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SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
 Commission file number 0-21982
 Diametrics Medical, Inc.
  
  
 
 
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Diametrics Medical, Inc.
 PagePart I  FINANCIAL INFORMATION
    
    
    4Report of Independent Registered Public Accounting Firm
    
    
    5Item 1. Consolidated Financial Statements (unaudited)
    
    
    4Consolidated Statements of Operations:
    
    
    4Three Months and Nine Months Ended September 30, 2005 and 2004
    
    
    4Consolidated Balance Sheetsas of September 30, 2005 and December 31, 2004
    
    
    5Consolidated Statements of Cash Flows:
    
    
    6Nine Months Ended September 30, 2005 and 2004
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Results of Operations and Financial Condition
    
    
    11Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    14Item 4. Controls and Procedures
    
    
    14Part II  OTHER INFORMATION
    
    
    15Item 1. Legal Proceedings
    
    
    15Item 1A. Risk Factors
    
    
    15Item 3. Defaults Upon Senior Securities
    
    
    16Item 6. Exhibits
    
    
    16Signatures
    
    
    17Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
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/s/ McKennon Wilson & Morgan LLP 
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PART I  FINANCIAL INFORMATION
 
 Item 1. Consolidated Financial Statements (unaudited)
 DIAMETRICS MEDICAL, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Cost of revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross profit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating expenses:Research and development
    
    
    
    
    
    
    
    
    
    
    477,432
    
    
    
    Selling, general and administrative
    
    
    198,394
    
    
    
    687,603
    
    
    
    983,297
    
    
    
    1,665,794Restructuring and other nonrecurring charges
    
    
    
    
    
    
    2,018,212
    
    
    
    
    
    
    
    2,018,212Total operating expenses
    
    
    198,394
    
    
    
    2,705,815
    
    
    
    1,460,729
    
    
    
    3,684,006Operating loss
    
    
    (198,394
    )
    
    
    (2,705,815
    )
    
    
    (1,460,729
    )
    
    
    (3,684,006
    )Interest expense
    
    
    (350,493
    )
    
    
    (399,437
    )
    
    
    (8,832,800
    )
    
    
    (1,333,668
    )Interest income
    
    
    
    
    
    
    3,379
    
    
    
    
    
    
    
    10,394Gain on change in fair value of warrant liability
    
    
    182,306
    
    
    
    
    
    
    
    1,863,429
    
    
    
    Other expense, net
    
    
    
    
    
    
    46,824
    
    
    
    508
    
    
    
    (11,050
    )Loss before discontinued operations
    
    
    (366,581
    )
    
    
    (3,055,049
    )
    
    
    (8,429,592
    )
    
    
    (5,018,330
    )Discontinued operations:Income (loss) from discontinued operations
    
    
    
    
    
    
    (809,040
    )
    
    
    
    
    
    
    (3,374,608
    )Gain on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    14,500
    
    
    
    557,052Net loss
    
    
    (366,581
    )
    
    
    (3,864,089
    )
    
    
    (8,415,092
    )
    
    
    (7,835,886
    )Beneficial conversion featurepreferred stock dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,733,644Deemed dividend on preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,050,690Loss available to common shareholders
    
    $
    (366,581
    )
    
    $
    (3,864,089
    )
    
    $
    (8,415,092
    )
    
    $
    (10,620,220
    )Basic and diluted net loss per common share:Loss before discontinued operations
    
    $
    (0.01
    )
    
    $
    (0.09
    )
    
    $
    (0.24
    )
    
    $
    (0.25
    )Discontinued operations:Net loss from discontinued operations
    
    
    
    
    
    $
    (0.02
    )
    
    
    
    
    
    $
    (0.09
    )Loss available to common shareholders
    
    $
    (0.01
    )
    
    $
    (0.11
    )
    
    $
    (0.24
    )
    
    $
    (0.34
    )Weighted average number of common shares outstanding
    
    
    35,121,739
    
    
    
    34,915,784
    
    
    
    35,121,739
    
    
    
    31,251,142
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DIAMETRICS MEDICAL, INC.
 
 CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2005
    
    
    2004(UNAUDITED)
    
    
    (AUDITED)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    585
    
    
    $
    1,095,800Prepaid expenses and other current assets
    
    
    17,447
    
    
    
    24,815Assets of discontinued operations
    
    
    
    
    
    
    25,017Total current assets
    
    
    18,032
    
    
    
    1,145,632Property and equipment, net
    
    
    
    
    
    
    3,171Other assets, net
    
    
    20,596
    
    
    
    107,226$
    38,628
    
    
    $
    1,256,029LIABILITIES AND SHAREHOLDERS DEFICITCurrent liabilities:Accounts payable
    
    $
    535,518
    
    
    $
    636,055Accrued interest
    
    
    
    
    
    
    675,843Other accrued expenses
    
    
    294,245
    
    
    
    42,941Convertible
debt, net of discount of $1,771,719 at December 31, 2004
    
    
    
    
    
    
    28,281Liabilities of discontinued operations
    
    
    107,232
    
    
    
    93,677Total current liabilities
    
    
    936,995
    
    
    
    1,476,797Long-term liabilities:Convertible
subordinated debt, net of discount of $6,311,894 at December 31,
2004
    
    
    9,250,000
    
    
    
    988,106Accrued interest
    
    
    1,203,399
    
    
    
    Warrant and
registration rights liabilities
    
    
    1,268,803
    
    
    
    Total liabilities
    
    
    12,659,197
    
    
    
    2,464,903Shareholders deficit:Preferred stock, $.01 par value: 5,000,000 shares authorized, 25,000 shares
issued and outstanding at both September 30, 2005 and December 31, 2004
(liquidation preference of preferred shares is $2,500,000 at September 30, 2005
and December 31, 2004)
    
    
    250
    
    
    
    250Common
stock, $.01 par value: 1,000,000,000; authorized
35,121,739 and 35,121,835
shares issued and outstanding
    
    
    351,218
    
    
    
    351,218Additional paid-in capital
    
    
    162,435,932
    
    
    
    165,432,535Accumulated deficit
    
    
    (175,407,969
    )
    
    
    (166,992,877
    )Total shareholders deficit
    
    
    (12,620,569
    )
    
    
    (1,208,874
    )$
    38,628
    
    
    $
    1,256,029
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DIAMETRICS MEDICAL, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 Nine Months Ended,September 302005
    
    
    2004Cash flows from operating activities:Net loss
    
    $
    (8,415,092
    )
    
    $
    (7,835,886
    )Adjustments to reconcile net loss to net cash flows from operating activities:Income on liquidation of discontinued operations
    
    
    (14,500
    )
    
    
    Depreciation and amortization
    
    
    89,801
    
    
    
    480,965Accretion of convertible notes
    
    
    8,218,612
    
    
    
    724,679Change in
fair value of warrant liabilities
    
    
    (1,862,800
    )
    
    
    Write-down of assets
    
    
    
    
    
    
    1,435,000Stock-based compensation and warrant repricing
    
    
    
    
    
    
    254,890Loss on disposal of property and equipment
    
    
    
    
    
    
    3,723Recognition of deferred gain on sale of business
    
    
    
    
    
    
    (718,924
    )Accounts receivable
    
    
    
    
    
    
    202,547Inventories
    
    
    
    
    
    
    1,297,999Prepaid expenses and other current assets
    
    
    32,385
    
    
    
    182,641Accounts payable
    
    
    (72,482
    )
    
    
    365,491Accrued interest
    
    
    1,160,458
    
    
    
    Other accrued expenses
    
    
    (381,598
    )
    
    
    333,745Deferred credits and revenue
    
    
    
    
    
    
    (72,499
    )Net cash
used in operating activities
    
    
    (1,245,216
    )
    
    
    (3,345,629
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    
    
    
    
    (239,686
    )Release of escrowed proceeds on sale of business
    
    
    
    
    
    
    720,169Net cash provided by investing activities
    
    
    
    
    
    
    480,483Cash flows from financing activities:Proceeds from borrowings
    
    
    150,000
    
    
    
    Redemption of Preferred Stock
    
    
    
    
    
    
    (25
    )Principal payments on borrowings and capital leases
    
    
    
    
    
    
    (124,791
    )Net proceeds from the issuance of preferred stock and common stock warrants
    
    
    
    
    
    
    2,667,957Net proceeds from the issuance of common stock
    
    
    
    
    
    
    11,834Net cash provided by (used in) financing activities
    
    
    150,000
    
    
    
    2,554,975Effect of exchange rate changes on cash and cash equivalents
    
    
    
    
    
    
    83,467Net increase (decrease) in cash and cash equivalents
    
    
    (1,095,216
    )
    
