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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-K

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(Mark One)

|x | Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ------------------------------------------------------------------------------------

For the fiscal year ended September 30, 2005

or

| ̈ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from              to

Commission File Number: 001-32541

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HEMOSENSE, INC.

(Exact name of registrant as specified in its charter)

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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 77-0452938                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|651 River Oaks Parkway San Jose, California                    |  | 94545                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

Registrants telephone number, including area code: (408) 719-1393

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value

(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ̈

Indicate by check mark whether the registrant is an
accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x

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

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the
closing sale price of the Common Stock on September 30, 2005 (which is the last business day of registrants most recently completed fourth fiscal quarter), as reported on the American Stock Exchange was approximately $38.5 million. The
registrant was not a reporting company as of March 31, 2005. Shares of Common Stock held by each executive officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may
be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of November 28, 2005, the registrant had outstanding 11,481,482 shares of common stock. The registrant does not
have any non-voting common equity.



DOCUMENTS INCORPORATED
BY REFERENCE

The registrant has incorporated by reference into Part III of this Annual Report on Form 10-K portions of its
definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this Annual Report.

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HEMOSENSE, INC.



FORM 10-K



TABLE OF CONTENTS



|         |  |                                                                                                |  |   
|-------- |  | ---------------------------------------------------------------------------------------------- |  | --
|PART I  
|         |  |                                                                                               
|Item 1.  |  | Business                                                                                       |  | 3 
|         |  |                                                                                               
|Item 2.  |  | Properties                                                                                     |  | 19
|         |  |                                                                                               
|Item 3.  |  | Legal Proceedings                                                                              |  | 19
|         |  |                                                                                               
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                            |  | 19
|        
|PART II 
|         |  |                                                                                               
|Item 5.  |  | Market for Registrants Common Equity and Related Stockholder Matters                          |  | 20
|         |  |                                                                                               
|Item 6.  |  | Selected Financial Data                                                                        |  | 21
|         |  |                                                                                               
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operation           |  | 22
|         |  |                                                                                               
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                     |  | 46
|         |  |                                                                                               
|Item 8.  |  | Financial Statements and Supplementary Data                                                    |  | 48
|         |  |                                                                                               
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           |  | 72
|         |  |                                                                                               
|Item 9A. |  | Controls and Procedures                                                                        |  | 72
|         |  |                                                                                               
|Item 9B. |  | Other Information                                                                              |  | 72
|        
|PART III
|         |  |                                                                                               
|Item 10. |  | Directors and Executive Officers of the Registrant                                             |  | 72
|         |  |                                                                                               
|Item 11. |  | Executive Compensation                                                                         |  | 72
|         |  |                                                                                               
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 72
|         |  |                                                                                               
|Item 13. |  | Certain Relationships and Related Transactions                                                 |  | 72
|         |  |                                                                                               
|Item 14. |  | Principal Accountant Fees and Services                                                         |  | 72
|        
|PART IV 
|         |  |                                                                                               
|Item 15. |  | Exhibits, Financial Statement Schedules                                                        |  | 73
|         |  |                                                                                               
|         |  | Signatures                                                                                     |  | 76



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PART I



Certain statements in
this Annual Report on Form 10-K are forward-looking statements within the meaning of federal securities laws. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties
and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking
statements. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe,
estimate, predict, potential, continue or the negative of these terms or other comparable terminology. Forward-looking statements include, but are not limited to, the statement regarding: opportunities
for revenue growth from expanding indications; the financial impact of our future royalty obligations; our ability to generate positive gross margins on our test strips; and future trends in revenue, cost of goods sold and operating expenses. In
evaluating these statements, you should specifically consider various factors, including the risks outlined under Factors Affecting Future Operating Results. These factors may cause our actual results to differ materially from any
forward-looking statements.



We were incorporated under the
laws of the State of Delaware in March 1997 as CardioSense, Inc. We changed our name to HemoSense, Inc. in January 1998. Our principal executive offices are located at 651 River Oaks Parkway, San Jose, California 95134 and our telephone number at
that location is (408) 719-1393. Information about our company is also available at our website at www.HemoSense.com, which includes links to reports we have filed with the Securities and Exchange Commission. The contents of our website
are not incorporated by reference in this Annual Report on Form 10-K.



ITEM 1. Business



Overview



We develop, manufacture and sell easy-to-use, handheld blood coagulation
monitoring systems for use by patients and healthcare professionals in the management of warfarin medication. Warfarin is an oral anticoagulation, or blood thinning, drug given to patients to prevent potentially lethal blood clots. Our product, the
INRatio System, consists of a small, portable meter and disposable test strips and provides a quick and accurate measurement of a patients blood clotting time, known as a PT/INR value. The accurate measurement of the PT/INR value is critical
to ensuring the safety and effectiveness of warfarin in maintaining a patients blood coagulation level within a therapeutic range. The INRatio System represents an alternative to the current laboratory-based standard of care, which generally
involves monthly or less frequent testing and delayed results. The U.S. Centers for Medicare & Medicaid Services, or CMS, has observed that monthly testing is inadequate for the majority of patients on chronic warfarin therapy. More
frequent testing helps maintain patients within their therapeutic range and may minimize adverse events, such as dangerous blood clots or serious bleeding, associated with insufficient or excessive anticoagulation. Numerous studies reviewed by CMS
showed that frequent self-testing through the use of a home PT/INR monitor improves a patients time in therapeutic range. CMS approved Medicare coverage for weekly home PT/INR monitoring of patients with mechanical heart valves on warfarin.
This decision went into effect in 2002 and, in the latter half of 2003, reimbursement payments began to reach service providers. Similar to the shift that has occurred in the standard of care for management of diabetes and blood glucose monitoring,
we believe that the Medicare coverage decision and growing physician and patient awareness of the benefits of weekly PT/INR patient self-testing signal a shift in the standard of care for PT/INR testing from the clinical laboratory to point-of-care
testing and, ultimately, patient self-testing.



Warfarin has
been prescribed since the 1950s and is regarded as safe and effective when it is dosed correctly. It is the most widely prescribed oral anticoagulant besides aspirin. There are approximately three million people in the United States who take
warfarin daily. In 2003, there were over 20 million prescriptions for warfarin written in the United States, either in generic form, or under its brand name Coumadin. Based upon Medicare claims data, there were 18.3 million PT/INR tests
conducted on U.S. Medicare patients in 2003, comprised of approximately 13.4 million clinical laboratory tests and 4.9 million point-of-care or patient



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self-tests. By contrast, there were 13.8 million tests performed in 2000, consisting of 12.1 million clinical laboratory tests, and
1.7 million point-of-care tests. The total number of PT/INR tests increased by more than 30% over this three-year period, with 11% growth in the laboratory testing market, as compared with 190% growth in the point-of-care and patient self-test
markets. We believe that similar trends have occurred with private insurance payors and in countries outside of the United States. In Germany, where reimbursement was established in 1996, more than 100,000 patients are performing PT/INR
self-testing. As the global population ages and develops disorders requiring management of blood coagulation, and as weekly patient self-testing gains wider acceptance, we expect these trends in PT/INR testing to accelerate. We believe our INRatio
System is well positioned to gain a meaningful share of the global market for PT/INR patient self-testing and point-of-care testing.



We have designed our INRatio System to address the needs of the emerging PT/INR patient self-testing and point-of-care markets. Our proprietary system
requires one drop of blood from a patients finger to quickly and reliably determine the rate at which their blood coagulates by measuring changes in the bloods electrical properties during the coagulation process. For ease of use, the
INRatio System integrates into each disposable test strip clinical laboratory-like quality controls designed to ensure test-by-test accuracy. These controls are designed to verify the accuracy of each PT/INR test without the need for additional
costly and time consuming steps requiring separate chemicals and test strips. Unlike test strips offered by competitors, our test strips can be stored for up to one year at room temperature rather than requiring refrigeration for long-term storage.



After receiving U.S. and European regulatory clearances in
2002, we commercially launched the INRatio System in March 2003 in the U.S. and certain European markets. Tests performed using our INRatio System in the point-of-care setting are currently reimbursed by Medicare for all patients on warfarin as
is self-testing by mechanical heart valve patients on warfarin. We have established distribution agreements with several national and regional distributors of medical products, giving us access to over 1,000 U.S. sales representatives for the sale
of the INRatio System. We are dependent upon these distributors for a substantial portion of our revenue, and the loss of any key distributors would have a material adverse effect on our business. Our distributors Quality Assured Services, Medline
and Cardinal Health accounted for approximately 24%, 19% and 13%, respectively, of our total revenue in fiscal 2005. In addition, we have established international distribution agreements with 14 distribution partners covering 20 countries outside
the United States. We own five issued U.S. patents, one issued European patent, and one pending European application. Three of the issued U.S. patents cover, and the pending European application relates to, the INRatio System and its method of
measuring blood coagulation by monitoring changes in the electrical properties of the blood sample as it clots.



Background and Market



Blood Clotting Disorders



The formation of a blood clot, or thrombus, is a desirable and essential response to a wound, preventing a simple injury from becoming a potentially fatal bleeding event. However, blood clots can have unwanted effects when they block normal
blood flow in the body. Both heart attacks and strokes occur when a vessel that supplies blood is blocked by a blood clot. Heart disease is the leading cause of death in the United States today with heart attacks as the most publicized outcome.
Stroke is the third-leading cause and the leading cause of serious, long-term disability.



There are two types of patients requiring medication for potential blood clots; those with acute conditions requiring short-term therapy and those with chronic conditions requiring long-term therapy, often for life.
Acute risks of blood clots can result from accidents or from certain surgical procedures, like knee or hip replacements. Typically, these patients are initially treated at a hospital with combinations of intravenous drugs that dissolve blood clots
and blood thinning drugs. Often, these patients will continue treatment with an oral anticoagulant, such as warfarin, for several weeks following a hospital stay, until the blood clot risk has diminished. Long-term risks of blood clots result from
chronic conditions and are typically treated with oral anticoagulation medications, including warfarin and aspirin. The most common chronic uses of warfarin are for patients with mechanical heart valves and patients with atrial fibrillation.



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| |  |  | Mechanical Heart Valves. A faulty heart valve can be surgically replaced with a mechanical valve. Mechanical heart valves are designed to last for the life of the patient,
but they can lead to blood clots as a reaction to the presence of this foreign body. According to CMS, there are approximately 400,000 patients in the United States with mechanical heart valves, all of whom require warfarin. The American Heart
Association, or AHA, indicates that there were approximately 93,000 heart valve replacement surgeries in the United States during 2002, which we believe included more than 25,000 mechanical valve implants.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Atrial Fibrillation. Atrial fibrillation is an irregular, fluttering heartbeat that may cause blood to pool within the upper chambers of the heart, leading to blood clots
that can cause a heart attack or stroke. According to the AHAs Heart Disease and Stroke Statistics2005 Update, there are approximately 2.2 million patients in the United States with atrial fibrillation. The 2005 Update
estimates that atrial fibrillation is responsible for approximately 105,000 to 140,000 strokes, or 15% to 20% of all strokes in the United States annually. According to a 2004 publication in Clinical Cardiology, research to date shows that
warfarin provides a major potential benefit to patients with atrial fibrillation, reducing the risk of stroke by approximately 68%. However, fewer than 50% of eligible patients are treated because of fear of brain hemorrhage. To reduce this risk,
careful monitoring of warfarin dosage is critical.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



While our INRatio System is primarily marketed to physicians treating and patients suffering from these two chronic conditions, it is also sold to physicians for the management of warfarin dosage in patients with an acute need for the
medication.



Importance of Monitoring and Managing Warfarin Dosage



The safety and effectiveness of warfarin depends on
maintaining the bloods ability to coagulate within a narrow therapeutic range, which can be challenging if not actively managed. If there is too much warfarin in a patients bloodstream, there is a risk of hemorrhage, or uncontrolled
internal or external bleeding, which can be fatal. If there is too little warfarin in the bloodstream, it will be ineffective in reducing the risks associated with blood clots from the underlying condition, such as a stroke or heart attack.



A patients warfarin dosage typically is managed by first
giving a small starting dose and measuring the patients blood clotting time, adjusting the dose and measuring again, and so on, until the patients proper therapeutic dosage is achieved. When the correct dosage has been achieved, the
anticoagulation effect of the drug will be within a safe and effective therapeutic range. The effectiveness of warfarin can vary between patients and within the same patient, depending upon a number of factors. Changes in diet, alcohol consumption,
interaction with other drugs, a patients overall health and environmental factors can all affect the degree of anticoagulation caused by warfarin. These factors make it important for patients on warfarin to measure their blood clotting ability
frequently to provide their physicians with the information necessary to maintain an appropriate level of warfarin. Prothrombin time, or PT, is an expression of the time it takes for blood to clot and reflects the anticoagulation effect of warfarin.
The internationally recognized measurement standard for clotting time is known as PT/INR. INR is the International Normalized Ratio, which expresses PT in a common scale established by the World Health Organization. Higher PT/INR values indicate the
blood will take more time to clot, whereas lower values indicate the blood will clot more quickly.



Clinical Laboratory and Point-of-care PT/INR Testing and their Limitations



Clinical Laboratory Testing. PT/INR measurements have traditionally been and are mostly still performed and analyzed in a clinical laboratory using
sophisticated and costly high-volume screening equipment. Clinical laboratory tests accounted for 73% of all PT/INR tests performed in 2003 on Medicare patients. Clinical laboratory testing methods for PT/INR measurement are precise; however, these
methods are inconvenient for the patient and the physician, and therefore not conducive to compliance. Clinical laboratory test results typically are not available until the following day, which could prevent a physician from properly advising a
patient during



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their visit. In addition to being inconvenient for the patient, the delay in obtaining test results creates inefficiencies because the physician or nurse
practitioner must perform patient call backs in order to advise patients of changes needed to their warfarin dosages.



Point-of-care Testing. Handheld devices for PT/INR point-of-care measurement have existed since 1987. However, we believe that physician adoption
of these devices was limited due to mixed clinical results regarding their precision and accuracy. In contrast to PT/INR tests performed in a clinical laboratory, point-of-care PT/INR tests can use capillary blood from a finger stick and produce
quick results because tests are performed using a real time PT/INR measurement device directly at the patient point-of-care, such as at a physicians office, anticoagulation clinic or nursing home. The ability to obtain a quick PT/INR test
result is valuable because it allows the healthcare professional to adjust warfarin dosage and suggest lifestyle changes with the patient during the same office visit. In addition, point-of-care PT/INR testing reduces time required and costs
associated with the use of clinical laboratories that are not in close proximity to the physicians and patients. These costs include sample collection and processing steps, transportation costs, and the time spent by a physician or nurse
practitioner performing patient call backs.



CMS reimburses
both clinical laboratory and point-of-care PT/INR tests. However, as CMS has observed in its September 2001 National Coverage Decision Memorandum regarding PT/INR self-testing, clinical laboratory tests are generally performed only once every
four to six weeks, due in large part to practical constraints of access and labor-intensiveness. In the Decision Memorandum, CMS indicated that monthly testing is inadequate for the majority of patients on chronic warfarin therapy, because the
medication is highly individualized and affected by common variables like diet. More frequent testing helps to improve the time that patients spend within their therapeutic PT/INR range, which may minimize adverse events, such as dangerous blood
clots or serious bleeding, associated with inadequate or excessive anticoagulation. CMS evaluated 11 clinical studies published in peer-reviewed journal articles, all of which found patients using home PT/INR monitors performed favorably compared to
control groups treated at a medical facility. Seven of the eight studies that measured statistical significance showed statistically significant better time in therapeutic range, or TTR, for the patient self-testing group than for the group that
received either usual care from a hospital or commercial laboratory, or point-of-care testing, regardless of testing frequency.



