**Table ofContents**

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** **

** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

| **x**  | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|--------|----------------------------------------------------------------------------------------------------------|
|   |                                                                                                     |
|   | **For the quarterly period ended  September 30, 2008**                                              |
|   | ** **                                                                                               |
|   | **or**                                                                                                   |
|   |                                                                                                     |
| **o**  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

|   | **For the transition period from           to        ** |
|--------|------------------------------------------------------------------------------------------------------------------------------------|

 

**Commission File Number 333-103781**

 

**ProUroCareMedical Inc.**

(Exact name of registrantas specified in its charter)

 

| **Nevada**                                                        | ** ** | **20-1212923**                        |
|-------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction

of incorporation or  organization) |       | (I.R.S. Employer

Identification No.) |

 

**5500 Wayzata Blvd., Suite 310**

**Golden Valley, Minnesota 55416**

(Address of principalexecutive offices and Zip Code)

 

**(952) 476-9093**

(Registrant’s telephonenumber, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.                                                   YESx NO o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 
|   | Large accelerated filer o |   | Accelerated filer o         |
|--------|---------------------------|--------|----------------------------------|
|   | Non-accelerated filer o   |   | Smaller reporting company x |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). 
|   | YES o NO x |
|--------|------------|

 

The registrant has 1,786,984 shares of common stockoutstanding as of October 20, 2008.

 

 

 

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Tableof Contents

 

**ProUroCareMedical Inc.**

**Form 10-Qfor the**

**QuarterEnded September 30, 2008**

 

**Table of Contents**

 
| ** **                           | ** ** | ** **                                                                                  | **Page No.** |
|--------------------------------------|------------|---------------------------------------------------------------------------------------------|-------------------|
|                                 |       |                                                                                        |              |
| PART I - FINANCIAL  INFORMATION | [1]        |
|                                 |       |
|                                 | ITEM 1.    | FINANCIAL STATEMENTS                                                                        |              |
|                                 |       |                                                                                        |              |
|                                 |       | Consolidated  Balance Sheets                                                                | [1]               |
|                                 |       |                                                                                        |              |
|                                 |       | Consolidated  Statements of Operations                                                      | [2]               |
|                                 |       |                                                                                        |              |
|                                 |       | Consolidated  Statements of Cash Flows                                                      | [3]               |
|                                 |       |                                                                                        |              |
|                                 |       | Notes to  Consolidated Financial Statements                                                 | [5]               |
|                                 |       |                                                                                        |              |
|                                 | ITEM 2.    | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | [24]              |
|                                 |       |                                                                                        |              |
|                                 | ITEM 4T.   | CONTROLS AND  PROCEDURES                                                                    | [30]              |
|                                 |       |                                                                                        |              |
| PART II - OTHER  INFORMATION    |       | [32]                                                                                        |
|                                 |       |                                                                                        |              |
|                                 | ITEM 1.    | LEGAL PROCEEDINGS                                                                           | [32]              |
|                                 |       |                                                                                        |              |
|                                 | ITEM 1A.   | RISK FACTORS                                                                                | [32]              |
|                                 |       |                                                                                        |              |
|                                 | ITEM 2.    | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                | [32]              |
|                                 |       |                                                                                        |              |
|                                 | ITEM  4.   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        | [33]              |
|                                 |       |                                                                                        |              |
|                                 | ITEM 5.    | OTHER  INFORMATION                                                                          | [34]              |
|                                 |       |                                                                                        |              |
|                                 | ITEM 6.    | EXHIBITS                                                                                    | [34]              |
|                                 |       |                                                                                        |              |
|                                 | SIGNATURES | [35]                                                                                        |
|                                      |            |                                                                                             |                   |  |

** **

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**PART I.FINANCIAL INFORMATION**

*** ***

***Item 1. Financial Statements***

** **

**ProUroCare Medical Inc.**

**A Development Stage Company**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                             | ** ** | **September 30, 2008  (Unaudited)** | ** ** | **December 31, 2007  (Audited)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------------|------------|
| **Assets**                                                                                                                                                                             | ** ** | ** **                                    | ** ** | ** **                                 | ** ** |
| Current assets:                                                                                                                                                                        |       |                                          |       |                                       |       |
| Cash                                                                                                                                                                                   |       | $                                             | 42,291     |                                       | $          | 400,613 |   |
| Restricted cash                                                                                                                                                                        |       | 44,178                                        |       | 44,000                                     |       |
| Other current  assets                                                                                                                                                                  |       | 68,667                                        |       | 21,733                                     |       |
| Total current  assets                                                                                                                                                                  |       | 155,136                                       |       | 466,346                                    |       |
|                                                                                                                                                                                   |       |                                          |       |                                       |       |
| Equipment and  furniture, net                                                                                                                                                          |       | 146                                           |       | 605                                        |       |
| Deferred  offering expenses                                                                                                                                                            |       | 442,712                                       |       | 132,638                                    |       |
| Debt issuance  costs, net                                                                                                                                                              |       | 388,447                                       |       | 439,321                                    |       |
|                                                                                                                                                                                   |       | $                                             | 986,441    |                                       | $          | 1,038,910 |   |
| **Liabilities and Shareholders’ Deficit**                                                                                                                                         |       |                                          |       |                                       |       |
| Current  liabilities:                                                                                                                                                                  |       |                                          |       |                                       |       |
| Notes payable,  bank                                                                                                                                                                   |       | $                                             | 1,600,000  |                                       | $          | — |   |
| Notes payable,  net of original issue discount                                                                                                                                         |       | 753,285                                       |       | 263,143                                    |       |
| Convertible  debentures, net of original issue discount                                                                                                                                |       | 637,925                                       |       | —                                     |       |
| Convertible  notes, net of original issue discount                                                                                                                                     |       | 1,143,425                                     |       | —                                     |       |
| Accounts payable                                                                                                                                                                       |       | 867,130                                       |       | 484,375                                    |       |
| Accrued expenses                                                                                                                                                                       |       | 857,305                                       |       | 801,925                                    |       |
| Loans from  officers and directors                                                                                                                                                     |       | —                                        |       | 10,450                                     |       |
| Total current  liabilities                                                                                                                                                             |       | 5,859,070                                     |       | 1,559,893                                  |       |
|                                                                                                                                                                                   |       |                                          |       |                                       |       |
| Commitments and  contingencies                                                                                                                                                         |       |                                          |       |                                       |       |
| Long-term bank  debt                                                                                                                                                                   |       | —                                        |       | 1,600,000                                  |       |
| Long-term note  payable                                                                                                                                                                |       | —                                        |       | 600,000                                    |       |
| Long-term  convertible notes, net of original issue discount                                                                                                                           |       | 372,690                                       |       | 970,600                                    |       |
| Total  liabilities                                                                                                                                                                     |       | 6,231,760                                     |       | 4,730,493                                  |       |
| Shareholders’  deficit:                                                                                                                                                           |       |                                          |       |                                       |       |
| Common stock, $0.00001  par. Authorized 50,000,000 shares; issued and outstanding 1,786,984 and  1,727,311 shares on September 30, 2008 and December 31, 2007,  respectively |       | 18                                            |       | 17                                         |       |
| Additional  paid-in capital                                                                                                                                                            |       | 13,492,082                                    |       | 12,586,496                                 |       |
| Deficit  accumulated during development stage                                                                                                                                          |       | (18,737,419                                   | )          | (16,278,096                                | )          |
| Total  shareholders’ deficit                                                                                                                                                      |       | (5,245,319                                    | )          | (3,691,583                                 | )          |
|                                                                                                                                                                                   |       | $                                             | 986,441    |                                       | $          | 1,038,910 |   |

 

*See accompanying notes to financial statements.*

 

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**ProUroCare Medical Inc.**

**A Development Stage Company**

**Consolidated Statementsof Operations**

(Unaudited)

 
| ** **                                      | ** ** | **Three months ended  September 30** | ** ** | **Nine months ended  September 30** | ** ** | **Period from  August 17,1999  (inception) to  September 30,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008**                                                                           | ** ** | **2007** | ** ** | **2008** | ** ** |
| Operating  expenses:                            |       |                                                |       |                                               |       |                                                                               |       |   |   |   |   |
| Research and  development                       |       | $                                                   | 30,000     |                                               | $          | 1,082                                                                              |       | $ | 330,155 |   | $ | 108,316 |   | $ | 5,187,707 |   |
| General and  administrative                     |       | 263,987                                             |       | 199,892                                            |       | 726,521                                                                            |       | 1,075,325 |   | 8,531,017 |   |
| Total operating  expenses                       |       | 293,987                                             |       | 200,974                                            |       | 1,056,676                                                                          |       | 1,183,641 |   | 13,718,724 |   |
| Operating loss                                  |       | (293,987                                            | )          | (200,974                                           | )          | (1,056,676                                                                         | )          | (1,183,641 | ) | (13,718,724 | ) |
|                                            |       |                                                |       |                                               |       |                                                                               |       |   |   |   |   |
| Interest income                                 |       | 124                                                 |       | —                                             |       | 502                                                                                |       | — |   | 18,260 |   |
| Interest expense                                |       | (473,782                                            | )          | (315,600                                           | )          | (1,328,273                                                                         | )          | (890,061 | ) | (4,580,703 | ) |
| Debt  extinguishment cost                       |       | (29,045                                             | )          | (75,327                                            | )          | (74,876                                                                            | )          | (233,529 | ) | (456,252 | ) |
| Net loss                                        |       | $                                                   | (796,690   | )                                                  | $          | (591,901                                                                           | )          | $ | (2,459,323 | ) | $ | (2,307,231 | ) | $ | (18,737,419 | ) |
|                                            |       |                                                |       |                                               |       |                                                                               |       |   |   |   |   |
| Net loss per  common share:                     |       |                                                |       |                                               |       |                                                                               |       |   |   |   |   |
| Basic and  diluted                              |       | $                                                   | (0.45      | )                                                  | $          | (0.37                                                                              | )          | $ | (1.41 | ) | $ | (1.48 | ) | $ | (18.29 | ) |
|                                            |       |                                                |       |                                               |       |                                                                               |       |   |   |   |   |
| Weighted average  number of shares outstanding: |       |                                                |       |                                               |       |                                                                               |       |   |   |   |   |
| Basic and  diluted                              |       | 1,779,854                                           |       | 1,587,559                                          |       | 1,744,972                                                                          |       | 1,554,021 |   | 1,024,600 |   |

** **

***See accompanying notes tofinancial statements.***

 

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**ProUroCare Medical Inc.**

**A Development Stage Company**

**Consolidated Statementsof Cash Flows**

**(Unaudited)**

 
| ** **                                                                                              | ** ** | **Nine months  ended  September 30,** | ** ** | **Nine months  ended  September 30,** | ** ** | **Period from August  17, 1999 (inception) to** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2008**                                        | ** ** | **2007**                                        | ** ** | **September 30, 2008**                                         | ** ** |
| Cash flows from  operating activities:                                                                  |       |                                            |       |                                            |       |                                                                     |       |
| Net loss                                                                                                |       | $                                               | (2,459,323 | )                                               | $          | (2,307,231                                                               | )          | $ | (18,737,419 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                            |       |                                            |       |                                            |       |                                                                     |       |
| Depreciation and  amortization                                                                          |       | 459                                             |       | 2,670                                           |       | 20,651                                                                   |       |
| Gain on sale of  furniture and equipment                                                                |       | —                                          |       | —                                          |       | (2,200                                                                   | )          |
| Stock-based  compensation                                                                               |       | 48,085                                          |       | 511,239                                         |       | 1,753,187                                                                |       |
| Issuance of  common stock for services rendered                                                         |       | 37,964                                          |       | —                                          |       | 194,868                                                                  |       |
| Issuance of  common stock for debt guarantees                                                           |       | —                                          |       | —                                          |       | 88,889                                                                   |       |
| Issuance of  notes payable for intangibles expensed as research and development                         |       | 150,000                                         |       | —                                          |       | 150,000                                                                  |       |
| Warrants issued  for services                                                                           |       | —                                          |       | 72,000                                          |       | 540,636                                                                  |       |
| Warrants issued  for debt guarantees                                                                    |       | —                                          |       | —                                          |       | 320,974                                                                  |       |
| Warrants issued  for debt extinguishment                                                                |       | 66,548                                          |       | 233,529                                         |       | 377,205                                                                  |       |
| Amortization of  note payable original issue discount                                                   |       | 88,888                                          |       | 52,582                                          |       | 331,075                                                                  |       |
| Amortization of  convertible debt original issue discount                                               |       | 630,911                                         |       | 182,829                                         |       | 1,085,753                                                                |       |
| Amortization of  debt issuance and deferred offering costs                                              |       | 299,999                                         |       | 394,418                                         |       | 1,584,168                                                                |       |
| Write-off debt  issuance cost for debt extinguishment                                                   |       | —                                          |       | —                                          |       | 42,797                                                                   |       |
| Write-off of  deferred offering cost                                                                    |       | —                                          |       | —                                          |       | 59,696                                                                   |       |
| License rights  expensed as research and development, paid by issuance of common stock to CS  Medical   |       |                                            |       |                                            |       |                                                                     |       |
| Technologies,  LLC                                                                                      |       | —                                          |       | —                                          |       | 475,000                                                                  |       |
| License rights  expensed as research and development, paid by issuance of common stock to  Profile, LLC |       | —                                          |       | —                                          |       | 1,713,600                                                                |       |
|                                                                                                    |       |                                            |       |                                            |       |                                                                     |       |
| Changes in  operating assets and liabilities:                                                           |       |                                            |       |                                            |       |                                                                     |       |
| Deposits                                                                                                |       | —                                          |       | —                                          |       | (189,554                                                                 | )          |
| Other current  assets                                                                                   |       | 7,570                                           |       | 22,939                                          |       | 96,859                                                                   |       |
| Accounts payable                                                                                        |       | 146,022                                         |       | (7,238                                          | )          | 876,477                                                                  |       |
| Accrued expenses                                                                                        |       | 12,646                                          |       | 225,535                                         |       | 1,022,634                                                                |       |
| Net cash used in  operating activities                                                                  |       | (970,231                                        | )          | (616,728                                        | )          | (8,194,704                                                               | )          |
| Cash flows from  investing activities:                                                                  |       |                                            |       |                                            |       |                                                                     |       |
| Purchases of  equipment and furniture                                                                   |       | —                                          |       | —                                          |       | (20,797                                                                  | )          |
| Deposit into a  restricted cash account                                                                 |       | (178                                            | )          | —                                          |       | (44,178                                                                  | )          |
| Net cash used in  investing activities                                                                  |       | (178                                            | )          | —                                          |       | (64,975                                                                  | )          |
|                                                                                                    |       |                                            |       |                                            |       |                                                                     |       |
| Cash flows from  financing activities:                                                                  |       |                                            |       |                                            |       |                                                                     |       |
| Proceeds of note  payable, bank                                                                         |       | —                                          |       | —                                          |       | 500,000                                                                  |       |
| Payments of note  payable, bank                                                                         |       | —                                          |       | —                                          |       | (500,000                                                                 | )          |
| Proceeds of  notes payable                                                                              |       | 112,500                                         |       | 150,000                                         |       | 728,000                                                                  |       |
| Payment of notes  payable                                                                               |       | (386,976                                        | )          | (41,618                                         | )          | (1,424,272                                                               | )          |
| Proceeds from  long-term notes payable and bank debt                                                    |       | 1,040,625                                       |       | —                                          |       | 4,790,625                                                                |       |
| Payments on long-term  bank debt                                                                        |       | —                                          |       | —                                          |       | (600,000                                                                 | )          |
| Proceeds from  warrants                                                                                 |       | 46,875                                          |       | —                                          |       | 96,875                                                                   |       |
| Payments for  debt issuance costs                                                                       |       | (146,452                                        | )          | (5,495                                          | )          | (671,678                                                                 | )          |
| Payment for  rescission of common stock                                                                 |       | —                                          |       | —                                          |       | (100,000                                                                 | )          |
| Proceeds from  loans from officers and directors                                                        |       | —                                          |       | 154,650                                         |       | 172,600                                                                  |       |
| Payments of  loans from officers and directors                                                          |       | (10,450                                         | )          | (79,100                                         | )          | (137,300                                                                 | )          |
| Payments for  deferred offering expenses                                                                |       | (44,035                                         | )          | —                                          |       | (72,862                                                                  | )          |
| Cost of reverse  merger                                                                                 |       | —                                          |       | —                                          |       | (162,556                                                                 | )          |
| Net proceeds  from issuance of common stock                                                             |       | —                                          |       | 447,611                                         |       | 5,682,538                                                                |       |
| Net cash provided by  financing activities                                                              |       | 612,087                                         |       | 626,048                                         |       | 8,301,970                                                                |       |
| Net increase (decrease)  in cash                                                                        |       | (358,322                                        | )          | 9,320                                           |       | 42,291                                                                   |       |
| Cash, beginning  of the period                                                                          |       | 400,613                                         |       | 2,407                                           |       | —                                                                   |       |
| Cash, end of the  period                                                                                |       | $                                               | 42,291     |                                            | $          | 11,727                                                                   |       | $ | 42,291 |   |