    
    (226,704
    )Cash and cash equivalents at beginning of period
    
    
    1,095,800
    
    
    
    315,176Cash and cash equivalents at end of period
    
    $
    585
    
    
    $
    88,472Supplemental disclosure of cash flow information:Cash paid during the period for interest
    
    $
    
    
    
    $
    17,950
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DIAMETRICS MEDICAL, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(UNAUDITED)
 (1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
    Description of the Business.
  Principles of Consolidation.
 Accounting for Conversion Features and Warrants Issued with Convertible Debt and Preferred
Stock.
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Per Share Information.
  September 30,
    
    December 31,2005
    
    2004(UNAUDITED)Common stock options
    
    
    406,600
    
    
    
    1,422,600Common stock warrants
    
    
    70,561,426
    
    
    
    66,811,426Convertible subordinated debt
    
    
    365,000,000
    
    
    
    2,013,430Convertible senior notes
    
    
    97,500,000
    
    
    
    Convertible preferred stock-Series F
    
    
    6,666,667
    
    
    
    6,666,667Convertible preferred stock-Series G
    
    
    50,000,000
    
    
    
    25,000,000Restricted stock
    
    
    64,251
    
    
    
    64,251
 Stock Based Compensation.
 Three months ended September 30,
    
    Nine months ended September 30,2005
    
    2004
    
    2005
    
    2004Loss available to common shareholders, as reported
    
    $
    (366,581
    )
    
    $
    (3,864,089
    )
    
    $
    (8,415,092
    )
    
    $
    (10,620,220
    )Stock-based employee compensation expense included in
net loss available to common shareholders
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total stock-based employee compensation expense
determined under fair value-based method for all
awards
    
    
    
    
    
    
    (214,649
    )
    
    
    (143,518
    )
    
    
    429,298
    )Pro forma net loss available to common shareholders
    
    $
    (366,581
    )
    
    $
    (4,078,738
    )
    
    $
    (8,588,610
    )
    
    $
    (11,049,518
    )Loss per share available to common shareholders:Basic and diluted, as reported
    
    $
    (0.01
    )
    
    $
    (0.11
    )
    
    $
    (0.24
    )
    
    $
    (0.34
    )Basic and diluted, pro forma
    
    $
    (0.01
    )
    
    $
    (0.12
    )
    
    $
    (0.24
    )
    
    $
    (0.35
    )
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(2) GOING CONCERN
     (3) CONVERTIBLE DEBT
  Convertible senior
    
    
    Convertiblesecured
    
    
    subordinated debt,notes, net
    
    
    netBalance at December 31, 2004
    
    $
    28,281
    
    
    $
    988,106Net new additions
    
    
    15,000
    
    
    
    Principal payments
    
    
    
    
    
    
    Accretion of interest
    
    
    1,906,719
    
    
    
    6,311,894Balance at September 30, 2005 (Unaudited)
    
    $
    1,950,000
    
    
    $
    7,300,000
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(4) ASSET PURCHASE
  (5) INCOME TAXES
  (6) SHAREHOLDERS DEFICIT
  (7) SUBSEQUENT EVENTS
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Item 2. Managements Discussion and Analysis of Results of Operations and Financial Condition
 FORWARD-LOOKING STATEMENTS
  11




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OVERVIEW
  APPLICATION OF CRITICAL ACCOUNTING POLICIES
 Estimates.
 Accounting for Beneficial Conversion Features and Warrants Issued with Convertible Debt and
Preferred Stock.
  RESULTS OF OPERATIONS
 Revenue and Cost of Revenue.
 Operating Expenses.
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Restructuring and other non-recurring charges.
 Interest Expense.
 Gain on Change in Fair Value of Warrant Liability.
 Discontinued Operations.
  LIQUIDITY AND CAPITAL RESOURCES
    Operating Activities.
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Investing Activities.
 Financing Activities.
    Income Tax Carryforwards.
 Off Balance Sheet Arrangements.
 
 Item 3. Quantitative and Qualitative Disclosure About Market Risk
  
 Item 4. Controls and Procedures
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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
   
 Item 1A. Risk Factors
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Item 3. Defaults Upon Senior Securities
    
 Item 6. Exhibits
 ExhibitNo.31.1
    
    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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DIAMETRICS MEDICAL, INC.
 
 SIGNATURE
  DIAMETRICS MEDICAL, INC.By:
    /s/ Heng ChukHeng ChukChief Financial Officer (and Duly Authorized Officer)  17