CMS Decision Memorandum Observations



|                                       |  |            |  |               |  |                      
|-------------------------------------- |  | ---------- |  | ------------- |  | ---------------------
|                                       |  | Usual Care |  | Point-of-care |  | Patient Self- Testing
|General observations                   |  |            |  |               |  |                      
|Current site of patient testing        |  | <80%       |  | ≈20%          |  | <5%                  
|Testing intervals                      |  | 4-6 weeks  |  | 2-3 weeks     |  | Weekly               
|Adverse event rates                    |  | >15%       |  | <8%           |  | Lowest               
|                                       |  |            | 
|Observations based on specific studies |  |            |  |               |  |                      
|Time in therapeutic range, TTR         |  | 32-68%     |  | 32-68%        |  | 56-92%               



The studies described
by CMS consistently showed that the more frequently a patient was tested the more time that patient spent in their therapeutic range, leading CMS to observe in order to achieve time in therapeutic range of greater than 90%, a patient most
likely needs to be tested once a week. CMS went on to note that increased TTR leads to improved clinical outcomes, with reductions in thromboembolic and hemorrhagic events.



The Emergence of a Patient Self-Testing Market



The confluence of improved technology, approval of reimbursement coverage
and increased physician and patient awareness has led to the emergence of a patient self-testing market for warfarin users. By early 2000, the FDA had cleared three monitors for patient self-testing, but each instrument had limitations. Studies have



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demonstrated that the accuracy and reliability of newer devices for patient self-testing compared well with clinical laboratory testing. The patient
self-testing market has emerged as government and private payors have begun to provide reimbursement. Medicare reimbursement for up to weekly PT/INR monitoring of anticoagulation management for warfarin patients with mechanical heart valves went
into effect in 2002 following publication of the CMS Decision Memorandum. Several European countries have also implemented national reimbursement coverage of home PT/INR testing for chronic warfarin patients, including Germany, the United Kingdom,
Denmark and the Netherlands.



Medicare reimburses for services
provided to patients who perform PT/INR self-testing, similar to the Medicare reimbursement procedure for patients on pacemakers and Holter monitors. Our meters and test strips are distributed to Medicare patients without charge through a Medicare
licensed facility known as an Independent Diagnostic Testing Facility, or IDTF, which may also monitor patient compliance and convey test results to the treating physician. Medicare provides a one-time reimbursement of $251 per patient for the cost
associated with training patients in the proper use of our INRatio System. Medicare also provides for an annual total of over $1,900 per patient for physician review, monitoring service and the testing device. If all of the approximately 400,000
U.S. mechanical heart valve patients on warfarin performed weekly PT/INR self-testing, Medicare reimbursement for this population would be in excess of $800 million annually.



The Department of Veterans Affairs has sponsored a clinical study known as The Home INR Study, or THINRS, to evaluate weekly
PT/INR patient self-testing for patients with atrial fibrillation or a mechanical heart valve. THINRS is a randomized, open-label, active control outcome study designed to compare weekly patient self-testing with conventional monthly monitoring in
the clinic. This study commenced in 2003 and is expected to be completed in 2006. It is anticipated that 3,200 patients will be enrolled at 32 sites. The study participants must have atrial fibrillation or mechanical heart valves and be scheduled to
receive warfarin for at least two years. Participants are assigned into either a weekly patient self-testing group or monthly conventional monitoring group. The study evaluates adverse event rates, time to first adverse event, time in therapeutic
range for anticoagulation intensity, and total healthcare cost and utilization. We expect that results from this study will be influential in Medicares decision regarding reimbursement for PT/INR patient self-testing in atrial fibrillation. If
Medicare were to commence reimbursement for PT/INR patient self-testing for the approximately 1.2 million atrial fibrillation patients currently on chronic warfarin, this will significantly increase the PT/INR patient self-testing market.



As more physicians, insurance providers and patients become
aware of the healthcare benefits derived from more frequent PT/INR testing and the availability of simple and convenient PT/INR testing devices designed specifically for the patient self-testing market, we expect the PT/INR patient self-testing
market to grow significantly.



The HemoSense Solution



We believe that the INRatio System represents a new generation of PT/INR
testing devices designed specifically for use in both patient self-testing and by healthcare professionals at the point-of-care. We believe that physicians generally will not prescribe patient self-testing unless the physician is confident that the
patient will be able to comply with the testing requirements. Many patients needing warfarin are Medicare patients, some of whom may have limited manual dexterity and may be challenged by complex test instructions and training. We believe that we
offer a unique combination of factors that make our INRatio System a simple and straightforward patient self-testing PT/INR measurement device. These features also enable busy healthcare professionals to quickly train their patients in the use of
our system as a tool for monitoring their warfarin therapy. Specifically, these features include:



| |  |  | Patient-friendly, fast and easy-to-use meter and test strips. Our INRatio System weighs less than a pound, is handheld, battery-operated and provides test results generally
in two minutes or less. Results are displayed on an easy to read screen and stored in memory. A typical test requires a finger stick to provide one drop of blood, which is then deposited onto a disposable test strip that has been inserted into the
INRatio meter.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Integrated quality control tests. Our INRatio Systems fully integrated, on-board quality controls are designed to ensure the accuracy of each test and to help simplify
patient self- testing by eliminating the need to perform separate quality control tests. Each time a PT/INR test is conducted, the INRatio System automatically performs two laboratory-like quality control tests within the same single disposable test
strip. The integrated quality controls and self-tests built into the meter serve as additional safeguards against misuse. These tests are designed to confirm that the test strip has not been damaged, that the patient is using the system correctly
and that the meter is performing as intended. In some competing PT/INR testing systems, the quality control tests are not fully integrated and must be performed manually using additional test strips and separate containers of control solution.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Straightforward patient training. Our INRatio Systems features result in a clear-cut training procedure that we believe is easy for a patient to understand and remember
and that we believe will encourage more patients to self-test. Unlike some competing products, our training is so simple that it can be done by phone or online, rather than in person. With the INRatio Systems simple user interface, the meter
guides the patient through a few intuitive steps. Error messages appear on the screen in the event that proper procedures are not followed. There is no need to learn how to use quality controls that require additional test strips, special handling
and precise timing steps.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Test strips that may be stored up to one year at room temperature. Our INRatio Systems disposable test strips do not require refrigeration, which provides additional
convenience to patients and significant storage and handling cost savings to distributors and resellers. The test strips can be stored at room temperature for up to one year, compared to only 30 to 60 days for test strips used in other currently
available PT/INR devices. Refrigerated test strips must be warmed by a patient to room temperature prior to use, requiring patients and healthcare professionals to plan ahead in order to allow time for acclimation to occur.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Proprietary, reliable electrochemical technology. The INRatio System is the only PT/INR testing device that utilizes electrochemical technology to determine a patients
PT/INR value. Our proprietary electrochemical technology generates rapid results and does not rely on mechanical moving parts. The sensors used in our system are small and allow us to measure a patients PT/INR value and two levels of quality
control with a single drop of blood.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The ability
of patients to home test with our INRatio System reduces the time and inconvenience required to manage warfarin by reducing or eliminating trips to the laboratory or doctors office for testing, both for the patient and, often, for the
caregiver. In addition, the INRatio Systems patient-friendly design and functionality helps minimize the burden of PT/INR self-testing for patients. With PT/INR patient self-testing, patients play an active role in management of their warfarin
dosage, which we believe encourages optimal patient compliance.



Our
Strategy



Our objective is to become the leading provider
of PT/INR patient self-testing and point-of-care testing systems and related products for the monitoring of patients on warfarin. We seek to improve therapeutic outcomes while dramatically reducing the need for inconvenient visits by patients to
healthcare professionals for routine testing. To achieve these objectives, we are pursuing the following strategies:



| |  |  | Increase awareness among physicians and patients of the advantages of the INRatio System and the benefits of weekly PT/INR testing. Our goal is to establish the INRatio
System as the leading ease of use PT/INR testing device and the new standard of care. We continue to create awareness among patients and healthcare professionals of the advantages of the INRatio System for weekly patient self-testing and
point-of-care testing. Because the INRatio System is easy to use, we intend to establish the INRatio System as the standard of care for PT/INR testing by patients in their homes and by healthcare professionals and caregivers in clinics,
physicians offices, hospitals and long-term care facilities.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Leverage our established and growing network of distributors worldwide. Our target market can be broken down into several key segments, including
anticoagulation clinics, physician office practices,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | hospitals, long-term care facilities, home healthcare and patient self-testing. We are establishing relationships with nationally recognized partners to
optimize our distribution to each of these market segments. Our sales force assists our distributors in developing and maintaining relationships with leading medical professionals in order to facilitate the adoption of the INRatio System. We intend
to expand our distribution internationally in order to gain access to new markets, such as Asia, and to bolster our presence in Europe.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Utilize and expand reimbursement opportunities. Clinical studies are currently underway to evaluate weekly PT/INR patient self-testing specifically for patients with atrial
fibrillation. As data from these studies becomes available, we plan to campaign actively, both independently and in conjunction with our competitors as well as various healthcare professional associations, for reimbursement coverage of weekly PT/INR
self-testing for patients with atrial fibrillation in both the United States and Europe. In addition, we plan to participate in efforts and discussions that support reimbursement for weekly patient self-testing and point-of-care testing for other
indications.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pursue reimbursement for new and additional indications for PT/INR patient self-testing. Our focus initially is on increasing the use of the INRatio System in the monitoring
of patients on long-term warfarin, such as patients with implanted mechanical heart valves or those with atrial fibrillation. We also intend to address the PT/INR testing needs of patients on short-term warfarin therapy, such as patients at risk of
blood clots resulting from accidents or surgeries.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Develop product improvements. We intend to develop improvements to our INRatio System with a focus on assuring that our products continue to be easy to use and convenient for
our end-users.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our Products



Our INRatio System is an easy-to-use testing system designed specifically
for patient self-testing that provides PT/INR test results using one small drop of blood from the patients finger. The INRatio System consists of a small, handheld meter and disposable test strips with integrated, laboratory-like quality
control tests that are designed to assure the accuracy of PT/INR test results. We shipped our first commercial INRatio System in March 2003.



INRatio Meter



The INRatio meter contains a heater, digital user interface, and electronic components that measure the changes in resistance or impedance in a blood
sample during the coagulation process. To ensure the proper functioning of its components, the INRatio meter performs a series of self-diagnostic tests every time the device is turned on. The meter has three buttons that control all of its functions
and has a prominent, easy to read screen on which instructions and results are clearly displayed. The meter has the ability to store up to 60 PT/INR test results and contains a data port for interfacing with an optional printer. The meter is powered
by four AA batteries and has an optional external A/C adapter. The user can choose to display messages in any of ten languages programmed into the meter.



INRatio Disposable Test Strips



The INRatio disposable test strips use our proprietary electrochemical technology to measure a patients PT/INR value and perform two laboratory-like
quality control tests on a single test strip with a single drop, or approximately 15 microliters, of blood. The two quality control tests confirm standard PT/INR readings for the normal lower range, or low control, and the therapeutic upper range,
or high control. This helps ensure that the meter and test strip are functioning properly and that the patients PT/INR test result will be accurate. The meter and a single test strip automatically perform all three tests each time a
patients blood sample is applied to a test strip that has been inserted into the meter. When the INRatio meter detects an unacceptable quality control test result, it does not display a potentially incorrect PT/INR test result, but rather
alerts the user to the error. We designed our proprietary test strips with on-board quality control tests and our meter with built-in electronic



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diagnostic tests to help ensure the accuracy of test results and to simplify the process by eliminating the need to use specialized control test liquids and
additional test strips to obtain quality control test measurements. Our test strips do not require refrigeration and can be shipped and stored at room temperature for one year, which provides distribution advantages and improves patient convenience.
INRatio test strips can only be used with the INRatio meter.



INRatio
Accessories



We include all accessories needed for the use
of the INRatio System in the patient self-testing and point-of-care environments, such as lancets.



Our Technology Platform



The INRatio System utilizes an electrochemical sensor to detect and measure changes in electrical impedance of a blood sample as it coagulates. The change is then recorded by the meter and converted to a PT/INR reading. When the meter is
turned on, it performs an electronic diagnostic check, the first of a number of quality control tests performed by the INRatio System. Once the test strip is inserted into the meter, it is warmed to normal body temperature, and the meter alerts the
user to apply the blood sample. After a drop of blood is applied to the sample well on the test strip, it is drawn by capillary action across the surface of the test strip and into the test area where it mixes with reagents that cause coagulation.
The blood sample contacts separate electrodes which measure changes in impedance that occur during coagulation. As the reaction progresses, the electrical impedance increases and then gradually drops as the clotting process is completed. The elapsed
time, in seconds, until the endpoint is reached is the raw PT time, which is then used to calculate the INR of the sample. The meter displays the patients PT/INR results generally within two minutes or less after the blood sample is applied.



Sales and Marketing



The market for the INRatio System includes patient self-testing, physician
office practices, anticoagulation clinics, hospitals, long-term care facilities, nursing homes and home healthcare providers. We currently sell our INRatio meter and disposable test strips through distribution agreements in the United States and
internationally. In the United States, our distribution agreements provide us with access to more than 1,000 sales representatives.



U.S. Distribution



We have agreements with five national medical device distribution companies: Quality Assured Services, Cardinal Health, Raytel, Medline and McKesson
Medical. We also have agreements with four companies which provide regional distribution.



| |  |  | Quality Assured Services. We entered into a distribution agreement with QAS in March 2003. QAS is a specialized healthcare sales, service, marketing and distribution
company that focuses on new and evolving, easy-to-use medical diagnostics and related products for patient home care and professional office use. We believe that QAS is unique in the market due to its combination of medical diagnostics distribution,
telehealth services, disease management, health insurance adjudication, training, and market development services. The term of our agreement with QAS runs through February 2007 and will be automatically renewed for one-year periods unless
terminated by either party in the 60-day period preceding the end of any term. We are obligated to indemnify QAS in certain circumstances, including claims against us for malfeasance.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Cardinal Health. We entered into a distribution agreement with Cardinal Health in December 2003. Cardinal Health is one of the largest medical supply companies in the
United States and has over 500 sales and service specialists that focus on marketing to physician office practices and hospitals. Our agreement with Cardinal Health provides us with broad geographic coverage of the physician and hospital market
segments. The term of our agreement with Cardinal Health runs through April 2007 and may be renewed for successive one-year terms. Either party may terminate the agreement without cause upon 90 days written notice.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Raytel. We entered into a distribution agreement with Raytel in April 2004. Raytel is the market leader in contracted services for pacemaker and Holter monitoring, and
employs a U.S. field sales force of 25 sales representatives. Our agreement with Raytel is focused on the PT/INR patient self-testing market and provides us with exposure to the patient base of St. Jude Medical, the largest manufacturer of
mechanical heart valves. Raytel is the exclusive IDTF for St. Jude Medicals marketing of PT/INR patient self-testing in conjunction with its mechanical heart valve product. As an IDTF, Raytel focuses on managing and monitoring these
patients and has significant resources to handle claims processing and the logistics of product supply. The term of our agreement with Raytel runs through April 2006 and will be automatically renewed for one-year periods unless terminated by
either party in the 90-day period preceding the end of any term.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Medline. We entered into a distribution agreement with Medline in June 2004. Medline is the largest privately-held national manufacturer and distributor of medical
supplies in the United States and has over 700 dedicated sales representatives nationwide, and 29 distribution centers in North America. Our distribution agreement with Medline provides access to the long-term care, nursing home and home healthcare
market segments and is exclusive to Medline in those areas. The initial term of our agreement with Medline runs through December 2009 and may be renewed for additional one year periods. The agreement may be terminated by either party within 90
days following an uncured material breach. We are obligated to indemnify Medline in certain circumstances, including for intellectual property infringement claims, breaches of the agreement or our negligence.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | McKesson Medical-Surgical. We entered into a distribution agreement with McKesson Medical-Surgical in May 2005. McKesson Medical, a subsidiary of McKesson, the
worlds leading healthcare services company, is a leading distributor of medical supplies and equipment to physician practices, surgery centers, hospitals, home care and extended care facilities. Under our agreement, McKesson Medical will act
as a non-exclusive distributor of our products to medical clinics, hospitals, physician groups and other medical sites, excluding long-term care facilities and home health care. The term of our agreement runs through May 2010 and continues
automatically for successive five year terms. Either party may terminate the agreement without cause upon 90 days written notice or with cause upon 10 days written notice.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



International Distribution



We currently have 14 distribution agreements covering 20 countries internationally. These agreements generally provide that each distributor can sell into
the professional and home-use markets within a country. Germany, as an exception, has two distributors covering the country. Our distribution agreements internationally include those with MicroMedical, IMed Partners and InaBattke KG in Germany; as
well as agreements with distributors covering Australia, Austria, Belgium, China Denmark, Finland, Holland, Ireland, Israel, Italy, Lithuania, Luxembourg, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom. Germany is a
particularly important international market for us because its medical and patient communities have been leaders in the adoption of patient self-testing. We intend to continue to enter into distribution agreements in other select countries where
PT/INR patient self-testing and point-of-care testing are established medical practices. In emerging markets such as Asia, we intend to identify strategic partners as distributors of our product.