 

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| ** **                                                                                                                                                                               | ** ** | **Nine months  ended  September 30,** | ** ** | **Nine months  ended  September 30,** | ** ** | **Period from August  17, 1999 (inception) to** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **2008**                                        | ** ** | **2007**                                        | ** ** | **September 30, 2008**                                         | ** ** |
| Supplemental  cash flow information:                                                                                                                                                     |       |                                            |       |                                            |       |                                                                     |       |
| Cash paid for  interest                                                                                                                                                                  |       | $                                               | 105,726    |                                            | $          | 179,831                                                                  |       | $ | 699,062 |   |
| Non-cash  investing and financing activities:                                                                                                                                            |       |                                            |       |                                            |       |                                                                     |       |
| Conversion of  notes payable into long-term convertible debentures                                                                                                                       |       | —                                          |       | —                                          |       | 175,000                                                                  |       |
| Conversion of  loans from directors into long-term convertible debentures                                                                                                                |       | —                                          |       | —                                          |       | 25,000                                                                   |       |
| Deferred  offering costs included in accounts payable                                                                                                                                    |       | 176,634                                         |       | —                                          |       | 286,622                                                                  |       |
| Deferred  offering costs included in accrued expenses                                                                                                                                    |       | 89,404                                          |       | 105,000                                         |       | 112,054                                                                  |       |
| Debt issuance  costs included in accounts payable                                                                                                                                        |       | 60,099                                          |       | —                                          |       | 115,916                                                                  |       |
| Warrants issued  pursuant to notes payable                                                                                                                                               |       | 169,739                                         |       | 51,920                                          |       | 493,926                                                                  |       |
| Prepaid expenses  financed by note payable                                                                                                                                               |       | 54,504                                          |       | 42,585                                          |       | 165,526                                                                  |       |
| Convertible debt  issued in lieu of cash for accrued expenses                                                                                                                            |       | 23,750                                          |       | —                                          |       | 23,750                                                                   |       |
| Warrants issued  in lieu of cash for accrued expenses                                                                                                                                    |       | 1,250                                           |       | —                                          |       | 1,250                                                                    |       |
| Common stock  issued in lieu of cash for accrued expenses                                                                                                                                |       | 21,670                                          |       | 111,993                                         |       | 251,306                                                                  |       |
| Common stock  issued for debt issuance cost                                                                                                                                              |       | —                                          |       | —                                          |       | 158,167                                                                  |       |
| Common stock  issued in lieu of cash for accounts payable                                                                                                                                |       | —                                          |       | 20,704                                          |       | 122,291                                                                  |       |
| Common stock  issued in lieu of cash for loans from officers and directors                                                                                                               |       | —                                          |       | 10,300                                          |       | 10,300                                                                   |       |
| Proceeds from sale  of furniture and equipment                                                                                                                                           |       | —                                          |       | —                                          |       | 2,200                                                                    |       |
| Convertible debt  issued as debt issuance costs related to guarantee of long-term debt  (recorded as a beneficial conversion in additional paid-in capital) applied  to accounts payable |       | —                                          |       | —                                          |       | 733,334                                                                  |       |
| Issuance of note  payable for redemption of common stock                                                                                                                                 |       | —                                          |       | —                                          |       | 650,000                                                                  |       |
| Warrants issued  for debt issuance costs                                                                                                                                                 |       | —                                          |       | —                                          |       | 242,612                                                                  |       |
| Conversion of  accounts payable to note payable                                                                                                                                          |       | —                                          |       | —                                          |       | 241,613                                                                  |       |
| Deposits applied  to note payable and accrued interest                                                                                                                                   |       | —                                          |       | —                                          |       | 142,696                                                                  |       |
| Deposits applied  to accounts payable                                                                                                                                                    |       | —                                          |       | —                                          |       | 45,782                                                                   |       |
| Assumption of  liabilities in the Profile, LLC transaction                                                                                                                               |       | —                                          |       | —                                          |       | 25,000                                                                   |       |
| Deposits applied  to accrued expenses                                                                                                                                                    |       | —                                          |       | —                                          |       | 1,076                                                                    |       |
|                                                                                                                                                                                          |            |                                                 |            |                                                 |            |                                                                          |            |  |  |  |

 

*See accompanying notes to financial statements.*

 

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**ProUroCare Medical Inc.**

**ADevelopment Stage Company**

**Notes to Consolidated FinancialStatements**

** **

**September 30, 2008 and 2007 and the period from**

**August 17, 1999 (inception) to September 30, 2008**

 

(Unaudited)

 

**(1) Description of Business and Summary of Significant Accounting Policies**

** **

***(a)***                     Description ofBusiness, Development Stage Activities and Basis of Presentation

*** ***

ProUroCareMedical Inc. (“ProUroCare,” the “Company,” “we” or “us”) is a development stagecompany engaged in the business of developing for market innovative productsfor the detection and characterization of male urological prostate disease. Theprimary focus of the Company is currently the ProUroScanTM prostateimaging system, designed for use as an aid to the physician in visualizing anddocumenting tissue abnormalities in the prostate that have been previouslydetected by a digital rectal exam. The Company’s developmental activities,conducted by its wholly owned operating subsidiary ProUroCare Inc. (“PUC”),have included the acquisition of several technology licenses, the purchase ofintellectual property, the development of a strategic business plan and asenior management team, product development and fund raising activities.

 

PUChad no activities from its incorporation in August 1999 until July 2001,when it acquired a license to certain microwave technology from CS MedicalTechnologies, LLC (“CS Medical”). In January 2002, PUC acquired a licenseto certain prostate imaging technology from Profile, LLC (“Profile”).

 

Pursuantto a merger agreement effective April 5, 2004 (the “Merger”), PUC became awholly owned operating subsidiary of Global Internet Communications, Inc.(“Global”), which changed its name to ProUroCare Medical Inc. on April 26,2004. In connection with the Merger, the Company completed a private placementof 220,500 shares, as adjusted for the Reverse Split (as defined below), ofcommon stock (the “2004 Private Placement”) pursuant to Rule 506 under theSecurities Act of 1933, as amended (the “Securities Act”).

 

On December 27, 2007, the Company’s shareholdersapproved a one-for-ten reverse split of the Company’s common stock without a corresponding reduction in thenumber of authorized shares of the Company capital stock (the “Reverse Split”).The reverse stock split became effective on February 14, 2008. Theexercise price and the number of shares of common stock issuable under theCompany’s outstanding convertible debentures, options and warrants wereproportionately adjusted to reflect the Reverse Split for all periodspresented.

 

Theaccompanying consolidated financial statements include the accounts of theCompany and its wholly owned subsidiary, PUC. Significant intercompany accountsand transactions have been eliminated in consolidation.

 

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***(b)***                     Restatement ofShare Data

*** ***

Allshare data has been adjusted to give effect to the Reverse Split.

 

Atthe effective time of the Merger, all 350,100 shares of common stock of PUCthat were outstanding immediately prior to the Merger and held by PUCshareholders were cancelled, with one share of ProUroCare common stock issuedto Global. Simultaneously, the non-dissenting shareholders of PUC received anaggregate of 960,300 shares of common stock of Global in exchange for theiraggregate of 320,100 shares of PUC. All share data has been adjusted to giveeffect to the Merger under which each PUC share was converted into three sharesof Global. The share data in this paragraph has been restated to give effect tothe Reverse Split, as noted above.

 

***(b)***                     InterimFinancial Information

*** ***

The accompanying unaudited financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (“GAAP”) and pursuant to the rules andregulations of the Securities and Exchange Commission (the “SEC”) for interimfinancial information. Accordingly, certain information and footnotedisclosures normally included in financial statements prepared in accordancewith GAAP have been omitted pursuant to such rules and regulations. Operatingresults for the three and nine months ended September 30, 2008 are notnecessarily indicative of the results that may be expected for the year ending December 31,2008 or any other period. The accompanying financial statements and relatednotes should be read in conjunction with the audited financial statements ofthe Company, and notes thereto, contained in our Annual Report on Form 10-KSBfor the year ended December 31, 2007.

 

The financial information furnished reflects, in theopinion of management, all adjustments, consisting of normal recurringaccruals, necessary for a fair presentation of the results of the interimperiods presented.

 

***(c)***                      AccountingEstimates

*** ***

The preparation of financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of expenses during the reporting periods. The Company’ssignificant estimates include the determination of the fair value of its commonstock and stock-based compensation awarded to employees, directors, loanguarantors and consultants and the accounting for debt with beneficialconversion features. Actual results could differ from those estimates.

 

*Valuation of Stock-BasedCompensation.*Effectiveas of August 17, 1999 (inception), the Company adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 123 “Accounting forStock-Based Compensation”**(“SFAS 123”)**and on January 1, 2006 adopted SFAS No. 123(revised 2004) “**Share-BasedPayment”**(“SFAS 123R”), which requires the measurementand recognition of compensation expense for all share-based payment awards madeto employees and directors including employee stock options based on fair values.The Company’s determination of fair value of share-based payment awards isbased on the date of grant using an option-pricing model which incorporates anumber of highly complex and 

 

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subjective variables. These variables include, butare not limited to, the Company’s expected stock price volatility and estimatesregarding projected employee stock option exercise behaviors and forfeitures. TheCompany recognizes the expense related to the fair value of the awardstraight-line over the vesting period.

 

*Debt with Beneficial ConversionFeatures*. Thebeneficial conversion features of the promissory notes are valued using theBlack-Scholes pricing model which approximates fair value. The resultingoriginal issue discount is amortized over the life of the promissory notes(generally no more that 24 months) using the straight-line method, whichapproximates the interest method.

 

***(d)***                     Net Loss PerCommon Share

*** ***

Basic and diluted loss per common share is computedby dividing net loss by the weighted-average number of common sharesoutstanding for the reporting period. These calculations reflect the effects ofthe Company’s Reverse Split (see Note 1(a)). Dilutive common-equivalent shareshave not been included in the computation of diluted net loss per share becausetheir inclusion would be antidilutive. Antidilutive common equivalent sharesissuable based on future exercise of stock options or warrants couldpotentially dilute basic loss per common share in subsequent years. All optionsand warrants outstanding were antidilutive for the three and nine months ended September 30,2008 and 2007, and the period from August 17, 1999 (inception) to September 30,2008 due to the Company’s net losses. 1,605,386 and 872,411 shares of commonstock issuable under stock options, warrants, convertible debt and contingentshares and warrants issuable under agreements with loan guarantors wereexcluded from the computation of diluted net loss per common share for theperiods ended September 30, 2008 and 2007, respectively, as were theundetermined number of shares issuable pursuant to the convertible notes andwarrants issued in connection with our private placements and unit putarrangements as described and defined in Note 5 and Note 6.

