment Company II, LP dated June 15, 2005	Incorporated by reference to Exhibit 10.1 contained in the Company’s Current Report on From 8-K filed June 21, 2005 (File No. 0-27600).
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.	Filed electronically herewith.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.	Filed electronically herewith.
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C Section 1350.	Furnished electronically herewith.

(1) Confidential treatment has been requested from the Securities and Exchange Commission with respect to designated portions contained within the document. Such portions have been omitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities and Exchange Act of 1934, as amended.

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Signatures

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

	OPTICAL SENSORS INCORPORATED
Date August 15, 2005	/s/ Paulita M. LaPlante
	Paulita M. LaPlante President and Chief Executive Officer (Principal Executive Officer)
Date August 15, 2005	/s/ Wesley G. Peterson
	Wesley G. Peterson Chief Financial Officer, Vice President of Finance and Administration and Secretary (Principal Financial and Accounting Officer)

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