Sales and Marketing Organization



We intend to use a variety of marketing tools to build market awareness,
drive product adoption, ensure continued usage and establish brand loyalty for the INRatio System by:



| |  |  | creating awareness of the benefits of the INRatio System with distributors, physicians, nurse practitioners, educators and patients;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  |  | providing strong educational and training programs to healthcare providers and patients to ensure the understanding of the ease of use, safety and effectiveness of the INRatio
System;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | establishing a readily-accessible telephone and web-based technical and customer support infrastructure for our distribution partners, healthcare providers and patients; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | building upon our network of leading distributors to sell our products to physician office laboratories and directly to the patients.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



As of November 15, 2005, we employ 31 people in sales and marketing.
Sixteen salespeople are located in key locations throughout the United States working with distribution partners and healthcare providers. We employ five product specialists in the field that focus on training and product troubleshooting for large
accounts. The nine remaining employees are located in the corporate office, including five within marketing and four in customer and technical service. We also employ a director of international business development in Europe to support our
international distribution partners and healthcare providers.



Competition



The market for PT/INR patient self-testing and
point-of-care diagnostics is intensely competitive, subject to rapid changes and new product introductions. We believe that two companies, Roche Diagnostics and International Technidyne Corporation, a division of Thoratec, currently account for over
90% of the worldwide sales of PT/INR point-of-care and patient self-testing devices. Both of these competitors use a meter and disposable strips or cartridges, to test blood obtained by lancing the finger or drawing blood from a vein. Both of these
competitors are focused on expanding their presence in the patient self-testing market.



In addition to our current competitors, we expect to encounter new entrants to the market, particularly if increased reimbursement drives the adoption of patient self-testing and increased testing volume.
Specifically, Inverness Medical Innovations has announced that it plans to introduce its own warfarin anticoagulation monitoring device later in 2006.



Our competitors enjoy several competitive advantages, including:



| |  |  | significantly greater name recognition;
| | - |  | ---------------------------------------



| |  |  | established relationships with healthcare professionals, patients and third-party payors;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | established distribution networks;
| | - |  | ----------------------------------



| |  |  | additional product lines and the ability to offer rebates or bundle products to offer higher discounts or incentives to gain a competitive advantage;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | greater experience in conducting research and development, manufacturing, obtaining regulatory approval for products and marketing; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | greater financial and human resources for product development, sales and marketing and patent litigation.
| | - |  | ---------------------------------------------------------------------------------------------------------



We believe the principal competitive factors in our market include:



| |  |  | reliability and ease of use;
| | - |  | ----------------------------



| |  |  | technological leadership and superiority;
| | - |  | -----------------------------------------



| |  |  | improved patient outcomes and reduced overall time to manage therapy; and
| | - |  | -------------------------------------------------------------------------



| |  |  | effective marketing and distribution.
| | - |  | -------------------------------------



Emerging Oral Anticoagulation Therapies



A number of pharmaceutical companies are working on the development of a new class of oral direct thrombin inhibitors, or DTIs, to replace older
anticoagulants such as warfarin. In theory, these new oral DTIs



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should have very few drug/non-drug interactions and should not require the same level of monitoring that warfarin requires. One goal of current research in
this area is the elimination of the need for PT/INR testing, which if successful could render our device obsolete. One oral DTI, AstraZenecas Exanta, is approved in Europe for preventing blood clots in connection with knee and hip
replacements. However, in the fourth quarter of 2004, the FDA did not grant approval based on Exantas dangerous side effects to patients livers. As of yet, it is unknown whether oral DTIs will be approved in the United States or perform
as well as warfarin, especially for the chronic user.



Manufacturing



The primary components of the INRatio System are the
INRatio meter and the INRatio disposable test strips. We manufacture the INRatio test strips at our California headquarters and we contract with an electronic manufacturing services supplier to manufacture the INRatio meter. We offer other
accessories as part of the INRatio System such as lancets, blood collection devices, power supplies, and printers. These supplies and accessories are manufactured by third parties and are not customized for the INRatio System.



Both the INRatio meter and test strips are manufactured using components and
assemblies that have been supplied by outside vendors. The test strip manufacturing process includes reagent dispensing and drying steps, mechanical assembly, packaging and calibration. Plastic film substrates are purchased from outside vendors that
perform printing, die cutting and laminating operations according to specifications we have established. These printed and cut films are shipped to our manufacturing facility where we perform an incoming quality control check prior to test strip
assembly. The meter is manufactured by an electronic manufacturing services company that is responsible for procuring materials, assembly, and testing of the device according to our specifications. The meters are shipped to our manufacturing
facility where we perform calibration, packaging and labeling.



We use contract manufacturing relationships to minimize our capital investment, help control costs, and take advantage of the expertise these third parties have in the production of these assemblies. We also purchase certain components and
materials from single sources due to constraints resulting from intellectual property requirements, quality or cost reasons. Currently, those single sources are Dade Behring, which produces a reagent used in our test strips, Haematologic
Technologies, which produces the control reagents and Plexus, which manufactures our meters. We have supply agreements in place with these single source suppliers that provide for notification and termination periods; however, because of the custom
nature of the components and the FDA requirements for validation and verification of significant changes, a supply interruption from any of these suppliers would limit our ability to produce our systems and could have a material adverse effect on
our business. Our agreement with Dade Behring is terminable upon 90 days notice. Prior to the expiration of the agreement in March 2007, we have the option to extend the term until January 2015, the date of the last expiring patent covered
by the agreement, by making a payment of $2.5 million, if made prior to March 2006, or $2.75 million, if made prior to March 2007. Our agreement with Haematalogic Technologies is terminable upon 18 months notice and our agreement with
Plexus is terminable upon 180 days notice.



Research and Development



We are determining the feature set for a new version of
the INRatio meter that we believe would make our system even more attractive for the PT/INR patient self-testing market. The system design of the new version plans for a device that is smaller in size than our current INRatio meter. We expect this
new product to utilize the current architecture of the INRatio disposable test strip and deliver the same patient-friendly feature set as the current INRatio meter. We believe that our next generation INRatio System could potentially be attractive
for patients who are only on warfarin for a short period of time.



In addition, based on our initial specifications, we expect the new version could reduce our per-unit manufacturing costs at comparable volumes, using the same manufacturing technologies as the current INRatio System. Beyond investing in
the design of a future version, we intend to continue developing a number of product enhancements for the current INRatio System. We are also developing an integrated communications



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capability for use in the professional setting that will provide an automated means to interface the INRatio meter to a data management system. Product
development efforts related to the current INRatio System are focused on manufacturing process enhancements aimed at cost reduction and quality improvements, as well as functional enhancements. Specifically, we are designing process development and
automation projects for our disposable test strip production line that we believe will significantly increase manufacturing capacity and reduce our costs.



We believe that our electrochemical technology has applications in other tests beyond the measurement of PT/INR values for patients on warfarin. We plan
to conduct feasibility studies for additional coagulation parameters including APTT, or activated partial thromboplastin time, and ACT, or activated clotting time.



We have had research and development expenses of $1.3 million, $1.4 million and $1.7 million in fiscal 2005, 2004 and 2003,
respectively.



Intellectual Property



Protection of our intellectual property is a priority for us. We plan to
pursue and maintain patent protection in both the United States and Europe. We rely on a combination of patents, copyrights, trade secrets and nondisclosure agreements to protect our proprietary rights. Currently, we have five issued U.S. patents
and one issued European patent, which has been validated in certain member states of the European Patent Convention, including Germany and Austria. In addition, we have one pending European patent application. Three of the issued U.S. patents cover
the INRatio System and its method of measuring blood coagulation. They expire in 2017. Similarly, the pending European application contains claims that would cover our INRatio System and its method of measuring blood coagulation if it were to issue
in its present form. The pending European application, if issued, would expire in 2018.



The medical device industry is characterized by the existence of a large number of patents and frequent litigation based on assertions of patent infringement. On June 22, 2005, we received a letter from Beckman
Coulter claiming that our test strip includes intellectual property covered by one of their patents, U.S. Patent 5,418,141, and that we could require a license to the patent. After requesting more information from Beckman Coulter and performing an
investigation on their assertion, we concluded that their patent does not cover our test strip and that we do not need to obtain a license from them. Together, our patents, patent application and licenses of patents
protect aspects of our technologies. We believe that our patent and license position will provide us with sufficient rights to develop, sell and protect our product.



We also rely on trade secrets, technical know-how and continuing innovation to develop and maintain our competitive
position. We seek to protect our proprietary information and other intellectual property by generally requiring our employees, consultants, contractors, outside scientific collaborators and other advisors to execute non-disclosure agreements on
commencement of their employment or engagement.



In
April 2003, Inverness Medical Innovations filed suit against us, alleging that disposable test strips for our INRatio System infringed certain patents held by Inverness. In July 2004, we entered into a settlement and mutual release
agreement with Inverness pursuant to which we received a non-exclusive, perpetual, non-transferable worldwide license to the patent rights in exchange for a product royalty of 1.5% of net sales, which is subject to a cap on aggregate royalties
payable of $5.0 million, which begins to accrue in July 2006 and the issuance to Inverness of a $1.0 million secured subordinated promissory note.



Government Regulation



Our products are medical devices subject to extensive regulation by the FDA and other regulatory bodies. FDA regulations govern, among other things, the
following activities that we perform and will continue to perform to ensure that medical products distributed domestically and exported internationally are safe and effective for their intended uses:



| |  |  | product design and development;
| | - |  | -------------------------------



| |  |  | product testing;
| | - |  | ----------------



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| |  |  | product manufacturing;
| | - |  | ----------------------



| |  |  | product safety;
| | - |  | ---------------



| |  |  | product labeling;
| | - |  | -----------------



| |  |  | product storage;
| | - |  | ----------------



| |  |  | recordkeeping;
| | - |  | --------------



| |  |  | premarket clearance or approval;
| | - |  | --------------------------------



| |  |  | advertising and promotion; and
| | - |  | ------------------------------



| |  |  | product sales and distribution.
| | - |  | -------------------------------



FDAs Premarket Clearance and Approval Requirements



Unless an exemption applies, each medical device we wish to commercially distribute in the United States will require either prior 510(k) clearance or
prior premarket approval from the FDA. The FDA classifies medical devices into one of three classes. Devices deemed to pose lower risk to the patient are placed in either class I or II, which requires the manufacturer to submit a premarket
notification requesting permission for commercial distribution. This process is known as 510(k) clearance. Most class I devices are exempted from this requirement. Devices deemed by FDA to pose the greatest risk, such as life-sustaining,
life-supporting or implantable devices, or devices deemed not substantially equivalent to a previously cleared 510(k) device or a pre-amendment class III device for which premarket approval applications, or PMAs, have not been required by the FDA,
are placed in class III, requiring premarket approval. All of our current products are class II devices.



510(k) Clearance Pathway. To obtain 510(k) clearance, we must submit a premarket notification demonstrating that the proposed device is
substantially equivalent to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of PMAs. By statute and regulation, the FDA is required
to clear, deny, or request additional information on a 510(k) premarket notification within 90 days of submission of the application. As a practical matter, 510(k) clearance often takes significantly longer. The FDA may require further information,
including clinical data, to make a determination regarding substantial equivalence.



We received 510(k) clearance for our INRatio System for professional use in May 2002, and for use in patient self-testing in October 2002. The components of our system include the meter, test strips, blood
lancets, blood collection device and power supplies. A printer, manufactured by a third-party, is available as an accessory.



Product Modifications



After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major
change in its intended use, requires a new 510(k) clearance or could require a premarket approval. The FDA requires each manufacturer to make this determination initially, but the FDA can review any of these decisions. We have modified various
aspects of our INRatio System since receiving regulatory clearance, but we believe that new 510(k) clearances are not required for these modifications. If the FDA disagrees with our determination not to seek new 510(k) clearances, the FDA may
require us to seek 510(k) clearance or premarket approval. The FDA also can require us to cease marketing and/or recall the modified device until 510(k) clearance or premarket approval is obtained. Also, in these circumstances, we may be subject to
warning letters, significant regulatory fines or penalties, seizure or injunctive action, or criminal prosecution.



Premarket Approval Pathway. If the FDA denies 510(k) clearance for one of our products or if one of our products is not eligible for 510(k)
clearance, we must follow the premarket approval pathway for that product



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before marketing commences. A PMA requires reasonable assurance of the safety and effectiveness of the device to the FDAs satisfaction. A PMA must
provide extensive pre-clinical and clinical trial data and also information about the device and its components, including, among other things, device design, manufacturing and labeling. After approval of a PMA, a new premarket approval or premarket
approval supplement is required in the event of a significant modification to the device, its labeling or its manufacturing process. The premarket approval pathway is much more costly, lengthy and uncertain than 510(k) clearance. It generally takes
from one to three years or even longer from submission of a complete application to PMA approval.



No device that we have developed has required premarket approval, nor do we currently expect that any future device or indication will require premarket
approval.



Pervasive and Continuing FDA Regulation



After a device is placed on the market, numerous regulatory requirements
apply. These include:



| |  |  | quality system regulations, which require manufacturers, including third-party manufacturers, to follow stringent design, testing, control, documentation and other quality assurance
procedures during all aspects of the manufacturing process;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | labeling regulations, which prohibit the promotion of products for uncleared, unapproved or off-label uses;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | medical device reporting regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned
in a way that would likely cause or contribute to a death or serious injury if it were to recur;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | correction and removal regulations, which require that manufacturers report to the FDA any corrections to, or removals of, distributed devices that are made to reduce a risk to
health; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | post-market surveillance regulations, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



We will need to continue to invest significant
time and other resources to ensure ongoing compliance with FDA quality system regulations and other postmarket regulatory requirements.



The FDA enforces the quality system regulations, or QSRs, through scheduled and through unannounced inspections. We recently underwent an inspection of
our facilities by the FDA, which resulted in the issuance of an FDA Form 483 containing two observations. First, the inspector observed that we failed to timely file Medical Device Reports, or MDRs, for six of seven complaints the inspector reviewed
claiming that our INRatio device took inaccurate readings none of which resulted in a patient injury. MDRs are required to be filed, even if an injury has not occurred, if our device may have caused or contributed to a death or serious injury or if
it may have malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur. We categorize as complaints instances reported to us in which our device takes a reading that is different from what the user
expected. For example, discrepant results can be different readings obtained by the user on separate occasions using either the same or another testing device. In addition to potential device malfunction, discrepant PT/INR test results can arise
from a number of factors, such as failure to follow our instructions for use, a patients medication or diet between measurements, or variability in measurement results among different manufacturers instruments. Since we began selling our
product, we have received complaints of discrepant test results representing approximately .01% of all test strips sold. At the time that we received the complaints reviewed by the FDA, our written procedure did not provide for the analysis of
whether to file an MDR if the complaint solely involved discrepant results, without any resulting patient injury. In addressing the FDAs observation, we have revised our MDR reporting procedure to now determine when discrepancies between
measurements taken with our device and those taken with a clinical laboratory device should be classified as a malfunction and result in an MDR filing. As a result of this revised procedure, we will be filing an increased number of MDRs. The
FDAs second observation was that we had not properly defined and documented the



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procedures we employ to identify the statistical techniques for calibration of our test strips. This observation requires us to provide clarification of how
our current strip calibration procedures are in conformity with standards applicable to PT/INR testing. We have filed a response to these observations that includes a description of and basis for our revised MDR reporting procedure, as well as the
documentation of procedures employed to identify valid statistical techniques for our test strip calibration and our conformity to applicable standards. The FDA subsequently issued a Warning Letter on October 5, 2005. The Warning Letter
indicates that the FDA believes that our response did not provide sufficient detail and documentation for the FDA to evaluate whether our corrective actions would be adequate to prevent recurrence of the observations. We have submitted a further
written response to the FDA, which we believe addresses this concern. The FDA has accepted our response, but there can be no assurance that the FDA will not in the future impose more serious enforcement actions, which may include the following
sanctions:



| |  |  | fines, injunctions and civil penalties;
| | - |  | ---------------------------------------



| |  |  | recall or seizure of our products;
| | - |  | ----------------------------------



| |  |  | operating restrictions, partial suspension or total shutdown of production;
| | - |  | ---------------------------------------------------------------------------



| |  |  | delays in clearance or approval, or failure to obtain approval of our products or product modifications;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | withdrawal of clearances or approvals; and
| | - |  | ------------------------------------------



| |  |  | criminal prosecution.
| | - |  | ---------------------



We are subject to unannounced inspections by the FDA and the Food and Drug Branch of the California Department of Health Services, and these inspections
may include the manufacturing facilities of our subcontractors. Our most recent inspections by these agencies resulted in no observations.