 

***(e)***                      Stock-BasedCompensation

*** ***

Effectiveas of August 17, 1999, the Company adopted the fair value recognitionprovisions of SFAS 123 to record option and warrant issuances, includingstock-based employee compensation. The Company’s policy is to grant stockoptions at fair value at the date of grant and to record the expense at fairvalue as required by SFAS 123, using the Black-Scholes pricing model.

 

Effective January 1, 2006, the Company adoptedSFAS 123R, that focuses primarily on accounting for transactions in which anentity obtains employee services in share-based payment transactions. Thisstatement replaced SFAS 123 and supersedes Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees.”  SFAS 123R requires all companies to expensethe fair value of employee stock options and similar awards, which has been theCompany’s policy to date. Stock-based employee and non-employee compensationcost related to stock options was $18,366, $33,585 and $1,615,663 for the threeand nine months ended September 30, 2008 and the period from August 17,1999 (inception) to September 30, 2008, respectively. Stock-based employeeand non-employee compensation cost related to stock options was $53,138 and$415,239 for the three and nine months ended September 30, 2007. TheCompany estimates the amount of 

 

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future stock-based compensation expense related tocurrently outstanding options to be approximately $52,000, $31,000, $24,000 and$12,000 for the years ending December 31, 2008, 2009, 2010 and 2011,respectively.

 

TheBlack-Scholes option-pricing model was developed for use in estimating the fairvalue of traded options that have no vesting restrictions and are fullytransferable. In addition, option pricing models require the input of highlysubjective assumptions. Because the Company’s employee and consultant stockoptions have characteristics significantly different from those of tradedoptions, and because changes in the subjective input assumptions can materiallyaffect the fair value estimate, the existing models may not necessarily providea reliable single measure of the fair value of the Company’s employee stockoptions.

 

Indetermining the compensation cost of the options and warrants granted duringthe three and nine months ended September 30, 2008 and September 30,2007, as specified by SFAS 123R, the fair value of each option grant has beenestimated on the date of grant using the Black-Scholes pricing model and theweighted-average assumptions used in these calculations are summarized asfollows:

 
| ** **                        | ** ** | **Three Months Ended  September 30** | ** ** | **Nine months Ended  September 30** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk-free  Interest Rate          |       | 3.13                                                | %          | n/a                                                |       | 3.13 | % | 4.90 | % |
| Expected Life of  Options Granted |       | 4.3 years                                           |       | n/a                                                |       | 4.3 years |   | 4.0 years |   |
| Expected  Volatility              |       | 131.2                                               |       | n/a                                                |       | 131.2 |   | 133.4 | % |
| Expected  Dividend Yield          |       | 0                                                   |       | n/a                                                |       | 0 |   | 0 |   |

 

The expected life of the options is determined using asimplified method, computed as the average of the option vesting periods andthe contractual term of the option. For performance based options that vestupon the occurrence of an event, the Company uses an estimate of when the eventwill occur as the vesting period used in the Black-Scholes calculation for eachoption grant. Because of the limited trading history of the Company’s stock, untilDecember 31, 2007 the expected volatility was based on a simple average ofdaily price data since the date of the Merger on April 5, 2004. Beginningon January 1, 2008, expected volatility is based on a simple average ofweekly price data since the date of the Merger. Based on the lack of history tocalculate a forfeiture rate, the Company has not adjusted the calculated valueof the options. The risk-free rates for the expected terms of the stock optionsand awards are based on the U.S. Treasury yield curve in effect at the time ofgrant.

 

***(f)***                        Warrants

*** ***

In accordance with Emerging Issues Task Force (“EITF”)Issue No. 96-18, “Accounting for Equity Instruments that are Issued toOther than Employees for Acquiring, or in Conjunction with Selling, Goods andServices” (“EITF 96-18”) and EITF Issue No. 98-5, “Accounting forConvertible Securities with Beneficial Conversion Features or ContingentlyAdjustable Conversion Ratios” (“EITF 98-5”), the Company has elected to utilizethe fair-value method of accounting for warrants issued to non-employees asconsideration for goods or services received, including warrants issued tolenders and guarantors of Company debt. The weighted-average per share fairvalue of warrants granted during the three and nine months ended September 30,2008 was $1.33 and $1.23, respectively, and such warrants were 

 

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immediately vested and exercisable on the date ofgrant. See Note 7(c) for a description of warrants issued during the threeand nine months ended September 30, 2008.

 

Thefair value of stock warrants is the estimated present value at grant date usingthe Black-Scholes pricing model with the following weighted-averageassumptions:

 
| ** **                           | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk-free  Interest Rate             |       | 2.82                                                | %          | 4.73                                               | %          | 3.12 | % | 4.71 | % |
| Expected Life of  Warrants Issued(1) |       | 4.2 years                                           |       | 5.0 years                                          |       | 3.6 years |   | 4.9 years |   |
| Expected  Volatility                 |       | 134.0                                               | %          | 134.3                                              | %          | 131.2 | % | 135.2 | % |
| Expected  Dividend Yield             |       | 0                                                   |       | 0                                                  |       | 0 |   | 0 |   |

 

----

(1) The contractual termof the warrants.

 

Because of the limited trading history of the Company’sstock, until December 31, 2007 the expected volatility was based on asimple average of daily price data since the date of the Merger on April 5,2004. Beginning on January 1, 2008, expected volatility is based on asimple average of weekly price data since the date of the Merger. Based on the lackof history to calculate a forfeiture rate, the Company has not adjusted thecalculated value of the warrants. The risk-free rates for the expected terms ofthe stock warrants are based on the U.S. Treasury yield curve in effect at thetime of grants.

 

***(g)***                     Debt IssuanceCosts

*** ***

Debtissuance costs at December 31, 2007 consisted of legal and accounting fees, printing costs andcommissions paid to theplacement agentsrelated to the Company’s Crown Bank promissory notes, a promissory note issuedto the Phillips W. Smith Family Trust, a five percent shareholder (the “SmithTrust”) and the Company’s December 27, 2007 private placements ofconvertible debentures and warrants (the “2007 Private Placement”) (see Note5(a)). During the three and nine months ended September 30, 2008, theCompany incurred additional debt issuance costs related to a second closing onthe 2007 Private Placement, the closings on an aggregate of $720,000 of units consisting of unsecured,subordinated, convertible promissory notes and common stock purchase warrantsin additional private placements (the “2008Private Placements”) (see Note5(b)) and the closing on a$325,000 unit put financing facility (see Note 6). Debt issuance costs are amortized over theterm of the related debt as interest expense using the straight-line method,which approximates the interest method.

 

***Debt issuancecosts are summarized as follows:***

 
| ** **                  | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Debt issuance  costs, gross |       | $                            | 701,238    |                        | $          | 452,113 |   |
| Less  amortization          |       | (312,791                     | )          | (12,792                     | )          |
|                        |       |                         |       |                        |       |
| Debt issuance  costs, net   |       | $                            | 388,447    |                        | $          | 439,321 |   |

 

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Amortization expense related to debt issuance costs was $114,180,$299,999 and $1,584,168 for the three and nine months ended September 30,2008 and the period from August 17, 1999 (inception) to September 30,2008, respectively. Amortization expense related to debt issuance costs was$132,917 and $394,418 for the three and nine months ended September 30,2007, respectively.

 

***(h)***                     DeferredOffering Costs

*** ***

Thelegal fees related to an anticipated public offering the Company expects tocomplete in the second half of 2008 (see Note 12) were recorded as a deferredoffering cost asset as of September 30, 2008. The deferred costs relatedto the public offering will be recorded as a cost of the offering upon itsclosing, or expensed as a general and administrative expense if no such closingoccurs.

 

***(i)***                        Restricted Cash

*** ***

Pursuantto the renewal of the Crown Bank promissory notes (see Note 2), the Companyagreed to deposit with Crown Bank four months worth of future interest paymentsdue under the notes. The Company has further agreed to deposit with Crown Bankall of the interest due on the notes through maturity upon the closing, and outof the net proceeds of, a futureunderwritten public offering of equity securities of the Company (see Note 12).The funds on deposit are not available to the Company for any purpose otherthan for debt service on the Crown Bank promissory notes.

 

***(j)***                        Going Concern

** **

We have incurred operatinglosses, accumulated deficit and negative cash flows from operations sinceinception. As of September 30, 2008, we had total shareholders’ deficit ofapproximately $5,245,000. These factors, among others, raise substantial doubtabout our ability to continue as a going concern. The accompanying unauditedconsolidated financial statements do not include any adjustments related torecoverability and classification of asset carrying amounts or the amount andclassification of liabilities that might result should we be unable to continueas a going concern.

 

**Note 2. Notes Payable –Bank.**

** **

In February 2006, the Company completed twoclosings of senior debt financing totaling $2,200,000 pursuant to promissorynotes issued to Crown Bank. On October 15, 2007, the Company retired$600,000 of the Crown Bank Promissory notes, and on October 31, 2007, theCompany renewed the remaining $1,600,000 of notes to mature in February 2009.The renewed notes bear interest at a rate of the prime rate plus one percent(6.00 percent and 8.25 percent at September 30, 2008 and December 31,2007, respectively), with $1,200,000 of the renewed notes subject to a minimuminterest rate of 6.5 percent. The average interest rate of the notes was 6.37percent and 6.70 percent for the three and nine months ended September 30,2008, respectively. The promissory notes are secured by a pledge of all Companyassets, including its intellectual property, and are guaranteed by BruceCulver, James Davis and William Reiling, each five percent shareholders of theCompany.

 

In connection with the renewal, and as a conditionto the effectiveness of the terms and conditions of the renewal of the notes,the Company agreed to deposit into escrow with Crown Bank four months worth offuture interest payments due under the notes. On December 28, 2007, theCompany deposited $44,000 with Crown Bank as the four months interestrequirement, thereby making effective the terms of the renewed notes. TheCompany has further agreed to deposit into 

 

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escrow with Crown Bank all of the interest due onthe notes through maturity upon the closing, and out of the net proceeds of, an underwritten public offering of equitysecurities of the Company.

 

**Note 3. Notes Payable.**

** **

On June 1, 2006, theCompany borrowed $75,000 from Mr. Roman Pauly, and in connection therewithissued to Mr. Pauly a promissory note to mature on August 30, 2006(the “Pauly Note”). On March 20, 2007, the Pauly Note was amended toextend the due date of the note until the Company closes on an aggregate of$750,000 of incremental debt or equity financing. On January 22, 2007, January 3,2008 and February 29, 2008, the Company repaid $25,000, $33,000 and $7,650of the principal of the Pauly Note, respectively. At September 30, 2008,the outstanding balance of the Pauly Note was $9,350. The Pauly Note, asamended, bears interest at the prime rate (5.00 percent and 7.25 percent at September 30,2008 and December 31, 2007, respectively). In connection with theamendments, following repayment of the Pauly Note, the Company will issue afive-year warrant to Mr. Pauly to acquire 41.7 shares of the Company’scommon stock at $5.00 per share for each day the promissory note is outstandingafter August 30, 2006. The guidance provided by EITF Issue No. 96-19 “Debtor’sAccounting for a Modification or exchange of Debt Instruments (“EITF 96-19”)indicates that a substantial modification of debt terms should be accounted foras an extinguishment of debt. The present value of the cash flows under the August 24,2006 modification was greater than 10 percent different from the present valueof the cash flows under the original agreement. Accordingly, the accrual ofwarrants to be issued pursuant to the amended note was recorded as debtextinguishment expense (see Note 7(c)).

 

On November 30, 2006,the Company borrowed $100,000 from Adron Holdings, LLC (“Adron”). In connectiontherewith, the Company issued to Adron an unsecured promissory note that borean annual interest rate of 60 percent and was set to mature on January 2, 2007(the “Adron Note”). On each of March 20, 2007 and August 8, 2007, theCompany amended the Adron Note, resulting in a change of the annual interestrate to 42 percent, the extension of its due dates and an agreement to issue toAdron five-year warrants to acquire 167 shares at $5.00 per share for each daythe principal remained unpaid on and after March 1, 2007. In January 2008,the Company repaid the outstanding principal amount of the Adron Note andissued five-year, immediately exercisable warrants to acquire up to 52,357shares of the Company’s common stock at $5.00 per share (see Note 7(c)). Theguidance provided by EITF 96-19 indicates that a substantial modification ofdebt terms should be accounted for as an extinguishment of debt. The present valueof the cash flows under the modifications was greater than 10 percent differentfrom the present value of the cash flows under the existing agreement. Accordingly,the accrual of warrants to be issued pursuant to the Adron Note was recorded asdebt extinguishment expense (see Note 7(c)).

 

On May 27, 2008, the Company borrowed $43,860from a commercial lender pursuant to an insurance policy financing agreement. Thefinancing agreement calls for ten monthly installment payments of $4,554beginning July 1, 2008, with an imputed annual interest rate of 8.26percent. The proceeds were paid directly to an insurance company as aprepayment on an insurance policy. On September 16, 2008, the Companyborrowed an additional $10,644 from the same commercial lender pursuant to anincrease in its insurance coverage, resulting in an increase in the remainingmonthly payments of $1,823 beginning November 1, 2008.

 

**On July 31,2007, the Company borrowed, for working capital purposes, $100,000 from theSmith Trust pursuant to a promissory note. The note bears interest at the primerate (5.00 percent on September 30, 2008)**. Followingrepayment of the promissory note, the Company will issue a five-year warrant tothe Smith Trust to acquire 1 share of the Company’s common stock per $1,000 

 

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**principal balance outstanding at $5.00 per share, for eachday the promissory note is outstanding (see Note 7(c)).**On January 3, 2008, the Company repaid $66,000of this note. On March 11, 2008, the Company amended thepromissory note with the Smith Trust. Under the terms of the amendment, unpaidprincipal and interest will be payable upon the Company’s closing of anaggregate of $500,000 or more of incremental debt or equity financing followingthe date of the amendment. Interest expense recorded duringthe three and nine months ended September 30, 2008 and the period from August 17,1999 (inception) to September 30, 2008was $420, $1,447 and $4,774,respectively. Interest expense recognized during the three and nine monthsended September 30, 2007 was $1,406 and $1,406, respectively.