CLIA waiver. The Clinical Laboratory Improvement Amendments, or CLIA, is intended to ensure the quality and reliability of clinical laboratories in
the United States by mandating specific standards in the areas of personnel qualifications, administration, participation in proficiency testing, patient test management, quality control, quality assurance and inspections. The regulations
promulgated under CLIA establish three levels of diagnostic tests: waiver, moderately complex and highly complex, and the standards applicable to a clinical laboratory depend on the level of tests it performs. A CLIA waiver is available to clinical
laboratory test systems if they meet certain requirements established by the statute. Waived tests are exempt from quality standards and are defined as simple tests having an insignificant risk of an erroneous result. Following the 510(k) clearance
of our self-testing submission, we applied for a CLIA waiver for professional use of our INRatio System and received that waiver in December 2002. For patient self-testing, the INRatio System was waived under a CLIA provision that provides that
tests approved by the FDA for home use automatically qualify for CLIA waiver.



International



International sales of medical
devices are subject to foreign government regulations, which vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may
differ.



The primary regulatory environment in Europe is that
of the European Union, which consists of 25 countries encompassing most of the major countries in Europe. Other countries, such as Switzerland, have voluntarily adopted laws and regulations that mirror those of the European Union with respect to
medical devices. The European Union has adopted numerous directives and standards regulating the design, manufacture, clinical trials, labeling, and adverse event reporting for medical devices. Devices that comply with the requirements of a relevant
directive will be entitled to bear CE conformity marking, indicating that the device conforms with the essential requirements of the applicable directives and, accordingly, can be commercially distributed throughout Europe. The method of assessing
conformity varies depending on the class of the product, but normally involves a combination of self-assessment by the manufacturer and a third-party assessment by a Notified Body. This third-party assessment may consist of an audit of
the manufacturers quality system and specific testing of the



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manufacturers product. An assessment by a Notified Body in one country within the European Union is required in order for a manufacturer to
commercially distribute the product throughout the European Union. In November 2002, our INRatio System was certified by TÜV Rhineland Product Safety of Cologne, Germany, a Notified Body, under the European Union In-Vitro Diagnostic
Directive allowing the CE conformity marking to be applied and marketing to commence throughout the European Union.



Third Party Reimbursement



Healthcare providers that purchase medical devices, such as the INRatio System, generally rely on third party payors, including Medicare and Medicaid
programs and private payors, such as indemnity insurers, employer group health insurance programs and managed care plans, to reimburse all or part of the cost of the products and services they provide to patients. The INRatio System will be sold
principally to independent diagnostic testing facilities, or IDTFs, anticoagulation clinics, and physician practices that receive reimbursement from these third parties. As a result, demand for the INRatio System is dependent in part on the coverage
and reimbursement policies of these payors.



Medicare Coverage and
Reimbursement for Anticoagulation Self-Testing



Medicare
published a National Coverage Decision, or NCD, memorandum in May 2002, which provided certain coverage for Medicare beneficiaries with mechanical heart valves. This determination covered anticoagulation self-testing as a diagnostic testing
service paid under the Physician Fee Schedule through IDTF and physician services.



To qualify for coverage under Medicare, the NCD requires patients with mechanical heart valves to have been on anticoagulation therapy for a minimum of three months, to undergo training on anticoagulation management
and on the use of the self-monitoring device, and to perform tests according to the prescribing physicians order, but no more frequently than once a week.



For eligible beneficiaries, Medicare provides reimbursement for training the beneficiary on anticoagulation management and proper use of the
self-testing device, physician review of the test results and the equipment and supplies required to perform the test.



Medicare Point-of-care Reimbursement



Reimbursement for testing in a physicians office has been covered as outpatient services and reimbursed under Current Procedural Terminology codes.
These codes cover all in-vitro diagnostic tests regardless of how the test is performed. Additionally, the physician can bill for an office visit in conjunction with performing the test.



Government reimbursement encourages point-of-care over central laboratory testing by paying for patient evaluation and
management when done in the physician office or an anticoagulation clinic under the supervision of a physician. Evaluation and management services include reviewing the patient history, examining the patient, reading and interpreting the test
results, determining if dosage change is necessary, and counseling the patient. In contrast, if the physicians staff or anticoagulation clinic does a venous draw, sends the sample to the lab and calls the patient with the results and advice,
no evaluation and management reimbursement is allowed.



Private Payors



Many third party private payors, including indemnity
insurers, employer group health insurance programs and managed care plans, presently provide coverage for the patients purchase or health professionals use of medical equipment which may include our INRatio System. The scope of coverage
and payment policies varies among third party payors and may vary by region for certain private payors. To date, only a few of these payors have issued a coverage decision for any warfarin monitoring indication. Despite this, many private payors
have



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been reimbursing individual patients on warfarin based on the medical necessity when provided by their physician. The possibility exists that coverage
policies of individual third party payors may change unpredictably over time.



International



Point-of-care testing and
reimbursement in the international marketplace is in various stages of approval and penetration. Point-of-care reimbursement outside the United States differs country by country, with the most advanced coverage of home testing established in 1996
for the German market. In Germany, both meters and test strips are provided to the patients through mechanical heart valve patient training centers or pharmacies. The Nordic region and the Netherlands work similar modes through thrombosis centers,
while the UK government only covers the supplies and not the meter.



Employees



As of November 15, 2005, we
had 76 full-time equivalent employees, including 35 engaged in manufacturing operations and quality assurance, 5 in research and development, 31 in sales and marketing and 5 in general and administrative functions. None of our employees is
represented by a labor union or is covered by a collective bargaining agreement. We have never experienced any employment-related work stoppages and consider our employee relations to be good.



Available Information



We are subject to the reporting requirements under the Securities Exchange
Act of 1934. Consequently, we are required to file reports and information with the Securities and Exchange Commission (SEC), including reports on the following forms: annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. You can read our SEC filings, including the registration statement, over the Internet at the SECs web
site at http://www.sec.gov. You may also read and copy any document we file with the SEC at its public reference facilities at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. You may also obtain copies of the documents at prescribed
rates by writing to the Public Reference Room of the SEC at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Please call the SEC at (202) 551-8090 for further information on the operation of the public reference facilities.



You may also find on our website at http://www.hemosense.com
electronic copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The
contents of our website are not incorporated by reference in this Annual Report on Form 10-K. Our charter for our Audit, Compensation and Nominating Governance Committees and our Code of Ethics are available on our website. In the event that we
grant a waiver under our Code of Ethics, to any of our officers and directors, we will publish it on our website.



ITEM 2: PROPERTIES



We maintain
our headquarters in San Jose, California in a 15,250 square foot facility, which includes manufacturing, research and development, marketing and general administrative functions. The lease for this facility expires in April 2009. We have the
option to extend this lease for an additional five years, and a right of first offer for an adjacent facility as space becomes available in that facility. We believe our existing facility is adequate to meet our needs through the initial lease term,
and that suitable additional space will be available in the future on commercially reasonable terms.



ITEM 3: LEGAL PROCEEDINGS



We are
not party to any material pending or threatened litigation



ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



None.



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PART II



ITEM 5: MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS



Our common stock began trading on June 28, 2005 and is quoted on the American Stock Exchange, AMEX, under the symbol HEM. The following
table sets forth the quarterly high and low trading prices for our common stock as reported by the AMEX for the periods indicated.



|                 |  |      |      |     |   |     
|---------------- |  | ---- | ---- | --- | - | ----
|                 |  | HIGH |      | LOW
|FISCAL YEAR 2005 |  |      |      |     |   |     
|Third Quarter    |  | $    | 5.60 |     | $ | 5.50
|Fourth Quarter   |  | $    | 9.50 |     | $ | 5.50



As of
November 28, 2005, the last reported sales price of our common stock on the American Stock Exchange was $8.10 per share, and the number of holders of record was approximately 60. We currently intend to retain any earnings to fund the
development and growth of our business.



During fiscal 2005, we
have issued and sold the following unregistered securities:



1. On February 7, 2005, we issued and sold to accredited investors an aggregate of 2,124,218 shares of our Series C-3 preferred stock at a purchase price of $1.58 per share for an aggregate purchase price of
$3,356,264. In connection with this transaction, these investors also participated in the following stock exchanges:



| |  |  | on February 15, 2005, we issued to existing stockholders an aggregate of 1,429,566 shares of our Series A-3 preferred stock in exchange for an aggregate of 1,429,566 shares of
our Series A-2 preferred stock held by such stockholders;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | on February 15, 2005, we issued to existing stockholders an aggregate of 1,914,555 shares of our Series B-3 preferred stock in exchange for an aggregate of 1,914,555 shares of
our Series B-2 preferred stock held by such stockholders; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | on February 15, 2005, we issued to existing stockholders an aggregate of 16,487,912 shares of our Series C-3 preferred stock in exchange for an aggregate of 16,487,912 shares
of our Series C-2 preferred stock held by such stockholders.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2. On February 16, 2005, we issued to an existing stockholder an aggregate of 94,936 and 95,249 shares of our common stock in connection with the conversion of 1,898,734 shares of our Series B-2 preferred stock
and 1,905,024 shares of our Series C-2 preferred stock held by such stockholder, respectively, into shares of our common stock.



3. On March 1, 2005, we issued to an accredited investor warrants to purchase an additional 189,874 shares of our Series C-3
preferred stock at $1.58 per share for an aggregate exercise price of $300,001. As of November 15, 2005, none of these warrants had been exercised.



4. On April 25, 2005, we sold nonconvertible promissory notes in the aggregate principal amount of $1.5 million to existing
stockholders. In consideration for the purchase of these notes we issued to these stockholders warrants to purchase an aggregate of 54,542 shares of our common stock at $5.50 per share.



The sales and issuances of securities in the transactions described in paragraphs 1 through 4 above were deemed to be exempt
from registration under the Securities Act in reliance upon the following exemptions:



| |  |  | with respect to transactions described in paragraphs 1, 3, and 4, Section 4(2) of the Securities Act or Rule 506 of Regulation D promulgated thereunder, as
transactions by an issuer not involving any public
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | offering. The recipients of securities in each transaction represented their intentions to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof and appropriate legends were affixed to the securities issued in such transactions. The sale of these securities were made without general solicitation or advertising. All recipients were
accredited investors and had adequate access, through their relationship with us, to information about us; and
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | with respect to the transactions described in paragraph 2, Section 3(a)(9) of the Securities Act, as transactions involving an exchange with existing security holders for no
consideration.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



During fiscal 2005, we granted
options to purchase 319,000 shares of common stock to employees, directors and consultants under our 1997 Stock Plan at an exercise price of $0.80 to $7.00 per share for an aggregate exercise price of $425,700. These option grants were deemed to be
exempt from registration under the Securities Act in reliance upon Rule 701 promulgated under Section 3(b) of the Securities Act, as transactions pursuant to a written compensation benefit plan and contracts relating to compensation as provided
under Rule 701.



We registered for the initial public offering
of our common stock, par value $0.001 per share, on a Registration Statement on Form S-1 (Registration No. 333-123705), which was declared effective on June 28, 2005. On July 1, 2005 we completed the initial public offering of our
common stock by selling 3.5 million shares at $5.50 per share. Additionally on July 27, 2005, the underwriters exercised their over-allotment option to purchase 12,207 shares at $5.50 per share. Gross proceeds from the offering were $19.3
million. Total expenses from the offering were $2.6 million, which included underwriting discounts and commissions of $1.3 million, and $1.3 million in other offering-related expenses. Net offering proceeds, after deducting total expenses were $16.7
million. Of the $16.7 million in net proceeds, through September 30, 2005, we have spent approximately, $1.9 million for sales and marketing initiatives to support the ongoing commercialization of our INRatio System, $453,000 for research and
development activities, including support of product development, regulatory and clinical study initiatives, $1.5 million for repayment of outstanding principal and interest due from promissory notes bearing interest at the rate of 6% annually held
by affiliates, plus accrued interest, and $2.4 for working capital and general corporate purposes. In addition, we invested the proceeds from the offering in short-term, investment grade, interest-bearing instruments.



Dividend Policy



We have never declared or paid any cash dividends on our capital stock, and we do not currently intend to pay any cash
dividends on our common stock in the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. The declaration of dividends is subject to the discretion of our board of directors and will
depend on various factors, including our results of operations, financial condition, future prospects and any other factors deemed relevant by our board of directors. In addition, the terms of any current or future debt or credit facility may
preclude us from paying dividends on our common stock.



Equity Compensation
Plans



The information require by this item regarding
equity compensation plans is incorporated by reference under the section entitled Equity Compensation Plan Information contained in our proxy statement for our 2006 meeting of stock holders



ITEM 6: SELECTED FINANCIAL DATA



The selected financial data set forth below are derived from our financial statements. The statement of operations data for the years ended September 30, 2005, 2004 and 2003, and the balance sheet data as of September 30, 2005 and
2004 are derived from our audited financial statements included elsewhere in this Form 10-K. The historical results are not necessary indicative of results expected for any future period. The data presented below has been derived from financial
statements that have been prepared in accordance with



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##### Table of Contents

accounting principles generally accepted in the United States of America and should be read with our financial statements, including the accompanying Notes
to the Financial Statements, and with Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K.



|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                  |  | Years Ended September 30,             |        
|                                                  |  | 2005                                  |         |   | 2004 |   |         | 2003 |  |   | 2002   |   |  | 2001 |       
|                                                  |  | (in thousands, except per share data) |        
|Statement of Operations Data:                     |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Revenue                                           |  | $                                     | 8,768   |   |      | $ | 3,250   |      |  | $ | 427    |   |  | $    |       |   |  | $ |       |  
|Cost of goods sold                                |  |                                       | 9,371   |   |      |   | 5,065   |      |  |   | 1,519  |   |  |      |       |   |  |   |       |  
|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Gross loss                                        |  |                                       | (603    | ) |      |   | (1,815  | )    |  |   | (1,092 | ) |  |      |       |   |  |   |       |  
|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Operating expenses:                               |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Research and development                          |  |                                       | 1,259   |   |      |   | 1,398   |      |  |   | 1,681  |   |  |      | 3,354  |   |  |   | 3,008  |  
|Sales and marketing                               |  |                                       | 6,733   |   |      |   | 5,206   |      |  |   | 3,186  |   |  |      | 745    |   |  |   | 762    |  
|General and administrative                        |  |                                       | 1,962   |   |      |   | 1,499   |      |  |   | 912    |   |  |      | 711    |   |  |   | 739    |  
|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total operating expenses                          |  |                                       | 9,954   |   |      |   | 8,103   |      |  |   | 5,779  |   |  |      | 4,810  |   |  |   | 4,509  |  
|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Loss from operations                              |  |                                       | (10,557 | ) |      |   | (9,918  | )    |  |   | (6,871 | ) |  |      | (4,810 | ) |  |   | (4,509 | )
|                                                  |  |                                       |         |   |     
|Interest income                                   |  |                                       | 130     |   |      |   | 16      |      |  |   | 39     |   |  |      | 142    |   |  |   | 605    |  
|Interest expense                                  |  |                                       | (1,314  | ) |      |   | (318    | )    |  |   | (67    | ) |  |      | (21    | ) |  |   | (36    | )
|Other expense                                     |  |                                       | (5      | ) |      |   | (41     | )    |  |   | (11    | ) |  |      | (19    | ) |  |   | (10    | )
|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net loss                                          |  | $                                     | (11,746 | ) |      | $ | (10,261 | )    |  | $ | (6,910 | ) |  | $    | (4,708 | ) |  | $ | (3,950 | )
|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net loss per share:                               |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Basic and diluted                                 |  | $                                     | (4.26   | ) |      | $ | (30.45  | )    |  | $ | (20.69 | ) |  | $    | (14.27 | ) |  | $ | (11.52 | )
|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Shares used to compute net loss per common share: |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Basic and diluted                                 |  |                                       | 2,758   |   |      |   | 337     |      |  |   | 334    |   |  |      | 330    |   |  |   | 343    |  
|                                                  |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  



|                                                  |  |                     |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------- |  | ------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                  |  | As of September 30, |        
|                                                  |  | 2005                |         |   | 2004 |   |         | 2003 |  |   | 2002    |   |  | 2001 |        
|                                                  |  | (in thousands)      |        
|Balance Sheet Data:                               |  |                     |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Cash, cash equivalents and short term investments |  | $                   | 11,541  |   |      | $ | 433     |      |  | $ | 5,445   |   |  | $    | 5,276   |   |  | $ | 10,414  |  
|Working capital                                   |  |                     | 12,861  |   |      |   | 1,072   |      |  |   | 5,800   |   |  |      | 5,909   |   |  |   | 10,427  |  
|Total assets                                      |  |                     | 19,003  |   |      |   | 6,202   |      |  |   | 9,458   |   |  |      | 7,518   |   |  |   | 12,180  |  
|Long term liabilities                             |  |                     | 4,766   |   |      |   | 2,946   |      |  |   | 736     |   |  |      | 83      |   |  |   | 120     |  
|Redeemable convertible preferred stock            |  |                     |        |   |      |   | 36,679  |      |  |   | 32,751  |   |  |      | 25,183  |   |  |   | 25,183  |  
|Accumulated deficit                               |  |                     | (47,186 | ) |      |   | (35,440 | )    |  |   | (25,179 | ) |  |      | (18,269 | ) |  |   | (13,561 | )
|Total stockholders equity (deficit)              |  |                     | 10,012  |   |      |   | (35,220 | )    |  |   | (24,959 | ) |  |      | (18,174 | ) |  |   | (13,498 | )



ITEM 7: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION



The following discussion of our financial conditions and results of operations should be read in conjunction with our financial statements and the
notes to those financial statements appearing elsewhere in this prospectus. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under Risk
Factors and elsewhere in this prospectus, our actual results may differ materially from those anticipated in these forward-looking statements.



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Overview



We develop, manufacture and sell easy-to-use, handheld blood coagulation monitoring systems for use by patients and healthcare professionals in the
management of warfarin medication. Our product, the INRatio System, measures the patients blood clotting time to ensure that patients with a propensity to form clots are maintained within the therapeutic range with the proper dosage of oral
anticoagulant therapy. Our system is 510(k) cleared by the FDA for use by healthcare professionals as well as for patient self-testing. Our system is also CE marked in Europe. The INRatio System is targeted to both the professional, or
point-of-care, market as well as the patient self-testing market, the latter being an opportunity that has emerged primarily following the establishment of Medicare reimbursement in 2002 for mechanical heart valve patients.



We believe the key factors underlying our past and anticipated future revenue
growth include:



| |  |  | the ease of use and reliability of our INRatio System with quality controls integrated into the test strip;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | continued and expanded reimbursement by insurance companies and Medicare;
| | - |  | -------------------------------------------------------------------------



| |  |  | our network of national, regional and international distribution partners;
| | - |  | --------------------------------------------------------------------------



| |  |  | our field sales personnel and marketing programs;
| | - |  | -------------------------------------------------



| |  |  | placing additional meters worldwide in the point-of-care environment;
| | - |  | ---------------------------------------------------------------------



| |  |  | rapid development of a patient self-testing market;
| | - |  | ---------------------------------------------------



| |  |  | adoption of the INRatio System by patients and their treating physicians; and
| | - |  | -----------------------------------------------------------------------------



| |  |  | the continual improvement of our technology.
| | - |  | --------------------------------------------



Currently, Medicare and private payors reimburse PT/INR testing in the point-of-care environment for all indications. Medicare reimburses patient
self-testing only for patients with mechanical heart valves, while reimbursement policies among private payors vary. Our revenue growth is dependent on such reimbursement continuing without any significant erosion in the reimbursement amounts. We
believe that there is a significant opportunity in patient self-testing for other indications, such as atrial fibrillation, in the event that reimbursement is expanded. If Medicare reimbursement for patient self-testing by atrial fibrillation
patients is not established in a timely fashion or at all, our revenue growth will be substantially limited.



Our cost of goods sold represents the cost of manufacturing our products. Our meters are manufactured for us by an electronics manufacturing service
company, and we incur direct labor costs to assemble meters into packaged kits at our facility. Our cost of goods sold for the meter also includes an allowance for product warranty obligations. Our disposable test strips are manufactured by us at
our facility, and our cost of goods sold is comprised of cost of materials, direct labor, associated overhead, yield losses and lot rejects, royalties on sales, and license fee costs. Included in royalties on sales is a royalty payable in connection
with our settlement with Inverness. While this royalty does not become payable until mid July 2006, we capitalized a portion of the settlement amount as prepaid royalties and are expensing that amount through mid July 2006, as a
cost of goods sold and do not believe that our obligation to pay royalties after that will have an adverse effect on our results of operations.



The manufacturing cost structure for our test strips currently includes a large component of fixed costs which is being spread over production that has
not been maximized. Increases in production volume will be a significant factor for cost reduction for our test strips. During the fourth quarter of fiscal 2005 we achieved a gross margin for the first time. We believe continuing volume increases
and process improvements will sustain and enhance cost reductions for our products in the future.



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##### Table of Contents

Comparison of Fiscal Years Ended September 30, 2005 and September 30, 2004



The following table sets forth our results of operations (in thousands)
expressed as a percentage of total revenue. Our historical operating results are not necessarily indicative of the results for any future period.



|                           |  |                                 |         |   |           |      |    |        |   |         |           |  |      |                             |  |   |                           |   |  |      |   
|-------------------------- |  | ------------------------------- | ------- | - | --------- | ---- | -- | ------ | - | ------- | --------- |  | ---- | --------------------------- |  | - | ------------------------- | - |  | ---- | --
|                           |  | Fiscal year Ended September 30, |         |   |           |      |    |        |  
|                           |  | 2005                            |         |   | 2004      |      |    |        |   |         |           | 
|                           |  | Amount                          |         |   | % ofSales |      |    | Amount |   |         | % ofSales |  |      | Amount ofIncrease(Decrease) |  |   | PercentIncrease(Decrease) |  
|Revenue                    |  | $                               | 8,768   |   |           | 100  | %  |        | $ | 3,250   |           |  | 100  | %                           |  | $ | 5,518                     |   |  | 170  | % 
|Cost of goods sold         |  |                                 | 9,371   |   |           | 107  |    |        |   | 5,065   |           |  | 156  |                             |  |   | 4,306                     |   |  | 85   |   
|                           |  |                                 |         |   |           |      |    |        |   |         |           |  |      |                             |  |   |                           |   |  |      |   
|Gross loss                 |  |                                 | (603    | ) |           | (7   | )  |        |   | (1,815  | )         |  | (56  | )                           |  |   | 1,212                     |   |  | (67  | ) 
|                           |  |                                 |         |   |           |      |    |        |   |         |           |  |      |                             |  |   |                           |   |  |      |   
|Operating expenses         |  |                                 |         |   |           |      |    |        |   |         |           |  |      |                             |  |   |                           |   |  |      |   
|Research and development   |  |                                 | 1,259   |   |           | 14   |    |        |   | 1,398   |           |  | 43   |                             |  |   | (139                      | ) |  | (10  | ) 
|Sales and marketing        |  |                                 | 6,733   |   |           | 77   |    |        |   | 5,206   |           |  | 160  |                             |  |   | 1,527                     |   |  | 29   |   
|General and administrative |  |                                 | 1,962   |   |           | 22   |    |        |   | 1,499   |           |  | 46   |                             |  |   | 463                       |   |  | 31   |   
|                           |  |                                 |         |   |           |      |    |        |   |         |           |  |      |                             |  |   |                           |   |  |      |   
|Total operating expenses   |  |                                 | 9,954   |   |           | 113  |    |        |   | 8,103   |           |  | 249  |                             |  |   | 1,851                     |   |  | 23   |   
|                           |  |                                 |         |   |           |      |    |        |   |         |           |  |      |                             |  |   |                           |   |  |      |   
|Loss from operations       |  |                                 | (10,557 | ) |           | (120 | )  |        |   | (9,918  | )         |  | (305 | )                           |  |   | (639                      | ) |  | 6    |   
|Interest income            |  |                                 | 130     |   |           | 1    |    |        |   | 16      |           |  |     |                             |  |   | 114                       |   |  | 713  |   
|Interest expense           |  |                                 | (1,314  | ) |           | 15   |    |        |   | (318    | )         |  | 10   |                             |  |   | (996                      | ) |  | (313 | ) 
|Other expense              |  |                                 | (5      | ) |           |     |    |        |   | (41     | )         |  | 1    |                             |  |   | (36                       | ) |  | (88  | ) 
|                           |  |                                 |         |   |           |      |    |        |   |         |           |  |      |                             |  |   |                           |   |  |      |   
|Net loss                   |  | $                               | (11,746 | ) |           | (134 | )% |        | $ | (10,261 | )         |  | (316 | )%                          |  | $ | (1,485                    | ) |  | (14  | )%
|                           |  |                                 |         |   |           |      |    |        |   |         |           |  |      |                             |  |   |                           |   |  |      |   



Revenue.
Revenue increased by $5.5 million, or 170%, from $3.3 million in 2004 to $8.8 million in 2005. INRatio Meters and accessories increased by $2.2 million, or 136%, from $1.6 million in 2004 to $3.8 million in 2005. Test strips revenue increased by
$3.3 million, or 203%, from $1.6 million in 2004 to $5.0 million in 2005. Approximately 72% of the growth in revenue was derived from the United States and approximately 28% from outside the United States. The increase in United States revenue was
the result of increased market penetration primarily attributable to the addition of distributors and increased field personnel. The international revenue increase was primarily attributable to the expansion of the European market. For fiscal year
2006, we expect revenue for both domestic and international to significantly increase as we continue to penetrate the worldwide markets for our products.



Cost of goods sold. Cost of goods sold increased by $4.3 million, or 85%, from $5.1 million in 2004 to $9.4 million in 2005. As a percentage of
revenue, cost of goods sold decreased from 156% of sales in the year ended September 30, 2004 to 107% in the same period in 2005. During our fourth quarter of fiscal 2005 we achieved a gross margin for the first time. This was due to volume
increases over earlier periods and process improvements. We expect that as volume continues to increase, these cost reductions will continue to improve into the future. The $4.3 million increase in the cost of goods sold, was primarily due to the
increase in number of meters and test strips sold. Included in cost of goods sold are royalties and amortization of technology licenses which increased by $409,000, from $377,000 in 2004 to $786,000 in 2005. The increase in royalty payments was due
to the increase in test strip sales and a full year of amortization in fiscal 2005 for two technology licenses obtained during fiscal year 2004. The increases were partially off set by improvements in statistical process control and other quality
improvements which reduced the amount of material scrap. Additionally, in the latter portion of fiscal year 2005 process improvements reduced the cost of test strips to a point which allowed us to eliminate the need for a lower of cost or market
provision. In fiscal 2004, our cost of goods sold included a lower of cost or market provision of $301,000.



Research and development expenses. Research and development expenses decreased by $139,000, or 10%, from $1.4 million in 2004 to $1.3 million in
2005. The decrease was completely attributable to the continuing



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transfer of resources from research and development to manufacturing during the first nine months of fiscal 2005. During the next fiscal year, we expect
research and development expense will increase as new projects are initiated.



Sales and marketing expenses. Sales and marketing expenses increased by $1.5 million, or 29%, from $5.2 million in 2004 to $6.7 million in 2005. The increase was primarily attributable to $1.3 million of
payroll and travel expenses for additional personnel, $474,000 for promotion programs and $71,000 in bad debt provisions. This was partially offset by $370,000 decrease in marketing consultants. As a percentage of revenue, sales and marketing
expenses were 77% in the year ended September 30, 2005 compared to 160% in the same period in 2004. The decrease in sales and marketing expense as a percentage of revenue is due to the revenue increase relative to the marketing programs and
efforts of the sales staff. We expect sales and marketing spending will increase in fiscal 2006 but to decrease as a percentage of revenue.



General and administrative expenses. General and administrative expenses increased by $463,000, or 31%, from $1.5 million in the fiscal year 2004
to $2.0 million in the fiscal year 2005. The increase was primarily attributable to payroll and other benefits increase of $330,000 primarily from increased head count. Additionally, professional services and insurance increase by $216,000 related
to the cost of being a public company. The decreased need for other consultants resulted in a $99,000 decline as full-time personnel were hired. As a percentage of revenues, general and administrative expenses were 22% in the year ended
September 30, 2005 compared to 46% in the same period in 2004. The decrease in general and administrative expenses as a percentage of revenue is due mainly to the rapid expansion of revenue which without the need for a proportional increase in
staff. We expect general and administrative expenses will increase during fiscal year 2006 due the costs relating to being a public company for a full year which may include the use of more consultants and increased staff.



Interest Income. Interest income increased by $114,000, or 713%, from
$16,000 in fiscal year 2004 to $130,000 in fiscal year 2005. The increase related to returns on short term investments purchased with a portion of the funds received from the initial public offering. Over the next year, we anticipate interest income
will increase due to the increase short term investments purchased in July 2005 and the proceeds from the private placement in November 2005.



Interest expense. Interest expense increased by $1.0 million, or 313%, from $318,000 in fiscal 2004 to $1.3 million in fiscal 2005. The increase
was attributable the full drawdown of a $7.5 million borrowings in January 2005, interest on $1.5 million short term notes payable which were repaid in July 2005 and accrued interest expense related to a note payable to Inverness Medical
Innovations.