** **

***Atvarious times the Company receives short-term, unsecured loans from certainofficers and directors solely for short-term working capital needs. These loansare made without any interest or other consideration accruing to the officersand directors, and had no defined terms. As of December 31, 2007, theCompany had borrowed a total of $10,450 from David Koenig, a director. Duringthe nine months ended September 30, 2008, the Company repaid the entireloan.***

*** ***

On October 31, 2007,the Company issued a promissory note for $600,000 in favor of the Smith Trust,effective as of October 15, 2007. The proceeds were used to retire$600,000 of the Crown Bank promissory notes. The promissory note issued to theSmith Trust matures on February 28, 2009, bears interest at the prime rateplus one percent (6.00 percent at September 30, 2008 and 8.25 percent at December 31,2007, respectively) and has a subordinated security interest in all of theCompany’s assets. Interest expense recorded during the three and nine monthsended September 30, 2008 and the period from August 17, 1999 (inception)to September 30, 2008 was $9,200, $29,387 and $40,280, respectively. Nointerest expense was recorded in the three and nine months ended September 30,2007. In consideration for this loan, on November 7, 2007, the Companyagreed to issue 33,333 shares of its common stock to the Smith Trust, the valueof which was recorded as debt issuance cost asset (see Note 1(h)). We alsoagreed to issue to the Smith Trust: (i) an aggregate amount of 6,667shares of our common stock if the Crown Bank promissory notes remainoutstanding on October 31, 2008 and (ii) five-year warrants toacquire a maximum aggregate of 16,667 shares of our common stock at an exerciseprice of $2.00. The total aggregate number of shares subject to the warrantswill be determined by dividing 100,000 by the per share price in anunderwritten public offering (not less than $2.00), minus 33,333. The warrantswill be issued on the earlier of (i) the date of an underwritten publicoffering or (ii) October 31, 2008, and will be exercisable beginningon the one-year anniversary of that date. On March 11, 2008, the Company amended the promissory note with theSmith Trust. Under the terms of the amendment, interest accrued pursuant to thepromissory note will be payable on the maturity date, rather than payablemonthly.

 

On April 3, 2008, theCompany purchased certain patents, patent applications and know-how fromProfile (the “Profile Assets”) (see Note 9). $150,000 of the purchase price wasfinanced under a secured promissory note issued in favor of Profile (the “ProfileNote”). Pursuant to the terms of the Profile Note, the principal and interestaccrued thereon was to become due and payable five business days following theclose of a public offering of the Company’s equity securities or August 29,2008, whichever occurred first (the “Maturity Date”). Interest accrued at anannual rate of 10 percent prior to the Maturity Date and 18 percent thereafter.On September 10, 2008, the Company amended the Profile Note such that itbecame due on September 25, 2008. On September 25, 2008, the Companypaid off the Profile Note and the accrued interest thereon.

 

**On April 3, 2008, the Company borrowedan aggregate of $112,500 pursuant to three promissory notes, each in the amountof $37,500. The promissory notes were issued in favor of James Davis,**

 

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**William Reiling and the Smith Trust. Theproceeds from the promissory notes were used toward the purchase of the ProfileAssets (see Note 9). Payment in full of the promissory notes and the interestaccrued thereon at an annual rate of 10 percent was due on September 1,2008. As consideration for providing the loans, the Company issued immediatelyexercisable, five-year warrants to purchase 25,000 shares of the Company’scommon stock at $1.50 per share to each lender. The gross proceeds wereallocated between the note and the warrants based on the relative fair value atthe time of issuance. The $42,769 relative fair value of the warrants wasrecorded as original issue discount on the related promissory notes andexpensed as interest expense over the term of the promissory notes. Interestexpense related to the amortization of the original issue discount was $17,221,$42,469 and $42,769 for the three and nine months ended September 30, 2008and**the period from August 17, 1999 (inception) to September 30,2008, respectively. On September 12, 2008,the Company amended the three promissory notes to extend the due date and toinclude a conversion feature (see Note 5).

** **

**Note 4. Convertible Debentures.**

 

As consideration to the guarantors (Bruce Culver,James Davis, William Reiling and the Smith Trust) to provide their guaranteesfor the Crown Bank promissory notes, the Company issued $733,334 of unsecuredconvertible 10 percent debentures. Of the $733,334, $400,000 matures on February 16,2009 and $333,334 matures on February 28, 2009. The debentures areconvertible into Company common stock at a price of $3.00 per share. The$733,334 face value of the convertible debentures (before the impact of thecalculation of the beneficial conversion feature — see below) is recorded as acurrent liability, with the offset of the cost of the debentures recorded as adebt issuance cost asset. The debt issuance cost asset is being amortized asinterest expense over the term of the underlying bank note payable. The convertible debentures are being treatedas debt issuance cost because they represent the costs directly attributable tothe bank promissory note financing.

 

The embedded conversion feature of the convertibledebentures does not meet all the characteristics of a derivative instrument asdescribed in SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities” (“SFAS 133”), and therefore was not separated from the hostcontract and accounted for as a derivative. The embedded conversion featuredoes not provide for net settlement, the shares to be issued pursuant to theexercise of the conversion feature will be unregistered and, due to the largenumber of shares involved and the thinly traded market for the Company’sshares, cannot be readily settled net by a means outside the contract. Thevalue of the beneficial conversion feature was computed as the differencebetween the fair market value of the shares at the transaction dates and thelowest possible conversion price during the debenture term ($3.00 per share),multiplied by the number of conversion shares that would be issued at thatconversion price (244,445 shares). The value so computed was in excess of theface value of the convertible debentures issued, and was therefore limited tothe face value of the debentures issued ($733,334). The beneficial conversionfeature was recorded as an original issue discount as defined in EITF 98-5against the convertible debt liability and is also being amortized as interest expense over the term of theconvertible debentures. Interestexpense related to the amortization of the original issue discount was $61,613,$183,500 and $637,925 for the three and nine months ended September 30,2008 and the period from August 17, 1999 (inception)to September 30, 2008, respectively. Interest expense related to the amortization of the original issue discountwas $61,613 and $182,819 for the three and nine months ended September 30,2007.

 

On March 21, 2007, theCompany and the four convertible debenture holders agreed to amend thedebenture agreements. Pursuant to the revised debenture agreements, among otherthings, the 

 

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Company issued a total of12,478 shares of its Investment Units to the four guarantors in lieu of $49,911of accrued interest. Each Investment Unit consists of one share of the Company’scommon stock and a 3-year warrant (immediately exercisable) to acquire 0.5shares of the Company’s common stock for $2.50 ($5.00 per share). The guidanceprovided by EITF 96-19 indicates that a substantial modification of debt termsshould be accounted for as an extinguishment of debt. The present value of thecash flows under the March 20, 2007 modification was greater than 10percent different from the present value of the cash flows under the originalagreement. Accordingly, the warrants issued, valued at $26,829 using theBlack-Scholes method, were recorded as debt extinguishment expense. No othergain or loss was recorded.

 

**On December 27, 2007, the**four convertibledebenture holders agreed to amend the terms of their debentures toprovide for automatic conversion of the principal amount of the debentures andthe unpaid interest accrued thereon into shares of the Company’s common stockat $3.00 per share upon the closing of an underwritten public offering by theCompany. The $733,334 outstanding principal amount of the debentures willconvert into 244,445 shares of the Company’s common stock. As of September 30,2008, $123,862 of unpaid accrued interest related to the debentures wasoutstanding. Interest will continue to accrue on the debentures until they areconverted or otherwise retired. Interest expense recordedduring the three and nine months ended September 30, 2008, and the periodfrom August 17, 1999 (inception) to September 30, 2008 was $18,742,$55,819 and $193,941, respectively. Interest expense recorded during the threeand nine months ended September 30, 2007 was $18,742 and $55,615,respectively.

** **

**Note 5. Convertible Notes.**

 

***(a)****      **2007 Private Placement*

** **

**On December 27, 2007, the Company closed on the saleof $1,050,000 of units consisting of unsecured, subordinated, convertiblepromissory notes (the “2007 Notes”) and common stock purchase warrants (the “2007Warrants”) in a private placement (the “2007 Private Placement”). Net cashproceeds to the Company were $712,923, after deducting $337,077 of expenses ofthe offering (including $105,000 of commissions paid to the placement agent)and excluding from the cash proceeds the conversion into units of $25,000 ofloans made to the Company by James Davis and $25,000 of certain loans from theCompany’s directors.**

** **

**At the closing, the Company issued $997,500 in principalamount of 2007 Notes and 2007 Warrants to purchase 210,000 shares of commonstock. The 2007 Notes bear interest at 10 percent per year, mature on June 27,2009 and will convert into the type of equity securities offered by the Companyin any underwritten public offering prior to maturity at 70 percent of thepublic offering price. In the event a public offering is not completed beforethe maturity date, the entire principal and unpaid accrued interest willconvert into the Company’s common stock at $0.05 per share. The Company may, atits option, prepay the 2007 Notes anytime on or after December 27, 2008. The2007 Warrants will become exercisable upon the earlier of the closing of apublic offering or the maturity date of the 2007 Notes, and will remainexercisable until December 31, 2012. The exercise price will be 50 percentof the public offering price, or in the event a public offering is notcompleted before the maturity date, at 50 percent of the closing price of theCompany’s common stock on the maturity date of the 2007 Notes.**

** **

**On December 27, 2007, the Company also converted$150,000 of existing loans from James Davis into a note (the “Davis Note”) andwarrants (the “Davis Warrants”). The principal amount of the**

 

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**note issued to Mr. Davis was $142,500. Mr. Davisalso received warrants to purchase 30,000 shares of the Company’s common stock.The terms of the Davis Note and Davis Warrants are the same as those issued inthe 2007 Private Placement, except that, the Davis note is convertible into thetype of equity securities offered by the Company in an underwritten publicoffering at 50 percent of the public offering price. In addition, Mr. Davisagreed that the equity securities issued upon conversion of the Davis Note andthe common stock issued upon exercise of the Davis Warrants will not betransferable for a period of one year beginning on the effective date of thepublic offering triggering conversion of the note.**

 

On January 4, 2008, theCompany closed on the sale of $80,000 of additional units as part of the 2007Private Placement with the same terms as noted above. Net cash proceeds to theCompany were $69,600, after deducting $10,400 of commissions paid to theplacement agent. At closing, the Company issued $76,000 in principal amount of2007 Notes and 2007 Warrants to purchase 16,000 shares of common stock. Intotal, in the two closings of the 2007 Private Placement, the Company issued atotal of $1,073,500 in principal amount of 2007 Notes and 2007 Warrants topurchase 226,000 shares of common stock.

 

*(b) 2008 Private Placement*

 

On February 13, February 28,May 2, July 15 and July 30, 2008, the Company closed on anaggregate $720,000 of units consistingof unsecured, subordinated, convertible promissory notes and common stockpurchase warrants (the “2008 PrivatePlacements”). Net cash proceeds to the Company were $539,716, after deducting$180,284 of expenses of the offerings (including $93,600 of commissions paid tothe placement agent). Each $10,000 unit consists of a note in theprincipal amount of $9,500 (the “2008 Notes”) and a warrant to purchase 2,000 shares of our common stock (the “2008Warrants”). The terms of the2008 Notes and 2008 Warrants are identical to the 2007 Notes and 2007 Warrants,respectively, except that the Company’s option to prepay $370,500 of the 2008Notes begins anytime on or after February 13, 2009 with a maturity date ofAugust 13, 2009, the Company’s option to prepay $147,250 of the 2008 Notesbegins anytime on or after May 2, 2009 with a maturity date of November 2,2009 and the Company’s option to prepay the remaining $166,250 of the 2008Notes begins anytime on or after July 15, 2009 with a maturity date of March 15,2010.

 

The embedded conversion features of the 2007 Notes,Davis Notes and the 2008 Notes do not meet all the characteristics of aderivative instrument as described in SFAS 133, and therefore were notseparated from the host contracts and accounted for as derivatives. Theembedded conversion features are indexed to the Company’s common stock, andwould be classified in shareholders’ equity under the guidance of EITF Issue No. 00-19“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock” (“EITF 00-19”), if they were freestandingderivatives. The embedded conversion feature contains an explicit limit on thenumber of shares to be delivered, the Company has sufficient authorized andunissued shares available to settle the maximum number of shares and thedebenture agreement does not contain a net cash settlement feature. Thebeneficial conversion features of the 2007 Notes, Davis Notes and the 2008Notes, valued at $946,539 using the Black-Scholes pricing model, along with the$153,735 relative fair value of the 2007 Warrants, the Davis Warrants and the2008 Warrants, were recorded as an original issue discount as defined in EITF98-5 against the convertible debt liability, and are being amortized asinterest expense over the term of the convertible debentures. During the threeand nine months ended September 30, 2008, $151,587 and $443,706 of theoriginal issue discount was amortized as interest expense, respectively.

 

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* *

*(c) Amendmentof Three Promissory Notes*

 

**On April 3,2008, the Company borrowed an aggregate of $112,500 pursuant to threepromissory notes, each in the amount of $37,500 (see Note 3). **On September 12, 2008, the Company amended thethree promissory notes.  Under the termsof the amendments, the maturity date of each $37,500 note was changed from September 1,2008 to the earlier of the seven days after the date the Company closes on anunderwritten public offering of equity securities or December 31,2008.  In addition, each note holder wasgiven the option of converting the principal and interest into shares of theCompany’s common stock at price equal to 70 percent of the price of thesecurities sold in that underwritten public offering, in lieu of cash.  EITF Issue No. 06-6 “Debtor’s Accountingfor a Modification (or Exchange) of Convertible Debt Instruments” requires thata modification or exchange of debt instruments be accounted for as debtextinguishment if a substantive conversion option is added to the new ormodified debt instrument.  Under theguidance of EITF Issue No. 05-1 “Accounting for the Conversion of anInstrument That Became Convertible upon the Issuer’s Exercise of a Call Option,”the added conversion option was deemed to be substantive.  Accordingly, the amendments were treated as adebt extinguishment.  No gain or loss wasrecognized.  The $48,214 fair value ofthe beneficial conversion feature was recorded as original issue discount, andis being amortized as debt extinguishment expense over the term of the notes.