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Comparison of Fiscal Years Ended September 30, 2004 and September 30, 2003



The following table sets forth our results of operations (in thousands)
expressed as a percentage of total revenue. Our historical operating results are not necessarily indicative of the results for any future period.



|                           |  |                                 |         |   |           |      |    |        |   |        |           |  |        |                             |  |   |                           |   |  |      |  
|-------------------------- |  | ------------------------------- | ------- | - | --------- | ---- | -- | ------ | - | ------ | --------- |  | ------ | --------------------------- |  | - | ------------------------- | - |  | ---- | -
|                           |  | Fiscal year Ended September 30, |         |   |           |      |    |        |  
|                           |  | 2004                            |         |   | 2003      |      |    |        |   |        |           | 
|                           |  | Amount                          |         |   | % ofSales |      |    | Amount |   |        | % ofSales |  |        | Amount ofIncrease(Decrease) |  |   | PercentIncrease(Decrease) |  
|Revenue                    |  | $                               | 3,250   |   |           | 100  | %  |        | $ | 427    |           |  | 100    | %                           |  | $ | 2,823                     |   |  | 661  | %
|Cost of goods sold         |  |                                 | 5,065   |   |           | 156  |    |        |   | 1,519  |           |  | 356    |                             |  |   | 3,546                     |   |  | 233  |  
|                           |  |                                 |         |   |           |      |    |        |   |        |           |  |        |                             |  |   |                           |   |  |      |  
|Gross loss                 |  |                                 | (1,815  | ) |           | (56  | )  |        |   | (1,092 | )         |  | (256   | )                           |  |   | (723                      | ) |  | 66   |  
|                           |  |                                 |         |   |           |      |    |        |   |        |           |  |        |                             |  |   |                           |   |  |      |  
|Operating expenses         |  |                                 |         |   |           |      |    |        |   |        |           |  |        |                             |  |   |                           |   |  |      |  
|Research and development   |  |                                 | 1,398   |   |           | 43   |    |        |   | 1,681  |           |  | 394    |                             |  |   | (283                      | ) |  | (17  | )
|Sales and marketing        |  |                                 | 5,206   |   |           | 160  |    |        |   | 3,186  |           |  | 746    |                             |  |   | 2,020                     |   |  | 63   |  
|General and administrative |  |                                 | 1,499   |   |           | 46   |    |        |   | 912    |           |  | 214    |                             |  |   | 587                       |   |  | 64   |  
|                           |  |                                 |         |   |           |      |    |        |   |        |           |  |        |                             |  |   |                           |   |  |      |  
|Total operating expenses   |  |                                 | 8,103   |   |           | 249  |    |        |   | 5,779  |           |  | 1,354  |                             |  |   | 2,324                     |   |  | 40   |  
|                           |  |                                 |         |   |           |      |    |        |   |        |           |  |        |                             |  |   |                           |   |  |      |  
|Loss from operations       |  |                                 | (9,918  | ) |           | (305 | )  |        |   | (6,871 | )         |  | (1,610 | )                           |  |   | (3,047                    | ) |  | 44   |  
|Interest income            |  |                                 | 16      |   |           |     |    |        |   | 39     |           |  | 9      |                             |  |   | (23                       | ) |  | (59  | )
|Interest expense           |  |                                 | (318    | ) |           | 10   |    |        |   | (67    | )         |  | 16     |                             |  |   | (251                      | ) |  | (375 | )
|Other expense              |  |                                 | (41     | ) |           | 1    |    |        |   | (11    | )         |  | 1      |                             |  |   | (30                       | ) |  | (273 | )
|                           |  |                                 |         |   |           |      |    |        |   |        |           |  |        |                             |  |   |                           |   |  |      |  
|Net loss                   |  | $                               | (10,261 | ) |           | (316 | )% |        | $ | (6,910 | )         |  | (1,618 | )%                          |  | $ | (3,351                    | ) |  | 48   | %
|                           |  |                                 |         |   |           |      |    |        |   |        |           |  |        |                             |  |   |                           |   |  |      |  



Revenue.
Revenue increased by $2.8 million, or 661%, from $427,000 in 2003 to $3.3 million in 2004. Approximately 76% of the growth in revenue was derived from the United States and approximately 24% was derived from outside the United States. Revenue for
meters and accessories increased by $1.3 million, or 453%, from $292,000 in 2003 to $1.6 million in 2004. Revenue for test strips increased by $1.6 million, or 1,114%, from $135,000 in 2003 to $1.7 million in 2004. We started selling our products in
March 2003. The increase in United States revenue was primarily attributable to the addition of two national distributors and increased field personnel. The increase in international revenue was primarily attributable to the addition of nine
distributors.



Cost of goods sold. Cost of goods sold
increased by $3.5 million, or 233%, from $1.6 million in 2003 to $5.1 million in 2004. Cost of goods sold for meters and accessories increased by $649,000, or 446%, from $145,000 in 2003 to $794,000 in 2004. Cost of goods sold for test strips
increased by $2.9 million, or 211%, from $1.4 million in 2003 to $4.3 million in 2004. The increase of $2.1 million was primarily due to the increase in number of meters and test strips sold. In addition, due to manufacturing scale up problems,
several test strip lots and subassemblies with a manufacturing cost of $1.0 million were rejected and written-off in 2004. Royalties and amortization of technology licenses increased by $369,000, from $8,000 in 2003 to $377,000 in 2004 due to the
increase in test strip sales and two technology licenses obtained in 2004. As a percentage of revenue, cost of goods sold decreased from 356% of sales in the year ended September 30, 2003 to 156% in the same period in 2004 due primarily to
increased volume of test strip production without an equivalent increase in factory spending.



Research and development expenses. Research and development expenses decreased by $283,000, or 17%, from $1.7 million in 2003 to $1.4 million in 2004. The decrease was primarily attributable to the full year
impact in 2004 of resources in research and development that were transferred to manufacturing in the middle of 2003. As a percentage of revenue, research and development expenses were 43% in the year ended September 30, 2004 compared to 394%
in the same period in 2003 due primarily to the redirection of activities from development to manufacturing.



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Sales and marketing expenses. Sales and marketing expenses increased by $2.0 million, or 63%, from
$3.2 million in 2003 to $5.2 million in 2004. The increase was primarily attributable to $1.7 million of payroll and travel expenses for additional personnel, $256,000 for marketing consultants and $110,000 for promotion programs. As a percentage of
revenue, sales and marketing expenses were 160% in the year ended September 30, 2004 compared to 746% in the same period in 2003. This was primarily the result of leveraging distributors sales force to increase sales without a
proportional increase in the Companys head count.



General and administrative expenses. General and administrative expenses increased by $587,000, or 64%, from $912,000 in 2003 to $1.5 million in 2004. The increase of $319,000 was primarily attributable to increased administrative
personnel and consultants, legal expenses of $125,000 related to an intellectual property infringement action, and $83,000 for increased coverage for liability and business insurance. As a percentage of revenues, general and administrative expenses
were 46% in the year ended September 30, 2004 compared to 214% in the same period in 2003.



Interest and other expense, net. We recognized interest expense of $318,000 for the year ended September 30, 2004, an increase of $251,000
from $67,000 for the same period in 2003. The increase was attributable to interest expense on amounts drawn down against a debt line of $7.5 million which was put in place in March 2004, as well as interest expense related to a note payable.



Liquidity and Capital Resources



Since our inception, our operations have been primarily financed through the
sale of equity securities, both public and private, bank equipment financing loans, debt capital and capital leases. As of September 30, 2005, our cash, cash equivalents and short term investments were $11.5 million. All of our cash equivalents
and investments have original maturities of one year or less.



On November 5, 2005 the Company closed a private equity offering of 1,481,482 shares of the Companys common stock at $6.75 per share. Gross proceeds from the offering were $10.0 million. Net proceeds were $9.2 million after
offering expenses included underwriting discounts and commissions.



During the fiscal year ended September 30, 2005, our operating activities used cash of approximately $11.9 million, compared to approximately $9.5 million for the fiscal year ended September 30, 2004, an increase of $2.3 million.
Cash used in operating activities increased by $2.3 million due to our increased net loss and additional investment in accounts receivable and inventory. The net loss for the current year (less depreciation and other non-cash items) used $253,000
more cash than last year. An additional $2.3 million was used for changes in current assets and liabilities. Cash used for expanding inventories was $1.6 million for the fiscal year 2005, an increase of $1.2 million from fiscal year 2004, due to
material purchased to meet our expected future sales. The change in accounts receivable was $1.3 million for the fiscal year 2005, an increase of $407,000 from $773,000 used for the same period in 2004 due to higher sales during the fourth quarter
of the current year. We expect future increases in revenue to result in increases in the need for working capital due to increases in accounts receivable and inventories but at a lower rate than the current year increases.



Our investing activities used cash of approximately $8.2 million during
fiscal year 2005 compared to $429,000 for fiscal year 2004. Investing activities during fiscal 2005 primarily consisted of the purchase of short term investments with the proceeds of our initial public offering.



Cash provided by financing activities was approximately $23.2 million for
fiscal year 2005 compared to $4.9 million provided during fiscal year 2004. The increase in cash provided was primarily due to $16.7 million from the sale of common stock in our initial public offering. Additionally we incurred net borrowing of $3.2
million of proceeds from draw downs against a debt line facility and $3.3 million in preferred stock proceeds.



For the year ended September 30, 2004, our operating activities used cash of approximately $9.5 million. This was an increase of $2.8 million from
the cash used in operating activities of $6.7 million for the year ended



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September 30, 2003. This change was primarily due to a loss of $10.3 million in the year ended September 30, 2004 compared to a loss of $6.9
million in 2003. Offsetting the loss were adjustments for non-cash items which reduced cash used in operations in the year ended September 30, 2004 by $1.0 million compared to $270,000 in 2003. The change in accounts receivable was $773,000 for
the year ended September 30, 2004, an increase of $639,000 from $134,000 for the same period in 2003, which was related to an increase in our sales. The change in inventories was $319,000 for the year ended September 30, 2004, an increase
of $173,000 from $146,000 for the same period in 2003, which was due to an increase in our sales. During fiscal year 2003 we did not purchase any meters as we had a sufficient number in inventory. We did not commence purchasing meters again until
the second quarter of fiscal year 2004.



For the year ended
September 30, 2004, our investing activities used cash of approximately $429,000. This was an increase of $32,000 from cash used in investing activities of $397,000 for the year ended September 30, 2003 due to acquisitions of equipment.



For the year ended September 30, 2004, our financing
activities generated $4.9 million. This was a decrease of $2.3 million from cash provided by financing activities of $7.2 million for the year ended September 30, 2003. The decrease was primarily due to proceeds from equity financing of $3.0
million for the year ended September 30, 2004 compared to $6.4 million for the year ended September 30, 2003. This decrease was offset by loan proceeds of $2.0 million, net of repayment of previous loans outstanding, for the year ended
September 30, 2004 compared to $886,000 for the year ended September 30, 2003. In March 2004, we obtained a debt line from Lighthouse Capital Partners in the amount of $7.5 million to be drawn down over a 12-month period. During the
draw down period interest-only payments were required to be made monthly on amounts drawn down and a usage fee was payable quarterly on unused amounts. As of March 1, 2005, we had drawn down the full amount of $7.5 million which is being
amortized monthly over 36 months with a final payment of $937,500 due at the end of the term. In conjunction with the loan, we issued warrants to purchase Series C-3 preferred stock, which upon completion of our IPO, became exercisable for
118,670 shares of common stock at an exercise price of $6.32 per share. Upon receiving this credit line, we used the first draw down of $907,000 in March 2004 to repay the amount outstanding on the loans payable to Silicon Valley Bank. The
Silicon Valley Bank loans were drawn down under a $1.75 million equipment financing line of credit obtained by us in July 2003. The Silicon Valley Bank loans amortized over a 36-month term and also included warrants to purchase Series C-3
preferred stock, which upon completion of our IPO, became exercisable for 8,307 shares of common stock at an exercise price of $6.32 per share.



During the fiscal year ended September 30, 2003, our operating activities used cash of approximately $11.9 million. The use of cash was due to our
net loss of $6.9 million, increased accounts receivable and inventories. The increase in receivables related to higher sales during fiscal year 2003 and the increase in inventory was to support the anticipated demand for products in the next fiscal
year. Cash used in investing activities of $397,000 related to the purchase of capital asset.



As of September 30, 2005, we had a long-term loan, a long-term note payable and capital lease obligations, commitments under a facility operating lease, equipment rental lease and non-cancelable purchase
commitments. We had no other off-balance sheet items or commitments. Future payments under these obligations are included in the table below for each of the fiscal years ending September 30 (in thousands):



|                                    |  |      |       |      |   |       |  |      |       |       |   |     |  |   |       
|----------------------------------- |  | ---- | ----- | ---- | - | ----- |  | ---- | ----- | ----- | - | --- |  | - | ------
|                                    |  | 2006 |       | 2007 |   | 2008  |  | 2009 |       | Total
|Loan payable                        |  | $    | 2,000 |      | $ | 2,353 |  | $    | 1,788 |       | $ |    |  | $ | 6,141 
|Note payable                        |  |      |      |      |   |      |  |      |      |       |   | 573 |  |   | 573   
|Capital leases                      |  |      | 37    |      |   | 36    |  |      | 16    |       |   |    |  |   | 89    
|Facility lease                      |  |      | 143   |      |   | 153   |  |      | 162   |       |   | 90  |  |   | 548   
|Equipment lease                     |  |      | 8     |      |   | 8     |  |      | 7     |       |   |     |  |   | 23    
|Cancelable purchase commitments     |  |      | 504   |      |   |      |  |      |      |       |   |    |  |   | 504   
|Non-cancelable purchase commitments |  |      | 2,656 |      |   |      |  |      |      |       |   |    |  |   | 2,656 
|                                    |  |      |       |      |   |       |  |      |       |       |   |     |  |   |       
|Total                               |  | $    | 5,348 |      | $ | 2,550 |  | $    | 1,973 |       | $ | 663 |  | $ | 10,534



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During fiscal year 2005, we had drawn down an additional $4.6 million on the loan payable to lighthouse
Capital. These draw downs resulted in us fully utilizing the debt line of $7.5 million that was available. As of September 30, 2005 we have made principal payments of $1.4 million relating to loan payable. In addition, in April 2005, we
received $1.5 million in unsecured debt financing from certain preferred stockholders and in connection with that transaction issued to those stockholders warrants exercisable for shares of our common stock. This debt to preferred stockholders was
repaid with interest in July 2005.



We believe that our
existing cash and cash equivalents, proceeds from our private placement in November 2005 and cash generated from product sales, will be sufficient to meet our anticipated cash requirements for at least the next 12 months. Our future capital
requirements are difficult to forecast and will depend on many factors, including:



| |  |  | success of our product sales and related collections;
| | - |  | -----------------------------------------------------



| |  |  | future expenses to expand and support our sales and marketing activities;
| | - |  | -------------------------------------------------------------------------



| |  |  | Entering into new, or maintaining existing, distribution relationships;
| | - |  | -----------------------------------------------------------------------



| |  |  | maintaining and expanding our manufacturing capacity and capabilities;
| | - |  | ----------------------------------------------------------------------



| |  |  | costs relating to changes in regulatory policies or laws that affect our operations;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | the level of investment in research and development to maintain and improve our competitive edge and our technology position as well as broaden our technology platform;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights; and
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | our need or decision to acquire or license complementary products, technologies or businesses.
| | - |  | ----------------------------------------------------------------------------------------------



If at any time sufficient capital is not available, either through existing capital resources or through raising additional
funds, we may be required to delay, reduce the scope of, eliminate or divest one or more of our sales and marketing programs, research and development programs or our entire business. We may raise additional funds through public or private
offerings, debt financings, capital leases, corporate collaborations or other means. Due to the uncertainty of financial markets, financing may not be available to us when we need it on acceptable terms or at all. Therefore, we may raise additional
capital from time to time when market conditions are favorable, or if strategic considerations require us to do so, even if we have sufficient funds for planned operations.



Critical Accounting Policies and Estimates



We prepare our financial statements in accordance with accounting principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that



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affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. Our critical accounting policies are as follows:



Concentration of Credit Risk



Financial instruments which potentially subject the Company to concentrations of risk consist principally of cash and cash equivalents and accounts receivable. The Companys cash is invested in deposits with one financial institution.
At times, cash deposits may be in excess of insured limits. Management believes that the financial institution which holds the Companys cash and cash equivalents is financially sound and, minimal credit risk exists with respect to these
investments.



Inventories



Inventories are stated at the lower of cost or market, cost being determined
under a standard cost method, which approximates first-in, first-out basis.



The manufacturing cost of test strips previously exceeded their selling price. As a result, the Company recorded a charge to cost of goods sold on test strips inventory equal to the amount by which the manufacturing
cost exceeds the average market selling price. Inventories are evaluated and any non-usable inventory is written off. In addition, the Company reserves for any inventory that may be potentially on-usable. Charges for such write-offs and reserves are
recorded as a component of cost of goods sold. Changes in demand in the future could cause the Company to have additional write-offs and reserves.



Impairment of long-lived assets



The Company reviews long-lived assets, including property and equipment and intangibles, for impairment whenever events or changes in business
circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual
disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. The Company considers various valuation factors, principally discounted cash
flows, to assess the fair values of long-lived assets. To date, the Company has not recorded any impairment losses.



Intangible Assets



Intangible assets are comprised of licensed technologies, carried at cost less accumulated amortization. Amortization is computed using a straight-line
method over the shorter of the estimated useful lives or the term of the license agreements.



Revenue Recognition



We
recognize revenue from product sales when there is persuasive evidence that an arrangement exists, title has transferred to our customers, the price is fixed and determinable and collection is reasonably assured. Provisions for discounts to
customers, returns or other adjustments are recorded as a reduction of revenue and provided for in the same period that the related product sales are recorded based upon analysis of historical discounts and returns. When terms of sale are Freight on
Board, or FOB, shipping point, revenue is recognized at time of shipment and when the terms of sale are FOB receiving point, revenue is recognized when the products have reached the destination point and other criteria for revenue recognition have
been met. Shipping and handling charges are invoiced to customers based on the amount of products sold. Shipping and handling fees are recorded as revenue and the related expense as cost of goods sold.



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We offer an early payment discount to certain customers. We provide certain customers product return
rights in limited circumstances. To date, we have experienced no product returns and have determined that a reserve for product returns is not necessary. Future changes in our experience with product returns may cause us to make changes in our
reserve for product returns. Our inability to accurately estimate product returns in the future may cause us to defer recognition of revenue. We will, from time to time, provide free products to customers. The cost of these free products is charged
to cost of goods sold.



Allowance for Doubtful Accounts



While the Company has not had material bad debts written-off in the past, we
analyze the collectibility of its accounts receivable, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends, and changes in customer payment terms in evaluating whether an allowance needs to be made
during the period.



Warranties



The Company records an accrual for estimated warranty costs when revenue is
recognized. Warranty covers replacement costs of defective meters and related test strips. The warranty period is one year. The Company has processes in place to estimate accruals for warranty exposure. The processes include estimated failure rates
and replacement costs, and known design changes. Although the Company believes it has the ability to reasonably estimate warranty expenses, unforeseen changes in factors impacting the estimate for warranty could occur and such changes could cause a
material change in the Companys warranty accrual estimate. Such a change would be recorded in the period in which the change was identified.



Income taxes



The Company accounts for income taxes under the liability method. Under this method, deferred income tax assets and liabilities are computed for
differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected
to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.



Accounting for stock-based compensation



The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees. The Companys policy is to grant options with an exercise price equal to the estimated fair value of the Companys stock on the grant date. Accordingly, no compensation cost has
been recognized in the Companys statement of operations for employee stock options. The Company provides additional pro forma disclosures as required under Statement of Financial Accounting Standard No. 123 (SFAS 123),
Accounting for Stock-Based Compensation, as amended by SFAS No 148, Accounting for stock-based compensation, transition and disclosure.



Under APB Opinion No. 25, compensation expense is based on the difference, if any, on the date of the grant, between the estimated fair value of the
Companys stock and the exercise price. SFAS No. 123 defines a fair value based method of accounting for an employee stock option or similar equity instrument.



The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123
and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services which requires that such equity instruments are
recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest.



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Recent Accounting Pronouncements



In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which will replace SFAS No. 123
and APB 25. SFAS No. 123R addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of
the companys equity instruments or that may be settled by the issuance of such equity instruments. Under SFAS No. 123R, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in
accordance with APB 25, but will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of earnings. SFAS No. 123R is effective at the beginning of fiscal 2006.



In March 2005, the SEC issued Staff Accounting Bulletin No. 107,
Share-Based Payment (SAB 107). SAB 107 provides guidance on the initial implementation of SFAS 123R. In particular, the statement includes guidance related to share-based payment awards for non-employees, valuation
methods and selecting underlying assumptions such as expected volatility and expected term. SAB 107 also gives guidance on the classification of compensation expense associated with such awards and accounting for the income tax effects of those
awards upon the adoption of SFAS 123R. We are currently assessing the guidance provided in SAB 107 in connection with the implementation of SFAS 123R.



Adoption of this statement is expected to have a significant impact on our financial statements as we will be required to expense the fair value of our
stock option grants rather than disclose the impact on our net loss within our footnotes, as is our current practice. The full impact of SFAS 123R on our financial statements and related disclosures is still being evaluated by management but is
expected to be material to our results of operations. Our actual share-based compensation expense in 2006 will be dependent on a number of factors, including the amount of awards granted and the fair value of those awards at the time of grant.



In June 2005, the FASB issued as final FSP No. FAS 150-5
Issuers Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares that are Redeemable. The FSP clarifies that freestanding warrants and similar instruments on shares that are
redeemable should be accounted for as liabilities under FASB Statement No. 150 Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity regardless of the timing of the redemption feature or
price, even though the underlying shares may be classified as equity. The FSP is effective for the first reporting period beginning after June 30, 2005. Although the Company does have outstanding warrants, the shares issued upon exercise of the
warrants are not redeemable; consequently, the adoption of FSP No. FAS 150-5 has no impact on the Companys results of operations or financial condition.



On June 7, 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20,
Accounting Changes, and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. FAS No. 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle. Previously, most
voluntary changes in accounting principles were required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. FAS 154 requires retrospective application to prior periods financial
statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. FAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the
Statement does not change the transition provisions of any existing accounting pronouncements. We do not believe that the adoption of FAS 154 will have a material effect on the Companys financial position, results of operations or cash flows.



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Factors Affecting Future Operating Results



We have limited operating experience and a history of net losses. Unless we are able to significantly increase our revenue and reduce
our costs, we may never achieve or maintain profitability.



We have a limited history of operations and have incurred net losses in each year since our inception. We received regulatory clearance to market our INRatio System in 2002 and began commercial sales in early 2003. During the past five
fiscal years, we incurred net losses of $4.0 million in 2001, $4.7 million in 2002, $6.9 million in 2003, $10.3 million in 2004 and $11.7 million in 2005. As of September 30, 2005, we had an accumulated deficit of $47.2 million. We expect that
our operating expenses will increase as we expand our business, devote additional resources to our research and development, sales and marketing efforts and incur the costs of being a public company.



Our common stock has been publicly traded for a short period of time, and we expect
that the price of our common stock will fluctuate substantially.



Until June 2005, there was no public market for shares of our common stock. The market price for our common stock will be affected by a number of factors, including:



| |  |  | our quarterly operating performance;
| | - |  | ------------------------------------



| |  |  | changes in earnings estimates or recommendations by securities analysts;
| | - |  | ------------------------------------------------------------------------



| |  |  | changes in the availability of reimbursement in the United States or other countries;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | the announcement of new products or product enhancements by us or our competitors;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | announcements of technological or medical innovations in PT/INR monitoring or anticoagulation treatment;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | our ability to develop, obtain regulatory clearance for, and market, new and enhanced products on a timely basis;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | product liability claims or other litigation;
| | - |  | ---------------------------------------------



| |  |  | changes in governmental regulations or in our approvals or applications; and
| | - |  | ----------------------------------------------------------------------------



| |  |  | general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



We have only been a public company for a short period of time. Changes in the price of our
common stock will be unpredictable and any of these factors could cause our stock price to fluctuate substantially.



We will be unable to achieve profitability unless we increase revenue and decrease the cost of manufacturing our test strips.



We will need to both significantly increase the revenue we receive from
sales of our product and, to the extent possible, reduce our costs in order to achieve profitability. It is possible that we will never generate sufficient revenue to achieve profitability. Our failure to achieve and maintain profitability would
negatively affect our business and financial condition and the trading price of our common stock.



We may be unable to accurately predict our future performance, which could harm our stock price.



We provide guidance regarding future operating performance and our stock price is based, in part, upon those predictions. Because we have only recently
become a publicly-traded company, it may be difficult for us to accurately predict our operating performance each quarter, and we believe that our quarterly results will fluctuate as a result of many factors outside of our control, such as:



| |  | demand for our product;
| | - | -----------------------



| |  | timing of orders and shipments;
| | - | -------------------------------



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| |  | the performance of our distributors on our behalf;
| | - | --------------------------------------------------



| |  | our mix of sales between our distributors and our direct sales force;
| | - | ---------------------------------------------------------------------



| |  | foreign currency fluctuations;
| | - | ------------------------------



| |  | seasonality, in Europe, relating to mechanical heart valve surgeries;
| | - | ---------------------------------------------------------------------



| |  | new product introductions by our competitors; and
| | - | -------------------------------------------------



| |  | the timing and uncertainty of United States and foreign reimbursement decisions.
| | - | --------------------------------------------------------------------------------



We believe that our stock price would decline if we are unable to meet or exceed our predicted performance.



We depend upon a single product. If our INRatio® System fails to gain market acceptance our business will suffer.



The INRatio System is our only product. Sales of this product will account
for substantially all of our revenue for the foreseeable future. We cannot be sure that we will be successful in convincing patients and healthcare professionals to use our product. Certain competitors have products that are established in our
target markets, and we may not be able to convince users of those products to switch to the INRatio System. Healthcare professionals may be hesitant to recommend our product to their patients given our short operating history and the fact that we
are a relatively small company. If our product fails to gain acceptance in the point-of-care and patient self-testing markets, our business will be harmed.



The performance of our product may not be perceived as being comparable with established laboratory methods, which may limit the market acceptance of our product.



The majority of PT/INR testing has historically been
and continues to be performed by large hospital or commercial laboratories. Healthcare professionals responsible for managing patients on warfarin therapy have experience with and confidence in the results generated by these large laboratories. In
addition, these professionals influence many treatment decisions, including aspects critical to our business such as how often testing is to be performed, who is to perform the testing, and where testing is to be performed. In some instances, these
decision makers may determine that our INRatio System test results lack the clinical history and reliability of large laboratories. If we are unable to demonstrate to physicians satisfaction that the performance of our INRatio System closely
matches the results produced by these laboratories, market acceptance of our product will be limited.



We recently completed an FDA inspection and received a Warning Letter, which could lead to regulatory enforcement action.



Our product and facilities are subject to continual review and periodic inspections by the FDA and other regulatory bodies.
In particular, we are required to comply with quality system regulations, or QSR, and other regulations, which cover the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, storage, shipping
and post market surveillance of our product. The FDA enforces the QSR through scheduled and through unannounced inspections. We recently underwent an inspection of our facilities by the FDA, which resulted in the issuance of an FDA Form 483
containing two observations. First, the inspector observed that we failed to timely file Medical Device Reports, or MDRs, for six of seven complaints the inspector reviewed claiming that our INRatio device took inaccurate readings. MDRs are required
to be filed if our device malfunctions in a way that would likely cause or contribute to a death or serious injury if it were to recur. The second observation was that we had not properly defined and documented the procedures we employ to identify
the statistical techniques for calibration of our test strips. We have filed a response to these observations. The FDA subsequently issued a Warning Letter on October 5, 2005. The Warning Letter indicates that the FDA believes that our response
did not provide sufficient detail and documentation for the FDA to



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evaluate whether our corrective actions would be adequate to prevent recurrence of the observations. We have submitted a further written response to the FDA,
which we believe addresses this concern. The FDA has accepted our response, but there can be no assurance that the FDA will not in the future impose more serious enforcement actions, which may include the following sanctions:



| |  |  | fines, injunctions and civil penalties;
| | - |  | ---------------------------------------



| |  |  | recall or seizure of our products;
| | - |  | ----------------------------------



| |  |  | operating restrictions, partial suspension or total shutdown of production;
| | - |  | ---------------------------------------------------------------------------



| |  |  | delays in clearance or approval, or failure to obtain approval of our products or product modifications;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | withdrawal of clearances or approvals; and
| | - |  | ------------------------------------------



| |  |  | criminal prosecution.
| | - |  | ---------------------



If any of these actions were to occur, it would harm our reputation and cause our product sales and profitability to suffer. Responding to inspectional
observations may be time consuming and costly.



We are filing an
increasing number of MDRs, which could harm market adoption of our product.



In order to correct an FDA observation during our recent inspection, we have revised our written procedure that describes when to file an MDR. Our revised procedure requires us to file MDRs for device malfunctions,
including all allegations of inaccurate readings by our device. As a result, we have been filing, and expect to continue to file, an increased number of MDRs. MDRs are publicly available, and competitors could use this information in an attempt to
disrupt our customer and potential customer relationships, which could harm market adoption of our product.



The success of our business is largely dependent upon the growth of the PT/INR patient self-testing market. If that market fails to develop as we anticipate, our results will be adversely affected



Our business plan is targeted at the emerging PT/INR
patient self-testing market and our product has been designed to address that market. We cannot be sure that this market will grow as we anticipate. Such growth will require greater advocacy of patient self-testing from both healthcare professionals
and patients than currently exists. Future research and clinical data may not sufficiently support patient self-testing as a safe or effective alternative to clinical laboratory testing or point-of-care testing, which could inhibit adoption of
patient self-testing. If healthcare professionals fail to advocate self-testing for their patients or if patients do not become comfortable with it, self-testing may fail to become the standard practice for PT/INR measurement. If patient
self-testing fails to be adopted at the rate we expect, our anticipated growth will be adversely affected and our results will suffer.



We operate in a highly competitive market and face competition from large, well-established medical device manufacturers with significant resources. If we fail to
compete effectively, our business will suffer.



The
market for point-of-care and patient self-testing PT/INR measurement systems is intensely competitive, subject to rapid change, new product introductions and other activities of industry participants. We currently compete directly against Roche
Diagnostics, the largest diagnostic company in the world, and International Technidyne Corporation, a division of Thoratec. Together these two companies currently account for substantially all of the point-of-care and patient self-testing PT/INR
measurement market. Several other companies, including Inverness Medical Innovations, have announced that they are developing new products that would compete directly against us, and we expect one or more new products to become available next year.
In addition, other companies, including Johnson & Johnson and Beckman Coulter, have developed or acquired directly competitive products for the PT/INR market in the past, and while they are not current competitors, they could re-enter the
market at any time. Additionally, these and other potential competitors hold intellectual



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property rights that could allow them to develop or sell the right to develop new products that could compete effectively with our INRatio System. All of
these companies are larger than us and enjoy several competitive advantages, including:



| |  |  | significantly greater name recognition;
| | - |  | ---------------------------------------



| |  |  | established relationships with healthcare professionals, patients and insurance providers;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | large, direct sales forces and established independent distribution networks;
| | - |  | -----------------------------------------------------------------------------



| |  |  | additional product lines and the ability to offer rebates, bundled products, and higher discounts or incentives;
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | access to material information about our business, which we are required to publicly disclose, while not having to disclose their own comparable information, because it is an
immaterial part of their overall operations;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | greater experience in conducting research and development, manufacturing and marketing activities; and
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | greater financial and human resources for product development, sales and marketing and patent litigation.
| | - |  | ---------------------------------------------------------------------------------------------------------



We may not be able to compete effectively against these companies or their products and, if we fail to do so, our business
will be harmed.



If alternative drugs or other treatments reduce the need
for warfarin, the market for our product will be limited.



Our INRatio System is used to measure the rate of blood coagulation in patients using warfarin. As a result, the size of our market is directly dependent upon the number of warfarin users. If a new drug or other anticoagulation treatment
that does not require regular monitoring of PT/INR levels is successfully developed, approved and adopted, the size of the market for our product will be adversely affected.



While warfarin is a widely prescribed drug, it is known to have certain deficiencies which cause many physicians to be
reluctant to prescribe it regularly, or at all. Aspirin is a safer blood thinning drug than warfarin and it does not require monitoring. Aspirin has been shown to be an effective alternative to warfarin for certain chronic conditions, such as
blocked brain arteries. Warfarins narrow therapeutic range creates the need for frequent monitoring of patient blood coagulation levels. Warfarin is known to have adverse interactions with other drugs and is sensitive to changes in diet and
other factors. We are aware that pharmaceutical companies are researching and developing potential alternatives to warfarin. For example, AstraZeneca has developed an anticoagulant called Exanta. While the United States Food and Drug Administration,
or FDA, did not grant approval for its use in the United States, some European countries have approved it for certain indications.



Advances in the treatment of underlying conditions could also affect the use of warfarin. For example, improvements in replacement tissue heart valves
have reduced, and may in the future further reduce, the use of mechanical heart valves, one of the leading indications for chronic warfarin use. Additionally, several companies are pursuing new surgical procedures to treat atrial fibrillation,
another leading indication for warfarin use and monitoring. Any development that renders warfarin obsolete or diminishes the need for PT/INR testing by patients in our target markets would negatively affect our business and prospects.



Our ability to successfully market and sell our product is dependent on the
availability of adequate reimbursement from Medicare and other insurance providers.