** **

*(d) Issuanceof $150,000 Convertible Promissory Note*

 

**On September 25,2008, the Company borrowed $150,000 pursuant to a promissory note issued infavor of James Davis.  The proceeds ofthe loan were used to retire the $150,000 principal balance of the ProfileNote.  Payment in full of the promissorynotes and the interest accrued thereon at an annual rate of 10 percent is dueon the earlier of seven days after the date the Company closes an underwrittenpublic offering of equity securities or March 25, 2010.  In the event that the Company closes on apublic offering of equity securities before March 25, 2010, Mr. Daviswill have the option of converting the principal and accrued interest intoshares of the Company’s common stock at 70 percent of the public offeringprice.  As consideration for providingthe loan, the Company issued an immediately exercisable, five-year warrant topurchase 100,000 shares of the Company’s common stock at $1.50 per share to Mr. Davis.  The gross proceeds were allocated between thenote, the warrants and the bargain conversion feature of the note based on therelative fair value at the time of issuance. The $46,604 relative fair value of the warrants was recorded as originalissue discount and is being expensed as interest expense over the term of thepromissory note.  As the holder’s abilityto exercise the conversion feature of the note is contingent upon an eventoutside the control of the holder, the bargain conversion feature valued at$103,396 is not recorded until the contingency is removed.**

** **

**Note 6.  UnitPut Arrangements.**

** **

On September 16, 2008, the Company secured$325,000 of future funding through commitments to purchase units in accordancewith the terms of a unit put agreement (the “Unit Put Agreement,” such futurefunding commitments, the “Unit Put Arrangements”).  Upon the Company’s exercise of the put, allof the investors who have signed a Unit Put Agreement will purchase the unitsbeing put by the Company on a pro rata basis within 5 days after receiving theput notice.

 

In consideration of each purchaser’s future fundingcommitment, each purchaser received an origination warrant to purchase 1,000shares of the Company’s common stock for each $10,000 unit that an investorcommitted to purchase (each, an “Origination Warrant”).  Each Origination Warrant becomesexercisable when the right of the Company to exercise the put expires and 

 

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remainsexercisable until December 31, 2012 at an exercise price of $1.00 pershare.  We have issued Origination Warrants to purchase an aggregate 32,500shares of our common stock.  TheOrigination Warrants, valued at $42,575 using the Black-Scholes pricing model,were recorded as a debt issuance cost asset and are being amortized as interestexpense over the term of the Unit Put Agreement.

 

Each unit consists of a note in the principal amount of $9,500 (the “UnitPut Notes”) and a warrant to purchase2,000 shares of the Company’s common stock (the “Unit Put Warrants”).  Thepurchase price of the warrant portion of each unit is $500.  The Unit Put Notes bear interest at 10percent per year, mature on March 16, 2010 and convert into common stockat 70 percent of the initial offering price of the securities offered by theCompany in an underwritten public offering. In the event such an offering is not completed before the maturity date,the entire principal and unpaid accrued interest will convert into the Company’scommon stock at $0.15 per share.  TheCompany may, at its option, prepay the notes anytime on or after January 1,2009.  The warrants will be exercisableimmediately upon issuance and will remain exercisable until December 31,2012 at an exercise price of $1.00 per share.

 

On September 16,2008, the Company exercised $162,500 of its put options under the Unit PurchaseAgreement, and upon the September 24, 2008 closing thereof, issued UnitPut Notes in the principal amount of $154,375 and 32,500 Unit PutWarrants.  Cash proceeds from thisclosing were $137,500, while $25,000 of the Unit Put Notes and Warrants were paidfor by the reduction of accrued interest due to one of the investors.  Legal, accounting and other direct costsrelated to the offering totaling $13,002 were recorded as debt issuance costand are being amortized as interest expense over the term of the Unit PutAgreement.  The embedded conversion feature of the UnitPut Notes does not meet all the characteristics of a derivative instrument asdescribed in SFAS 133, and therefore was not separated from the host contractsand accounted for as derivatives.  Theembedded conversion feature is indexed to the Company’s common stock and wouldbe classified in shareholders’ equity under the guidance of EITF 00-19 if itwas a freestanding derivative.  Theembedded conversion feature contains an explicit limit on the number of sharesto be delivered, the Company has sufficient authorized and unissued sharesavailable to settle the maximum number of shares and the debenture agreementdoes not contain a net cash settlement feature. The beneficial conversion features of the Unit Put Notes, valued at$77,685 using the Black-Scholes pricing model, along with the $19,649 relativefair value of the Unit Put Warrants, were recorded as an original issuediscount as defined in EITF 98-5 against the convertible debt liability, andare being amortized as interest expense over the term of the convertibledebentures.  During both the three andnine months ended September 30, 2008, $1,144 of the original issuediscount was amortized as interest expense.

 

OnOctober 17, 2008, the Company exercised the remaining $162,500 of its putoption under the Unit Put Agreement, which it expects to close on October 28,2008.  Upon the closing, the Company willissue Unit Put Notes in the principal amount of $154,375 and 32,500 Unit PutWarrants.

 

**Note 7. Shareholders’ Equity.**

** **

***(a)******        ******Common Stock***

 

***On July 11, 2008, theCompany’s directors received 21,667 of shares of the Company’s common stock inlieu of cash for $21,667 of unpaid director’s fees accrued through June 30,2008.***

 

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***On July 11, 2008, theCompany issued a***total of 37,967 shares of the Company’s common stock to its directorsin recognition of extraordinary amount oftime and effort they have spent on the Company’s restructuring and refocusingefforts since January 2007.  Theshares were valued at $1.00 per share and expensed on the date of issuance.

*** ***

***(b)******        ******Stock Options***

 

On July 11, 2008, the Company issued incentivestock options to acquire 70,000 shares of its common stock to its ChiefExecutive Officer, Richard Carlson.  Theoptions are exercisable for a period of seven years at an exercise price of$1.00 per share.  Of the options, 10,000shares vest immediately and 20,000 shares will vest on July 1 of each of2009, 2010 and 2011.  At the same time, Mr. Carlsonagreed to cancel existing, fully-vested stock options to acquire 15,000 sharesof common stock at an exercise price of $23.50 per share.  SFAS 123R requires that options that arecancelled and reissued simultaneously be accounted for as a modification of theterms of the original option. Accordingly, the incremental compensation cost of the fully vestedportion of the newly issued options, valued at $0.79 per share using theBlack-Scholes pricing model, over the $0.31 per share value of the cancelledoptions on the cancellation date will be expensed immediately as general andadministrative expense.  The value of theunvested portion will be recorded as general and administrative expense overthe three-year vesting period.

 

On July 11,2008, the Company issued incentive stock options to acquire 35,000 shares ofits common stock to its Chief Financial Officer, Richard Thon.  The options are exercisable for a period ofseven years at an exercise price of $1.00 per share.  Of the options, 10,000 shares vestimmediately and 8,333 shares will vest on July 1 of each of 2009, 2010 and2011.  At the same time, Mr. Thonagreed to cancel existing, fully-vested stock options to acquire 20,000 sharesof common stock at an exercise price of $25.00 per share.  FAS 123R requires that options that arecancelled and reissued simultaneously be accounted for as a modification of theterms of the original option. Accordingly, the incremental compensation cost of the fully vestedportion of the newly issued options, valued at $0.79 per share using theBlack-Scholes pricing model, over the $0.27 per share value of the cancelledoptions on the cancellation date will be expensed immediately as general andadministrative expense.  The value of theunvested portion will be recorded as general and administrative expense overthe three-year vesting period.

 

***(c)***          Warrants

*** ***

***The warrants described below,issued or to be issued, are exempt from registration under Section 4(2) ofthe Securities Act as they were or will be issued in non-public offerings to alimited number of subscribers.  Each ofthe following warrants was valued using the Black-Scholes pricing model:***

*** ***

·                  On January 4, 2008, pursuant to a finalseparation agreement with a former employee of the Company, the Company issuedto the former employee five-year warrants (immediately exercisable) to acquireup to 14,500 shares of the Company’s common stock at an exercise price of $5.00per share, and amended a previously issued warrant to acquire up to 30,000shares of the Company’s common stock to provide for cashless exercisethereof.  The warrants, valued at $14,500using the Black-Scholes pricing model, were recorded as compensation expense inthe first quarter of 2008.  No expensewas recorded during the three months ended September 30, 2008.

 

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·                  Pursuant to the terms of the Adron Note (seeNote 3), upon the repayment of the principal thereon on January 16, 2008,the Company issued five-year, immediately exercisable warrants to acquire up to52,357 shares of the Company’s common stock at $5.00 per share.  The accrual of 1,347 and 52,357 warrants (andsubsequently issued as part of the January 16, 2008 issuance noted above)valued at $4,849 and $188,485 using the Black-Scholes pricing model wasexpensed as debt extinguishment expense during the nine months ended September 30,2008 and the period from August 17, 1999 (inception) to September 30,2008, respectively.  During the three andnine months ended September 30, 2007 the accrual of 15,336 and 40,674warrants valued at $55,211 and $145,426 was recorded as debt extinguishmentexpense, respectively.  During the ninemonths ended September 30, 2007, the issuance of 5,167 warrants valued at$23,162 was expensed as interest expense.

 

·                  In connection with amendments to the PaulyNote (see Note 3), following repayment of the Pauly Note, the Company willissue a five-year warrant (immediately exercisable) to Mr. Pauly toacquire 41.7 shares of the Company’s common stock at $5.00 per share for eachday the Pauly Note is outstanding after August 30, 2006.  As of September 30, 2008, the Companyhad accrued for issuance warrants to acquire 31,817 shares of the Company’scommon stock pursuant to this arrangement. The accrual of 3,836, 11,426 and 26,646 warrants valued using theBlack-Scholes pricing model at $20,717 $61,700 and $143,891, was expensed asdebt extinguishment expense during the three and nine months ended September 30,2008 and the period from August 17, 1999 (inception) to September 30,2008, respectively. During the three and nine months ended September 30,2007, the accrual of 3,836 and 11,384 warrants valued using the Black-Scholespricing model at $20,716 and $61,474, respectively, was expensed as debtextinguishment expense.

 

·                  On July 31, 2007, the Company borrowed$100,000 for short-term working capital needs pursuant to a promissory noteissued to the Smith Trust (see Note 3). Following repayment of the promissory note, the Company will issue afive-year warrant (immediately exercisable) to the Smith Trust to acquire 1 shareof the Company’s common stock per $1,000 principal outstanding at $5.00 pershare for each day the promissory note is outstanding after August 30,2006.  As of September 30, 2008, theCompany had accrued for issuance warrants to acquire 24,848 shares of theCompany’s common stock pursuant to this arrangement.  The accrual of 3,128, 9,448 and 24,848warrants valued using the Black-Scholes pricing model at $12,512, $37,792 and$99,392 was expensed as interest expense during the three and nine months endedSeptember 30, 2008 and the period from August 17, 1999 (inception) toSeptember 30, 2008, respectively. During each of the three and nine months ended September 30, 2007,the accrual of 6,200 warrants valued at $24,800 was recorded as interestexpense.

 

·                  On April 3,2008, as consideration to James Davis, William Reiling and the Smith Trust forproviding certain loans to the Company, the Company issued five-year warrants(immediately exercisable) to purchase a total of 75,000 shares of the Company’scommon stock at $1.50 per share to each lender (see Note 3).  The gross proceeds were allocated between thenote and the warrants based on the relative fair value at the time ofissuance.  The relative fair value ofwarrants was recorded as original issue discount on the related promissorynotes and was expensed as interest expense over the term of the promissorynotes.  During the three and nine monthsended September 30, 2008, original issue discounts of $17,220 and $42,768was expensed as interest expense.

 

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**·**                  On September 25, 2008, the Companyborrowed $150,000 pursuant to a promissory note issued in favor of James Davis(see Note 5(d)).  As consideration forproviding the loan, the Company issued an immediately exercisable, five-yearwarrant to purchase 100,000 shares of the Company’s common stock at $1.50 pershare to Mr. Davis.  The $46,604relative fair value of the warrant was recorded as original issue discount andis being expensed as interest expense over the term of the promissory note.

** **

***Note8.  Income Taxes.***

*** ***

InJuly 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN48”). FIN 48 prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in its tax return. FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. The Company adopted FIN 48 as of January 1,2007, and the adoption had no significant impact on the consolidated financialstatements.

 

The Company has adopted the policy of classifyinginterest in interest expense and penalties in general and administrativeexpense.  The Company had recorded noaccrued interest or penalties as of the date of adoption.

 

The Company had no significant unrecognized taxbenefits as of September 30, 2008 and December 31, 2007 and,likewise, no significant unrecognized tax benefits that, if recognized, wouldaffect the effective tax rate.  TheCompany had no positions for which it deemed that it is reasonably possiblethat the total amounts of the unrecognized tax benefit will significantlyincrease or decrease.

 

The Company has generated net operating losscarryforwards of approximately $4.7 million which, if not used, will begin toexpire in 2021.  Federal and state taxlaws impose significant restrictions on the utilization of net operating losscarryforwards in the event of a change in ownership of the Company thatconstitutes an “ownership change,” as defined by Section 382 of theInternal Revenue Code of 1986, as amended (the “Code”).  The Company has analyzed the Merger andprivate placement transactions that occurred in April 2004, and believesthat they do not constitute such an ownership change.  However, additional shares and warrantslikely to be issued pursuant to the Company’s financing efforts, together withcertain transactions occurring in the previous 36-month period, may constitutea change in ownership that could subject the Company’s use of its net operatingloss carryforwards to the above limitations. Based on the Company’s estimates, the limitation would apply tosubstantially all of the $4.7 million net operating loss carryforwards.

 

The net operating loss carryforwards are subject toexamination until they expire.  The taxyears that remain subject to examination by major tax jurisdictions currentlyare:

 

Federal 2005 - 2007 State of Minnesota 2005 - 2007

 

**Note 9.  AssetPurchase Agreement.**

 

**On April 3, 2008,the Company purchased the Profile Assets from Profile pursuant to an assetpurchase agreement.  Prior to purchasingthe Profile Assets, the Company had licensed certain rights to the ProfileAssets from Profile, then a five percent shareholder of the Company.  The technology encompassed by the ProfileAssets provides the basis for the ProUroScanTM system, the Company’sinitial product currently in the final stages of development.  The purchase price of the**

 

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**Profile Assets was$300,000, of which $150,000 was paid in cash and $150,000 was financed underthe Profile Note (see Note 3). As indicated by SFAS No. **2, “Accountingfor Research and Development Costs,” regarding costs of intangibles that arepurchased from others for a particular research and development project andthat have no alternative future uses, the entire $300,000purchase price was expensed as research and development expense in the ninemonths ended September 30, 2008.

** **

**Note 10.  EmploymentAgreement.**

 

On July 16, 2008, PUC entered into an employment agreement with Mr. Carlson,its Chief Executive Officer.  Theagreement provides for a minimum annual salary of $150,000, a cash incentivebonus potential of up to 40 percent of Mr. Carlson’s base pay andeligibility to participate in an annual grant of options to purchase shares ofcommon stock, as determined by the Company’s Board of Directors.  The agreement provides for severance paymentsif the Company terminates Mr. Carlson without cause or if Mr. Carlsonterminates the agreement for good reason that includes nine months of basesalary plus one month of base salary for each year of service (up to a maximumof 12 months of base salary), payment of earned bonuses, continued payment ofexisting health and life insurance benefits for a period of nine months andimmediate vesting of all unvested stock options then held by Mr. Carlson.  In addition, within a one-year periodfollowing a “change in control” of the Company, upon termination without cause,unacceptable demotion or reduction in responsibilities or a relocation of morethan 100 miles, Mr. Carlson will receive as severance, nine months of basesalary plus one month of base salary for each year of service (up to a maximumof 12 months of base salary) and immediate vesting of all unvested stockoptions then held by Mr. Carlson. The agreement prohibits Mr. Carlson from directly or indirectlyparticipating in the ownership, management, operation or control of acompetitive business for a period of one year after his employment with theCompany terminates.  The agreement willexpire on December 31, 2009.

 

**Note 11.  Agreementswith Artann Laboratories Inc.**

 

**On July 25,2008, the Company entered into two agreements with its development partner,Artann Laboratories Inc. (“Artann”). Under the first agreement, the “License Agreement,” Artann granted tothe Company an exclusive, worldwide, sublicensable license to certain patentapplications, trade secrets and technology to make, use and market certainmechanical imaging products in the diagnosis or treatment of urologic disordersof the prostate, kidney or liver field of use. Artann also agreed to transfer possession of five fully functionalprostate imaging systems to the Company and grant the Company full access toall relevant documentation thereto.  Asconsideration, the Company agreed to pay, on the effective date of theagreement, an upfront cash license fee of $600,000 and shares of the Company’scommon stock valued at $500,000.  Inaddition, the Company shall pay Artann a royalty equal to four percent of thefirst $30,000,000 of net cumulative sales of licensed products, three percentof the next $70,000,000 of net cumulative sales and two percent of netcumulative sales over $100,000,000. Further, the Company will pay Artann a technology royalty of 1 percentof net sales on prostate imaging system products**through December 31, 2016.  Thecombined royalties are subject to a minimum annual royalty equal to $50,000 peryear for each of the first two years after clearance from the Food and DrugAdministration (“FDA”) for commercial sale and $100,000 per year for each yearthereafter until termination or expiration of the License Agreement.  The Company also agreed to grant Artann a non-exclusive fully paid up,sublicensable, royalty free and worldwide license for Artann to make, use or sell any mechanical imaging system forthe diagnosis or treatment of disorders of the female human breast.  The License Agreement will become effectiveon the tenth day after the close of 

 

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**one or morepublic or private equity offerings by the Company that raises at least$4,000,000 or November 30, 2008, whichever is first to occur.** TheLicense Agreement will terminate upon the expiration of all royaltyobligations, by failure of either party to cure a breach of the agreementwithin a 60-day cure period, if the Company fails to make a payment to Artannand such failure is not cured within a 30-day cure period or should one of theparties become insolvent, go into liquidation or receivership or otherwise loselegal control of its business.

** **

**Under thesecond Artann agreement, the “Development and Commercialization Agreement,”**the parties intend tocollaborate together to develop, commercialize and market prostate mechanicalimaging systems.  Artann will conduct andcomplete all pre-clinical activities and testing on the prostate imagingsystem, conduct clinical trials, prepare and submit FDA regulatory submissionsand provide hardware and software development, refinement and debuggingservices to ready the prostate imaging system for commercial sale.  For these development services, the Companywill make cash milestonepayments to Artann of $250,000 upon initiation of an FDA approved clinicalstudy, $250,000 upon completion of that FDA approved clinical study andsubmission of an FDA regulatory approval application on the prostate imagingsystem and $750,000 upon FDA clearance to allow the prostate imaging system tobe commercially sold in the United States. In addition, the Company will issue to Artann shares of common stock of theCompany having a value of $1,000,000 upon completion of the FDA approved clinical study and submission of anFDA regulatory approval application on the prostate imaging system and, as asuccess bonus, the Company will issue to Artann shares of its common stockhaving a value of $1,000,000 upon FDAclearance.  The success bonus will bereduced by ten percent for each month that FDA clearance is delayed followingfifteen months from the effective date of the Development and CommercializationAgreement.  The Company will also pay a monthly retainer fee fortechnical advice and training by Artann personnel.  The monthly fee retainer shall be $30,000 permonth for each of the first nine months following the effective date of the Development and Commercialization Agreement and $15,000 per month for thenext twelve months.

** **

**Additionally, Artann will supply to theCompany such quantities of the prostate imaging system as is reasonablyrequired for pre-commercial testing, evaluation, marketing and clinical studyand to facilitate the transfer of commercial production to a third party.  Artann also agrees to use best reasonableefforts to provide a limited number of commercial systems, if requested by theCompany.  The pre-commercial andcommercial systems will be sold to the Company at prices yet to bedetermined.  Qualified Artann personnelshall provide manufacture and scale-up services to the Company or a third partymanufacturer designated by the Company to facilitate the commercial manufactureof the prostate imaging systems at a cost of $1,200 per day per individual forsuch services.**

** **

**The effectivedate of the Development and Commercialization Agreement is the tenth day afterthe close of**one or more public or private equityofferings that raises at least $4,000,000 by the Company or November 30,2008, whichever is first to occur.  The initial term of the Development andCommercialization Agreement is for three years and may thereafter be renewed foradditional one year terms upon mutual agreement of the parties.  The Development and Commercialization Agreement may also terminate if the Company fails to make a payment toArtann and such failure is not cured within a 60-day cure period or should oneof the parties become insolvent, go into liquidation or receivership orotherwise lose legal control of its business.

 

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**Note 12.  Filing of S-1Registration Statement.**

 

On September 19, 2008, the Company filed aRegistration Statement on Form S-1, File No. 333-153605, to registerup to $5,000,000 of units consisting of one share of common stock and oneredeemable common stock warrant in anticipation of a public offering that isexpected to close in the fourth quarter of 2008.

 

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***Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of***Operation.

*** ***

*The accompanyingManagement’s Discussion and Analysis of Financial Condition and Results ofOperation should be read in conjunction with our unaudited consolidatedfinancial statements, and notes thereto, in Part I, Item 1 of thisQuarterly Report on Form 10-Q for the quarter ended September 30,2008.*

 

**Disclosure Regarding Forward-Looking Statements**

 

Certainstatements contained in this Quarterly Report on Form 10-Q may be deemedto be forward-looking statements as defined by the Private Securities LitigationReform Act of 1995, and the Company intends that such forward-lookingstatements be subject to the safe-harbor created thereby. Such forward-looking statements relate to,among other things: general economic or industry conditions, nationallyand in the physician, urology and medical device communities in which we intendto do business; our ability to raise capital to fund our 2008 and 2009 workingcapital needs and launch our products into the marketplace in subsequent years;our ability to complete the development of our existing and proposed productson a timely basis or at all; legislation or regulatory requirements, includingour securing of all U.S. Food and Drug Administration (“FDA”) and otherregulatory approvals on a timely basis, or at all, prior to being able tomarket and sell our products in the United States; competition from larger andmore well established medical device companies and other competitors; thedevelopment of products that may be superior to the products offered by us; securingand protecting our intellectual property and assets, and enforcing breaches ofthe same; clinical results not anticipated by management of the Company; thequality or composition of our products and the strength and reliability of ourcontract vendors and partners; changes in accounting principles, policies orguidelines; financial or political instability; acts of war or terrorism; andother economic, competitive, governmental, regulatory and technical factorsaffecting our operations, proposed products and prices. We caution that these statements are qualified by important factorsthat could cause actual results to differ materially from those reflected bythe forward-looking statements contained herein.

** **

**Overview;Product Offerings.**

 

ProUroCare Medical Inc.(“ProUroCare,” the “Company,” “we,” “us” or “our,” which terms includereference to our wholly owned subsidiary, ProUroCare Inc. (“PUC”)) is adevelopment stage company that is focused on developing advanced mechanicalimaging technology for assessing the size, shape and volume of the prostate bycreating a visual image of the prostate gland for use in identifying andcharacterizing abnormal lesions or tissue and monitoring the effects ofprostate treatments.

 

The Company’s primaryactivities to date have focused on acquiring technology, intellectual propertyrights and working with Artann Laboratories Inc. (“Artann”) to completedevelopment of the ProUroScanTM prostate imaging system.  We have assembled an experienced managementteam and identified the necessary clinical, regulatory and reimbursementresources to assist us in moving the product to market.  We have aggressively worked to obtain thefunding to complete development of the ProUroScanTM system and tobring it to market.

 

Our initial product is the ProUroScanTMsystem, a mechanical imaging system that enables physicians to identify andcharacterize the existence of abnormal prostate tissue and monitor changes inprostate tissue over time.  During thenext 12 months, assuming our financing efforts are successful (see “Liquidity and Capital Resources,” below), we expect to prepare the ProUroScanTM system for clinicaltrials, obtain FDA clearance on a basic mappingand data maintenance labeling claim and prepare to launch our productinto 

 

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the market, although there can be no assurance thatwe will be successful in meeting these milestones.  We are currently exploring potentialmarketing relationships with medical device companies that are interested inmarketing products in the prostate cancer detection market.   Weexpect such a relationship would provide both financial support and access todown stream marketing, engineering, manufacturing and sales capabilities.

 

**Resultsof Operations**

 

The following discussionof the financial condition and results of operations should be read inconjunction with the financial statements included herewith. This discussionshould not be construed to imply that the results discussed herein willnecessarily continue into the future, or that any conclusion reached hereinwill necessarily be indicative of actual operating results in the future.

 

*CurrentOperations*

 

Wecurrently employ only two employees.  Weconduct our research and development, market research, regulatory and otherbusiness operations through the use of a variety of consultants and medicaldevice development contractors, primarily Artann.  We believe that using consultants andcontractors to perform these functions is more cost effective than hiringfull-time employees and affords us flexibility in directing our resourcesduring our development stage.  Over thenext three quarters, we expect to complete the clinical and regulatory processleading to FDA 510(k) market clearance and establish strategic marketingand contract manufacturing relationships in anticipation of regulatoryclearance to enter the market.

 

Weincur ongoing expenses that aredirectly related to being a publicly traded company, including professionalaudit and legal fees, financial printing, press releases and transfer agentfees.  We currently occupy temporaryoffices within the office of a former director, for which we accrue rent on amonth-to-month basis of approximately $2,200 per month.  Other expenses incurred include executiveofficer compensation, travel, insurance, telephone, supplies and othermiscellaneous expenses.

 

The remaining work toprepare the ProUroScan System for FDA clinical studies consists primarily ofengineering and user interface refinements, safety and bio-testing andcompletion of documentation and validation studies.  We expect this work to be performed by Artannand other independent contractors. Pursuant to the terms of our development agreement with Artann, we arerequired to make cash and equity payments of the Company’s common stock uponthe achievement of several project milestones. Assuming the achievement of all of the milestones up to and includingthe receipt of FDA 510(k) market clearance, these payments to Artann willtotal approximately $1,415,000 in cash and approximately $2,000,000 inequity.  In addition, pursuant to theterms of our license agreement with Artann, we expect to make a cash payment toArtann for licensing fees of $600,000 and an equity payment of our common stockvalued at approximately $500,000.

 

Duringthe next three quarters following the close of our anticipated equity offering(see “Liquidity and Capital Resources,” below) and prior to our entrance intothe commercial market, we expect to hire approximately six employees in theareas of engineering, regulatory compliance, marketing and quality assurance.  We estimate that the cash required forinternal salaries and benefits, operating expenses including projectmanagement, software and hardware development and regulatory work and interestwill be approximately $622,000, and cash required for outside consulting costs(excluding Artann) will be approximately $76,000.

 

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*Threemonths ended September 30, 2008 compared to the three months ended September 30,2007:*

 

*OperatingExpenses/Operating Loss**.*  Our operatingexpenses (and our operating loss) for the three months ended September 30,2008 were $293,987, an increase of $93,013 or 46 percent, compared to $200,974last year.  We incurred substantial legalfees during the three months ended September 30, 2008 relating to thenegotiation and consummation of the Artann agreements and certain patentwork.  Fees for these legal services wereapproximately $51,000 compared to approximately $2,000 incurred for generallegal services last year.  Fees paid tooutside directors increased to $48,092 for the three months ended September 30,2008 compared to $6,875 last year, due primarily to a one-time stock grant tothe directors in recognition of their efforts in the Company’s repositioningand financing since the beginning of 2007. During the three months ended September 30, 2008 we paid $30,000 toArtann under our development agreement to help advance the timetable forclinical trials on the ProUroScan system. These increases were offset by a reduction of stock-based compensation to$18,366 during the three months ended September 30, 2008 compared to$53,138 last year, as certain options became fully expensed in late 2007.

 

*NetInterest Expense**. *Net interest expense for the three monthsended September 30, 2008 was $473,658, an increase of 50 percent, comparedto $315,600 last year.  The increasedinterest can be primarily attributed to the issuance of convertible notes toinvestors in our 2007 and 2008 private placements.  Amortization of the original issue discountattributable to the warrants and the beneficial conversion feature of theconvertible notes issued in the private placements resulted in approximately$152,000 of recorded interest expense in the three months ended September 30,2008, while the interest on the convertible notes totaled approximately$47,000.  These increases were partiallyoffset by interest expense reductions resulting from declining interest ratesand a reduction in outstanding balances.

 

*Debt Extinguishment Expense*. Our debt extinguishment expense for the three months ended September 30,2008 was $29,045, a decrease of 61 percent, compared to $75,327 last year.  Our debt extinguishment expense arisesprimarily from the cost of warrants accrued for issuance pursuant to theprovisions of short-term loans from certain individual lenders.  The decrease was due to the repayment of asignificant portion of these outstanding short term loans in late 2007 and inearly 2008.

 

*Nine months**ended September 30,2008 compared to the nine months ended September 30, 2007:*

 

*OperatingExpenses/Operating Loss**.*

 

Our operating loss equalsour operating expenses because we have no revenue.  For the nine months ended September 30,2008 our operating expenses (and our operating loss) were $1,056,676, adecrease of $126,965 or 11 percent, compared to $1,183,641 last year.

 

Total employeecompensation and benefits costs decreased to $285,517 from $833,200 last year,or 66 percent.  In the nine months ended September 30,2007, we incurred stock-based compensation of $316,500 related to the extensionof the exercise period of certain stock options and warrants issued pursuant toseparation agreements with three former employees.  The remaining compensation expense reductioncame primarily as a result of the termination of the three employees in early2007 and to options that became fully vested in 2007.  Fees for legal services in the nine monthsended September 30, 2008 increased approximately $109,000, or 127 percent,compared to last year, due to legal fees associated with our negotiations withArtann, one-time costs of our reverse stock split, the filing of ourRegistration Statement on Form S-8 and other SEC filings and patentmaintenance related legal expenses.  Feespaid to outside directors increased to $60,592 for the nine months ended September 30,2008 

 

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compared to $18,542 lastyear, due primarily to a one-time stock grant to the directors in recognitionof their efforts in the Company’s repositioning and financing since thebeginning of 2007.

 

Research and developmentcosts in the nine months ended September 30, 2008 were $330,000, representingthe expensing of our $300,000 acquisition of certain intellectual property andknow-how from Profile and the payment of $30,000 to Artann under ourdevelopment agreement to help advance the timetable for clinical trials on theProUroScan system.  This represents anincrease of approximately $224,000, or 210 percent, compared to theapproximately $106,000 recognized as research and development expense duringthe nine months ended September 30, 2007, which included the issuance ofwarrants valued at $72,000 to Artann pursuant to a cooperation agreement signedin April 2007 and approximately $24,000 of research costs related to aprostate visioning system project.

 

*NetInterest Expense**. *Net interest expense for the nine monthsended September 30, 2008 was $1,327,771, an increase of $437,710 or 49percent, compared to $890,061 last year. The increased interest expense can be attributed to the issuance ofconvertible notes in our 2007 and 2008 private placements.  Amortization of the original issue discountattributable to warrants issued in the private placements resulted inapproximately $444,000 of recorded interest expense in the nine months ended September 30,2008, while the interest on the convertible notes totaled approximately$125,000.  These increases were partiallyoffset by interest expense reductions resulting from declining interest ratesand a reduction in the outstanding balances.

 

*Debt Extinguishment Cost*. Our debt extinguishment cost for the nine months ended September 30,2008 was $74,876, a decrease of 68 percent, compared to $233,529 lastyear.  Our debt extinguishment costresulted primarily from the cost of warrants issued in connection with theamendment of certain short term loans made to defer their maturity dates.  The decrease was due to the repayment of asignificant portion of these outstanding short term loans in late 2007 andearly 2008.

 

**Liquidityand Capital Resources**

 

*Anticipated Proceeds from Equity Offering*

 

On September 19, 2008, we filed a RegistrationStatement on Form S-1, File No. 333-153605, to register units consistingof one share of common stock and one redeemable common stock warrant inanticipation of a public offering that we expect to close in the fourth quarterof 2008 (the “Public Offering”).  Weexpect that the estimated $3,175,000 net proceeds of the Public Offering willbe sufficient to fund our cash obligations under the Artann Development andLicense Agreements and to finance our internal operations through receipt ofFDA 510(k) clearance, as described in “Current Operations” above, and toretire certain short-term liabilities. However, if the Public Offering is significantly delayed for any reason,or if our product development efforts experience significant unforeseen delays,we may not have sufficient funds to complete these objectives, and will requireadditional financing.  We do not expectthe funds from the Public Offering to be sufficient for us to initiate anysignificant market launch or scale-up manufacturing capabilities.

 

*Assets; Property Acquisitions and Dispositions*

 

Our primary assets are patents and patentapplications, which are the foundation for our proposed product offerings.  These assets****secure a$1,600,000 senior bank note and a note issued to an investor in the amount of$600,000 and, as a result, are not available to secure other senior debtfinancing.

 

We anticipate purchasing approximately $35,000 ofcomputer equipment, development tools and software during the next 12months.  We do not anticipate selling anysignificant assets in the near term.

 

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*Private Placements*

 

We have raised a total of $2,000,000 (includingconversion of $175,000 of existing debt) from the sale of convertible promissorynotes and warrants in four private placements since December 2007.

 

*Put Arrangements*

 

In September 2008, we raised $325,000 offuture funding through commitments to purchase units in accordance with theterms of a unit put agreement (the “Unit Put Agreement,” such future fundingcommitments, the “Unit Put Arrangements”). Upon our exercise of the put, all of the investors who have signed aUnit Put Agreement will purchase the units being put by us on a pro rata basiswithin 5 days after receiving the put notice from us.

 

In consideration of each purchaser’s futurefunding commitment, each purchaser received an origination warrant  to purchase 1,000 shares of our common stockfor each $10,000 unit that an investor has committed to purchase (each an “OriginationWarrant”).  Each Origination Warrant becomesexercisable when the right of the Company to exercise the put expires andremains exercisable until December 31, 2012 at an exercise price of $1.00per share.  We have issued Origination Warrants to purchase an aggregate 32,500shares of our common stock.

 

Each unit will consist of a note in theprincipal amount of $9,500 (the “Unit Put Notes”) and a warrant to purchase 2,000 shares of our common stock (the “UnitPut Warrants”).  The purchase price of the warrant portion ofeach unit is $500.  The notes bearinterest at 10 percent per year, mature on March 16, 2010, and willconvert into common stock at 70 percent of the initial offering price of theUnits offered pursuant to the Public Offering. In the event the Public Offering is not completed before the maturitydate, the entire principal and unpaid accrued interest will convert into ourcommon stock at $0.15 per share.  We may,at our option, prepay the notes anytime on or after January 1, 2009.  The warrants will be exercisable immediatelyupon issuance and will remain exercisable until December 31, 2012 at anexercise price of $1.00 per share.

 

On September 16,2008, the Company exercised $162,500 of its put options under the Unit PurchaseAgreement, and upon the September 24, 2008 closing thereof, issued UnitPut Notes in the principal amount of $154,375 and 32,500 Unit PutWarrants.  The beneficial conversionfeatures of the Unit Put Notes valued at $77,685 and the $19,649 relative fairvalue of the Unit Put Warrants were recorded as an original issue discount andare being amortized as interest expense over the term of the convertibledebentures.

 

***Purchase of Patents***

** **

**On April 3, 2008,we purchased certain previously-licensed patents, patent applications andknow-how associated with imaging technology from Profile L.L.C., a Delawarelimited liability company (“Profile”), pursuant to an asset purchase agreement(the “Profile Assets”).  The purchaseprice of the Profile Assets was $300,000, of which $150,000 was paid in cashand $150,000 was financed under a secured promissory note (the “Profile Note”).**

** **

**In addition, in connection withthe purchase of the Profile Assets, on April 3, 2008 we borrowed anaggregate of $112,500 pursuant to three convertible promissory notes each inthe amount of $37,500.  Payment in fullof the promissory notes and the interest accrued thereon at an annual rate of10 percent is due on the earlier of seven days following the closing date ofthe Public Offering or December 31, 2008. Upon the closing of the Public Offering, the holders of the threepromissory notes have the option of converting the notes into shares of ourcommon stock at 70 percent of the offering price of the equity securitiesoffered in the Public Offering.**

** **

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** **

**On September 25, 2008, theCompany borrowed $150,000 pursuant to a promissory note issued in favor ofJames Davis.  Payment in full of thepromissory notes and the interest accrued thereon at an annual rate of 10percent is due on the earlier of seven days after the date the Company closesthe Public Offering or March 25, 2010. In the event that the Company closes on the Public Offering before March 25,2010, Mr. Davis will have the option of converting the principal andaccrued interest into shares of the Company’s common stock at 70 percent of thepublic offering price.  As considerationfor providing the loan, the Company issued an immediately exercisable,five-year warrant to purchase 100,000 shares of the Company’s common stock at$1.50 per share to Mr. Davis.  Thegross proceeds were allocated between the note, the warrants and the bargainconversion feature of the note based on the relative fair value at the time ofissuance.  The $46,604 relative fairvalue of the warrants was recorded as original issue discount and is beingexpensed as interest expense over the term of the promissory note.  As the holder’s ability to exercise theconversion feature of the note is contingent upon an event outside the controlof the holder, the bargain conversion feature valued at $103,396 is notrecorded until the contingency is removed. The proceeds of the loan were used to retire the $150,000 principalamount of the Profile Note.**

** **

*Financing Plans*

 

We have $2,200,000 of secured debt and $733,334 ofconvertible debt, both of which mature at the end of February 2009,$1,900,000 of convertible notes due in maturities ranging from June 2009through January 2010, $150,000 of unsecured convertible debt that maturesin March 2010, $112,500 of unsecured convertible debt that matures in December 2008and other short term liabilities exceeding $1,700,000.  We plan to address each of these obligationsas follows:

 

·                  Weintend to address the remaining $2.2 million secured debt that matures in February 2009by seeking an equity investment or licensing fee from a strategic marketingpartner, or by seeking an extension of the maturity dates.  If we are unsuccessful in obtaining an equityinvestment or licensing fee, or an extension of the maturity date of thesecured debt, or if the convertible debt is not converted into our commonstock, we will need to raise additional funds.

 

·                  Underthe terms of the convertible debentures, the $733,334 debt will automaticallyconvert into common stock upon the closing of the Public Offering.

 

·                  Underthe terms of the convertible notes, the $1,900,000 debt will automaticallyconvert into equity upon our closing the Public Offering.

 

·                  Weexpect that the $262,500 of unsecured convertible debt will be converted intoequity upon closing of the Public Offering, although there can be no assuranceof this.

 

·                  Weanticipate that the net proceeds from the Public Offering will be sufficient toallow us to retire approximately $422,000 of short term liabilities, and theproceeds from our Unit Put Offering will allow us to retire a further $88,000of short-term liabilities.  Underprovisions of various convertible debt instruments, accrued interest totalingapproximately $250,000 will automatically convert into our equity securitiesupon the closing of the Public Offering. We expect to work with certain creditors to extend payments on theremaining short-term liabilities.

 

We expect to pursue one or more additional rounds offunding in 2009 to provide the working capital needed to fund a significantcommercial launch into the urology market. If additional funds are raised by the issuance of convertible debt orequity securities, or by the exercise of outstanding warrants, then existingshareholders will experience dilution in their ownership interest.  If additional funds are raised 

 

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by the issuance of debt or certain equityinstruments, we may become subject to certain operational limitations, and suchsecurities may have rights senior to those of our existing holders of commonstock.

 

Ifadequate funds are not available through these initiatives on a timely basis,or are not available on acceptable terms, we may be unable to fund expansion,or to develop or enhance our products. If we are forced to slow our development programs, or put them on hold,it would delay regulatory clearances or approvals needed, and thus delay marketentry for our products.  Ultimately, ifno additional financing is obtained beyond what has been secured to date, wecould potentially be forced to cease operations.

 

Please look under the heading “Risk Factors” in ourRegistration Statement on Form S-1, File No. 333-153605, filed on September 19,2008 (and any subsequent amendments thereto)for more complete information concerning our risk factors.

 

**Going Concern**

 

We have incurred operating losses, accumulateddeficit and negative cash flows from operations since inception.  As of September 30, 2008, we had totalshareholders’ deficit of approximately $5,245,000. These factors, among others, raise substantial doubt about our abilityto continue as a going concern.  Ourunaudited consolidated financial statements included in Part I, Item 1 ofthis Quarterly Report on Form 10-Q do not include any adjustments relatedto recoverability and classification of asset carrying amounts or the amountand classification of liabilities that might result should we be unable tocontinue as a going concern.

 

**CriticalAccounting Policies**

 

Ourfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”). The application ofGAAP requires that we make estimates that affect our reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenue and expensesduring the reporting period. We base our estimates on historical experience andon various other assumptions that we believe to be reasonable under thecircumstances. We evaluate our estimates and assumptions on an ongoing basis. Ouractual results may differ significantly from these estimates.

 

Adescription of the Company’s critical accounting policies used in thepreparation of the Company’s financial statements was provided in Item 6.Management’s Discussion and Analysis or Plan of Operations of the Company’sAnnual Report on Form 10-KSB for the year ended December 31, 2007.

 

***Item 4T.  Controls andProcedures.***

*** ***

**Disclosure Controls and Procedures**

 

We maintain disclosure controls and procedures designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”) isrecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the Securities and Exchange Commission (the “SEC”).As of September 30, 2008, the end of the period covered by this QuarterlyReport on Form 10-Q, we carried out an evaluation, under the supervisionand with the participation of management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures pursuant to Rule 13a-15 underthe Exchange Act. Based upon that evaluation, our Chief 

 

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Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures are effective.

 

**Changes in Internal Control Over Financial Reporting**

 

During the quarter ended September 30, 2008, there has been nochange in the Company’s internal control over financial reporting (as definedin Rule 13a-15(f) under the Exchange Act) that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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**PART II.  OTHER INFORMATION.**

 

***Item1. Legal Proceedings.***

*** ***

***The Company, like most other public companies, is involvedin legal proceedings in the conduct of the ordinary course of its business.***

*** ***

***Item 1A. Risk Factors***

 

**Investing in our common stock involves a highdegree of risk. The risk factors set forth under the heading “Risk FactorsAssociated with our Business, Operations and Securities” in our RegistrationStatement on Form S-1, File No. 333-153605, filed on September 19,2008 are incorporated herein by reference pursuant to Rule 12b-23 underthe Exchange Act.  These risks anduncertainties should be carefully considered before purchasing our commonstock.  These risks and uncertainties arenot the only ones facing our Company; additional risks and uncertainties mayalso impair our business operations. If any of the following risks actuallyoccur, our business, financial condition, results of operations or cash flowswould likely suffer. In that case, the trading price of our common stock couldfall, and you may lose all or part of your investment.  We undertake no obligation to update orrevise any forward-looking statement except as required by the SEC.**

** **

***Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds.***

*** ***

***Convertible PromissoryNote Issuances***

*** ***

**On July 15, 2008 and July 30,2008, the Company closed on** an aggregate $175,000 of units consisting of unsecured, subordinated, convertible promissory notes(the “Notes”) and common stock purchase warrants (the “Warrants”) in a privateplacement.  Net cash proceeds to the Companywere approximately $126,000, after deducting approximately $49,000 of expensesof the offering (including $22,750 of commissions and fees paid to theplacement agent).  The net proceeds willbe used to pay certain existing obligations and for general corporate purposes.

** **

**At the closings, theCompany issued $166,250 in principal amount of Notes and Warrants to purchase35,000 shares of common stock.  The Notesbear interest at ten percent per year, mature on January 15, 2010, andwill convert into the type of equity securities offered by the Company in anyunderwritten public offering prior to maturity at 70 percent of the publicoffering price.  In the event a publicoffering is not completed before the maturity date, the entire principal andunpaid accrued interest will convert into the Company’s common stock at $0.05per share.  The Company may, at itsoption, prepay the Notes anytime on or after July 15, 2009.  The Warrants will become exercisable upon theearlier of the closing of a public offering or the maturity date of the Notesand will remain exercisable until December 31, 2012.  The exercise price will be 50 percent of thepublic offering price, or in the event a public offering is not completedbefore the maturity date, at 50 percent of the closing price of the Company’scommon stock on the maturity date.**

** **

On April 3, 2008, the Company borrowedan aggregate of $112,500 pursuant to three promissory notes, each in the amountof $37,500 (see Note 3).  On September 12,2008, the Company amended the three promissory notes.  Under the terms of the amendments, thematurity date of each $37,500 note was changed from September 1, 2008 tothe earlier of the seven days after the date the Company closes on anunderwritten public offering of equity securities or December 31,2008.  In addition, each note holder wasgiven the option of converting the principal and interest into shares of theCompany’s common stock at price equal to 70 percent of the price of thesecurities sold in that underwritten public offering, in lieu of cash.

 

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On September 16,2008, the Company closed on a private placement of $325,000 of Unitputs pursuant to a Unit Put Agreement and exercised $162,500 of the put options. On September 24, 2008, theCompany closed on the $162,500 put options exercised. For each $10,000 Unitpurchased, purchasers received an unsecured, subordinated convertible promissorynote (a “Put Note”) in a principal amount of $9,500.  The principal amount of the Put Notes and anyunpaid interest accrued thereon will convert into common stock upon thethirtieth day following completion of the Public Offering at 70percent of the pershare price of the equity securities issued therein, or if no such offering iscompleted by then, on March 16, 2010 at $0.15 per share.  Each purchaser also received an immediatelyexercisable warrant to purchase 2,000 shares of Company common stock as a partof each $10,000 Unit they purchased.  Thepurchase price for the warrant included in each Unit is $500.  The warrants will remain exercisable until December 31,2012.  Each warrant is exercisable intocommon stock at $1.00 per share.  Inaggregate, the Company issued notes in the principal amount of $154,375 and32,500 warrants pursuant to the September 24, 2008 closing.

 

**On September 25, 2008, theCompany borrowed $150,000 pursuant to a convertible promissory note issued infavor of James Davis.  As considerationfor providing the loan, the Company issued an immediately exercisable,five-year warrant to purchase 100,000 shares of the Company’s common stock at$1.50 per share to Mr. Davis.**

** **

**Sales of thesecurities described above were made in compliance with the requirements of Rule 506of Regulation D under the Securities Act of 1933, as amended (the “SecuritiesAct”) and the exemption from registration provided under Section 4(2) ofthe Securities Act.  In qualifying forsuch exemption, the Company relied upon representations from the investorsregarding their status as “accredited investors” under Regulation D and thelimited manner of the offering as conducted by the placement agent and theCompany.**

** **

***Item4.*** Submissionof Matters to a Vote of Security Holders.

*** ***

***The Company held our Annual Meeting of Shareholders on August 12,2008, at which the shareholders took the following actions:***

*** ***

Matter 1: Election ofDirectors

 

The director nomineesdescribed in the Company’s Proxy Statement were elected as follows:

 
| ** **          | ** ** | **For** | ** ** | **Withhold** | ** ** | **Abstain** | ** ** | **Broker Non-  Votes** | ** ** |
|---------------------|------------|---------|------------|--------------|------------|-------------|------------|-----------------------------|------------|
| Richard C.  Carlson |       | 924,175 |       | 0            |       | 47,570      |       | 1                           |       |
| David F. Koenig     |       | 924,175 |       | 0            |       | 47,570      |       | 1                           |       |
| Robert Rudelius     |       | 924,175 |       | 0            |       | 47,570      |       | 1                           |       |
| Scott E. Smith      |       | 924,175 |       | 0            |       | 47,570      |       | 1                           |       |

 

Each director has consentedto hold office until the next annual meeting of shareholders or until hissuccessor is elected and shall have qualified.

 

Matter 2: Appointment ofIndependent Registered Accounting Firm

 

The appointment ofVirchow, Krause & Company, LLP as the Company’s independent registeredpublic accounting firm for the 2008 fiscal year was ratified as follows:

 
| **For** | ** ** | **Withhold** | ** ** | **Abstain** | ** ** |
|---------|------------|--------------|------------|-------------|------------|
| 936,603 |       | 5,925        |       | 29,218      |       |

*** ***

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***Item5.  Other Information.***

*** ***

None.

 

***Item6.  Exhibits***

 
| **Exhibit No.** |   | **Description**                                                                                                                                                                                                                                                                 |
|----------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                                                                                                                                                                                            |
| 4.1*                 |   | Warrant issued to James Davis dated September 25, 2008.                                                                                                                                                                                                                    |
|                 |   |                                                                                                                                                                                                                                                                            |
| 10.1                 |   | Amendment Number 1 to $150,000 Promissory Note Issued by ProUroCare  Medical Inc. in favor of Profile L.L.C., dated April 3, 2008  (incorporated by reference from Exhibit 10.1 to our Current Report of  Form 8-K filed September 16, 2008).               |
|                 |   |                                                                                                                                                                                                                                                                            |
| 10.2                 |   | Form of Amendment Number 1 to $37,500 Promissory Notes dated April 3,  2008 (incorporated by reference from Exhibit 10.2 to our Current Report  of Form 8-K filed September 16, 2008).                                                                 |
|                 |   |                                                                                                                                                                                                                                                                            |
| 10.3                 |   | Unit Put Agreement dated September 16, 2008 (incorporated by  reference from Exhibit 10.43 to Registration Statement on Form S-1,  File No. 333-153605, filed September 19, 2008).                                                                     |
|                 |   |                                                                                                                                                                                                                                                                            |
| 10.4                 |   | Form of Convertible Promissory Notes to be issued pursuant to  Unit Put Agreement dated September 16, 2008 (incorporated by reference  from Exhibit 10.44 to Registration Statement on Form S-1, File  No. 333-153605, filed September 19, 2008). |
|                 |   |                                                                                                                                                                                                                                                                            |
| 10.5                 |   | Form of Unit Put Origination Warrant to be issued pursuant to  Unit Put Agreement dated September 16, 2008 (incorporated by reference  from Exhibit 4.23 to Registration Statement on Form S-1, File  No. 333-153605, filed September 19, 2008).  |
|                 |   |                                                                                                                                                                                                                                                                            |
| 10.6                 |   | Form of Unit Put Warrant to be issued pursuant to Unit Put  Agreement dated September 16, 2008 (incorporated by reference from  Exhibit 4.22 to Registration Statement on Form S-1, File  No. 333-153605, filed September 19, 2008).              |
|                 |   |                                                                                                                                                                                                                                                                            |
| 10.7*                |   | Convertible Promissory Note dated September 25, 2008 issued in  favor of James Davis.                                                                                                                                                                                      |
|                 |   |                                                                                                                                                                                                                                                                            |
| 31.1*                |   | Certification of Principal Executive Officer pursuant to  Rule 13a-14(a)/15d-14(a) of the Sarbanes-Oxley Act of 2002.                                                                                                                                                 |
|                 |   |                                                                                                                                                                                                                                                                            |
| 31.2*                |   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a)/15d-14(a) of the Sarbanes-Oxley Act of 2002.                                                                                                                                                     |
|                 |   |                                                                                                                                                                                                                                                                            |
| 32.1*                |   | Certification of Chief Executive Officer and Chief Financial Officer  pursuant to pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                          |

 

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***Filed herewith.**

** **

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**SIGNATURES**

** **

 

Pursuant to the SecuritiesExchange Act of 1934, as amended, the Company has duly caused this report to besigned on its behalf by the undersigned thereunto duly authorized.

 

 
|                         | **ProUroCare  Medical Inc.**    |
|------------------------------|---------------------------------|
|                         |                            |
|                         |                            |
| Date:  October 22, 2008 | By:                             | /s/  Richard C. Carlson |
|                         | Name:  Richard C. Carlson       |
|                         | Title:  Chief Executive Officer |
|                         |                            |
|                         |                            |
| Date:  October 22, 2008 | By:                             | /s/  Richard Thon |
|                         | Name:  Richard Thon             |
|                         | Title:  Chief Financial Officer |
|                              |                                 |  |  |

 

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**Exhibit Index**

*** ***
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                    |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                               |
| 4.1*                 |       | Warrant issued  to James Davis dated September 25, 2008.                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                               |
| 10.1                 |       | Amendment Number  1 to $150,000 Promissory Note Issued by ProUroCare Medical Inc. in favor of Profile  L.L.C., dated April 3, 2008 (incorporated by reference from Exhibit 10.1 to  our Current Report of Form 8-K filed September 16, 2008).      |
|                 |       |                                                                                                                                                                                                                                               |
| 10.2                 |       | Form of  Amendment Number 1 to $37,500 Promissory Notes dated April 3, 2008  (incorporated by reference from Exhibit 10.2 to our Current Report of Form  8-K filed September 16, 2008).                                                            |
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| 10.3                 |       | Unit Put  Agreement dated September 16, 2008 (incorporated by reference from Exhibit  10.43 to Registration Statement on Form S-1, File No. 333-153605, filed  September 19, 2008).                                                                |
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| 10.4                 |       | Form of  Convertible Promissory Notes to be issued pursuant to Unit Put Agreement  dated September 16, 2008 (incorporated by reference from Exhibit 10.44 to  Registration Statement on Form S-1, File No. 333-153605, filed September 19,  2008). |
|                 |       |                                                                                                                                                                                                                                               |
| 10.5                 |       | Form of Unit Put  Origination Warrant to be issued pursuant to Unit Put Agreement dated  September 16, 2008 (incorporated by reference from Exhibit 4.22 to  Registration Statement on Form S-1, File No. 333-153605, filed September 19,  2008).  |
|                 |       |                                                                                                                                                                                                                                               |
| 10.6                 |       | Form of Unit Put  Warrant to be issued pursuant to Unit Put Agreement dated September 16, 2008  (incorporated by reference to Exhibit 4.23 from Registration Statement on  Form S-1, File No. 333-153605, filed September 19, 2008).               |
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| 10.7*                |       | Convertible  Promissory Note dated September 25, 2008 issued in favor of James Davis.                                                                                                                                                              |
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| 31.1*                |       | Certification of  Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the  Sarbanes-Oxley Act of 2002.                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                               |
| 31.2*                |       | Certification of  Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the  Sarbanes-Oxley Act of 2002.                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                                               |
| 32.1*                |       | Certification of  Chief Executive Officer and Chief Financial Officer pursuant to pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                      |

 

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*Filed herewith.

 

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