In the United States, purchasers of medical devices, including our INRatio System, generally rely on Medicare and other insurance providers to cover all or part of the cost of the product. Currently reimbursement for
PT/INR testing in the point-of-care environment is for all indications. However, Medicare currently only



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reimburses PT/INR self-testing for patients with mechanical heart valves, or approximately 400,000 mechanical heart valve patients on warfarin, which
represents approximately 15% of three million United States patients taking warfarin on a daily basis. Whether Medicare expands reimbursement for PT/INR patient self-testing for other indications, such as atrial fibrillation, will be partially
dependent on the outcome of ongoing and future clinical studies that we do not participate in or have any direct control over. Coverage and reimbursement determinations are subject to change over time and we cannot assure you that Medicare will not
reduce or change coverage and reimbursement policies.



Although
many other insurance providers follow Medicare coverage determinations, Medicare coverage does not and will not guarantee widespread coverage by other insurance providers. These organizations are not required to offer the same level of coverage as
Medicare, or any coverage at all, and their coverage policies are determined on a regional basis, carrier-by-carrier, so that obtaining nationwide coverage from all the major insurance providers will be a time-consuming process. We cannot assure you
that adequate coverage, if any, will be obtained. Further, coverage decisions for individual patients may be made on a case-by-case basis and may require the patient to seek and obtain prior authorization before being provided access to our product.
Future legislation, regulation or reimbursement policies of insurance providers may adversely affect the demand for our product or our ability to sell our product on a profitable basis. The lack of insurance coverage or the inadequacy of
reimbursement could have a material adverse effect on our business, financial condition and results of operations.



Reimbursement and healthcare payment systems in international markets vary significantly by country and include both government-sponsored healthcare and
private insurance. Obtaining international approvals is a lengthy process, and reimbursement policies may limit the marketability of our product in certain countries. International reimbursement approvals may not be obtained in a timely manner, if
at all, or may provide for inadequate reimbursement levels. Our failure to receive international reimbursement approvals could have a material adverse effect on market acceptance of our product in the markets in which those approvals are sought.



If we are unable to establish sufficient sales and marketing
capabilities or enter into and maintain appropriate arrangements with third parties to sell, market and distribute our product, our business will be harmed.



We have limited experience as a company in the sale, marketing and distribution of our INRatio System. We maintain a
relatively small sales and marketing team which as of November 15, 2005 was comprised of 31 employees and expect to depend heavily on third parties to sell our product both in the United States and internationally for the foreseeable future. To
achieve commercial success, we must further develop our sales and marketing capabilities and enter into and maintain successful arrangements with others to sell, market and distribute our product.



We currently have agreements with six national and four regional distributors
in the United States. We also have agreements with 14 international distributors of our product. Three of our distributors, Quality Assured Services, Medline and Cardinal Health, accounted for approximately 24%, 19% and 13%, respectively, of our
total revenue in fiscal 2005. Our success is dependent upon developing and maintaining current and future distribution relationships. We have only recently entered into most of our distribution relationships, which makes it difficult for us to
predict their future success. Some of our distribution agreements allow either party to terminate the relationship on short notice and without fault. Additionally, we may be unable to renew a distribution agreement upon its expiration on favorable
terms, or at all. Distribution partners may fail to commit the necessary resources to market and sell our product to the level of our expectations. In particular, several of our distribution partners also distribute the products of our competitors,
and as a result, we compete for the attention of these distributors against the experienced and well funded efforts of our competitors. If in the future our distribution partners elect to focus on selling the products of our competitors rather than
our products, our sales efforts will be seriously compromised. If we are unable to establish and maintain adequate sales, marketing and distribution capabilities, independently or with others, we may not be able to generate product revenue and may
not become profitable. If our current or future partners do not perform adequately, or we are unable to locate or retain partners, as needed, in particular geographic areas or in particular markets, our ability to achieve our expected revenue growth
rate will be harmed.



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If our commercial partners fail to provide customer service on our behalf, our business will be harmed.



In the United States, Independent Diagnostic Testing
Facilities, or IDTFs, are intermediary parties that provide our INRatio meters and test strips to patients and are often responsible for communicating patient results back to the prescribing physician and for monitoring patient compliance with the
prescribed testing plan. As such, our success is tied to how well our IDTF partners can:



| |  |  | convince prescribing physicians of the benefit of weekly PT/INR testing;
| | - |  | ------------------------------------------------------------------------



| |  |  | ensure patient compliance; and
| | - |  | ------------------------------



| |  |  | provide timely, quality customer service to patients and physicians.
| | - |  | --------------------------------------------------------------------



Since self-testing is relatively new, IDTFs will play a critical role in the acceptance of home testing among patients and physicians and the creation of
awareness of our INRatio System. If our IDTF partners are not successful in performing their role, our business will be adversely affected.



We have limited test strip manufacturing capabilities and personnel. If we cannot produce an adequate supply of test strips, our growth will be limited and our
business will be harmed.



The primary components of
the INRatio System are the INRatio meter and INRatio disposable test strips. We manufacture INRatio test strips at our facility, and we contract with an electronic manufacturing services supplier to manufacture the INRatio meter. To be successful,
we must manufacture our test strips in substantial quantities and at acceptable costs. We currently have limited experience manufacturing our test strips, and no experience manufacturing in the quantities that we anticipate we will need in the
foreseeable future. There are technical challenges to increasing our manufacturing capacity in a significant manner, including:



| |  |  | maintaining the consistency of our incoming raw materials;
| | - |  | ----------------------------------------------------------



| |  |  | equipment design and automation;
| | - |  | --------------------------------



| |  |  | material procurement;
| | - |  | ---------------------



| |  |  | production yields; and
| | - |  | ----------------------



| |  |  | quality control and assurance.
| | - |  | ------------------------------



Developing high volume manufacturing facilities will require us to invest substantial additional funds and to hire and retain additional management and
technical personnel who have the necessary manufacturing qualifications and experience. We may not successfully complete any required increase in manufacturing capacity in a timely manner or at all. If we are unable to manufacture a sufficient
supply of our product, maintain control over expenses or otherwise adapt to anticipated growth, or if we underestimate growth, we may not have the capability to satisfy market demand or improve our sales growth sufficiently to achieve profitability.



Because of our limited experience, we have in the past manufactured, and
may in the future manufacture, defective test strips that have to be discarded, which increases our costs of operations and may delay shipment of product to customers.



We manufacture our test strips in large lots that must be tested with blood from warfarin patients in order to determine if
our product has acceptable performance. There are many elements to manufacturing each lot of strips that can cause variability in PT/INR measurement beyond acceptable limits. Variability is not detected until the entire lot is complete and selected
strips are tested with patient blood samples. If the performance is not acceptable, we discard the entire lot after we have incurred substantially all the material and labor costs required to manufacture the test strips in the lot. In order to
manufacture test strips that will produce PT/INR measurement results that are sufficiently calibrated to clinical laboratory equipment, we are dependent upon our suppliers to deliver various components in conformity with our specifications. We have
in the past had to, and may in the future have to, discard lots because they fail to meet specifications, which increases our costs of operations and may delay shipment of product to customers.



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We depend on clinical sites to assist us in verifying the calibration of our test strips, and if they fail in that
role we may be unable to produce test strips in a timely manner.



We must calibrate each lot of test strips that we manufacture using blood samples from patients who are taking therapeutic levels of warfarin as well as from individuals who are not on anticoagulant therapy. We have
contracts in place with clinical sites that give us access to their patients on a regular basis to permit us to perform the testing we need to complete our manufacturing process. If these clinical sites fail to enroll a sufficient number of patients
for our calibration requirements or if they fail to ensure that the patients meet the inclusion criteria we specify in our protocols, our ability to properly calibrate our product may be compromised and we may be unable to produce our test strips in
a timely manner.



Our product could be misused or produce inaccurate
results, which could lead to injury to the patient and potential liability for us.



We expect our product to be used by patients without direct physician supervision. Many users will be elderly Medicare patients, who may have difficulty following the instructions for the use of our product.
Additionally, in the point-of-care setting, practitioners familiar with competitors products that function differently may fail to follow our directions and misuse our product. For example, we are aware of a few situations in which
practitioners have applied blood drawn from a vein using a syringe rather than capillary blood using a finger stick, which caused inaccurate readings. Warfarin management is complex, and there are many drugs, diseases and other factors that may
affect warfarin metabolism and the ability of our test to perform as intended in the presence of these factors. Additionally, there may be biologic variations and clinical conditions that exist in some patients that may have an adverse effect on the
performance of our product. We have in the past taken, and may in the future take, corrective action in our manufacturing procedure in order to respond to complaints that our test strips were producing inaccurate results. If our product is misused
or otherwise produces an incorrect reading, a patient could be either underdosed or overdosed with warfarin, which could lead to serious injury or death and expose us to potential liability.



Our manufacturing operations are dependent upon several single source suppliers, making
us vulnerable to supply disruption, which could harm our business.



Currently, we have three single source suppliers: Dade Behring, which produces a reagent used in our test strips, Haematologic Technologies, which produces our control reagents, and Plexus, which manufactures our
meters. Our suppliers may encounter problems during manufacturing due to a variety of reasons, including failure to follow our protocols and procedures, failure to comply with applicable regulations, or equipment malfunction, any of which could
delay or impede their ability to meet our demand. Our reliance on these outside suppliers also subjects us to other risks that could harm our business, including:



| |  |  | we may not be able to obtain an adequate supply of quality raw materials or component parts in a timely manner or on commercially reasonable terms;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | suppliers may make errors in manufacturing components that could negatively affect the performance of our product, cause delays in shipment of our product or lead to returns;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | significant lot-to-lot variation in our test strips could negatively affect the performance of our product or cause delays in shipment of our product;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may have difficulty locating and qualifying on a timely basis alternative suppliers for our single-sourced supplies;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | switching components may require product redesign and new submissions to the FDA, either of which could significantly delay production;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our suppliers manufacture products for a range of customers, and fluctuations in demand for the products these suppliers manufacture for others may affect their ability to deliver
components to us in a timely manner; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | our suppliers may encounter financial hardships either related or unrelated to our demand for components, which could inhibit their ability to fulfill our orders and meet our
requirements.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Additionally, we may become
involved in a contractual dispute with any one of these suppliers, or may be unable to negotiate the renewal of an expiring contract, either of which could mean an interruption or delay in the supplied component or material. Any interruption or
delay in the supply of components or materials, or our inability to obtain components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers and cause them to cancel
orders or switch to competitive products, which would harm our business.



We face the risk of product liability claims or recalls and may not be able to maintain or obtain insurance.



Our business exposes us to the risk of product liability claims that are inherent in the testing, manufacturing and marketing of medical devices,
including those which may arise from the misuse or malfunction of, or design flaws in, our product. We may be subject to such claims if our product causes, or merely appears to have caused, an injury. Claims may be made by patients, healthcare
providers or others selling our product.



In addition, we may
be subject to claims even if the apparent injury is due to the actions of others. For example, we rely on the expertise of physicians to determine if a patient is capable of performing patient self-testing. We similarly rely on IDTFs and other
medical personnel to properly train patients to test themselves using our device. If these professionals are not properly trained or are negligent, our product may be used improperly or the patient may suffer critical injury, which may subject us to
liability. These liabilities could prevent or interfere with our product commercialization efforts. Defending a lawsuit, regardless of merit, could be costly, could divert management attention and might result in adverse publicity, which could
result in the withdrawal of, or reduced acceptance of, our product in the market.



Although we have product liability insurance that we believe is adequate, this insurance is subject to deductibles and coverage limitations. If we are unable to obtain insurance at an acceptable cost or on acceptable
terms with adequate coverage or otherwise protect against potential product liability claims, we will be exposed to significant liabilities, which may harm our business. A product liability claim or other claim with respect to uninsured liabilities
or for amounts in excess of insured liabilities could result in significant costs and significant harm to our business.



The FDA has the authority to require the recall of our product in the event of material deficiencies, defects in design, manufacture or labeling, or other
product problems that could cause serious adverse health consequences or death. Comparable governmental entities in other countries have similar authority. Even where product problems do not present a risk of serious adverse health consequences or
death, we may need to conduct a voluntary recall, if our product presents a risk to health. A government mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors or design defects. Any recall would
divert managerial and financial resources and harm our reputation with customers.



We face the risk that modifications to our device may require new 510(k) clearance which may not be obtained.



We may be forced to make modifications to our product as a result of:



| |  |  | obsolescence of a key single-sourced component;
| | - |  | -----------------------------------------------



| |  |  | termination of a key supplier relationship;
| | - |  | -------------------------------------------



| |  |  | identification of a critical product defect;
| | - |  | --------------------------------------------



| |  |  | intellectual property issues; or
| | - |  | --------------------------------



| |  |  | enforcement action by a regulatory agency.
| | - |  | ------------------------------------------



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The FDA requires device manufacturers to initially make and document a determination of whether or not a
modification requires a new approval, supplement or clearance; however, the FDA can review a manufacturers decision. Any modifications to an FDA-cleared device that could significantly affect its safety or effectiveness, or that would
constitute a major change in its intended use would require a new 510(k) clearance or possibly a premarket approval. We may not be able to obtain additional 510(k) clearances or premarket approvals for new products, product modifications, or new
indications for our product in a timely fashion, or at all. Delays in obtaining required future clearances would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our future growth. We
have made modifications to our INRatio System in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. If the FDA disagrees and requires new clearances or
approvals for the modifications, we may be required to recall and to stop marketing the INRatio System as modified, which would harm our operating results and require us to redesign the INRatio System. In these circumstances, we may be subject to
significant enforcement actions.



We may be subject, directly or
indirectly, to federal and state healthcare fraud and abuse laws and regulations and, if we are unable to or have not fully complied with such laws, could face substantial penalties.



Our operations may be directly or indirectly affected by various broad state
and federal healthcare fraud and abuse laws, including the federal Anti-Kickback Statute, which prohibit any person from knowingly and willfully offering, paying, soliciting or receiving remuneration, directly or indirectly, to induce or reward
either the referral of an individual, or the furnishing or arranging for an item or service, for which payment may be made under federal healthcare programs, such as the Medicare and Medicaid programs. If our past or present operations, including,
but not limited to, our consulting arrangements with physicians, or our promotional or discount programs, are found to be in violation of these laws, we or our officers may be subject to civil or criminal penalties, including large monetary
penalties, damages, fines, imprisonment and exclusion from Medicare and Medicaid program participation.



We may be subject to false claims laws which could result in substantial penalties.



Because our customers will most likely file claims for reimbursement with government programs such as Medicare and Medicaid, we may be subject to the
federal False Claims Act if we knowingly cause the filing of false claims. Violations of the Act may lead to government enforcement actions resulting in substantial civil penalties, including treble damages. The federal False Claims Act
also contains provisions that allow private individuals to bring actions on behalf of the government alleging that the defendant has defrauded the government. Various states have enacted laws modeled after the federal False Claims Act. We are unable
to predict whether we could be subject to actions under the federal False Claims Act, or the impact of such actions. However, the costs of defending claims under the False Claims Act, as well as sanctions imposed under the Act, could significantly
harm our operations.



Our financial controls and procedures may not be
sufficient to ensure timely and reliable reporting of financial information, which, as a public company, could materially harm our stock price and Amex listing.



In March 2005, we restated our financial results for the fiscal year ended September 30, 2004 to reflect certain
adjustments. The restatement arose, in part, to defer the recognition of revenue on certain shipments made prior to fiscal year end for which title transfer to the customer did not occur until the subsequent period, as well as to correct the
accounting for a significant license and settlement agreement. Certain other accounting adjustments were also identified and made. As a result of these errors, we have determined that our internal controls over financial reporting were not effective
as of September 30, 2004. In connection with the restatement of our financial statements our independent auditors identified a material weakness in our internal controls and procedures related to inadequate resources in the finance function
which both the Audit Committee and management agreed. As a public company, we require greater financial resources than we had as a private company. During 2005, we have hired a member of our finance department, a Corporate Controller, with SEC

Reporting Experience; however, we cannot provide you with assurance that our finance department has or will



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maintain adequate resources to ensure that we will not have any future material weakness in our system of internal controls. The effectiveness of our
controls and procedures may in the future be limited by a variety of factors including:



| |  |  | faulty human judgment and simple errors, omissions or mistakes;
| | - |  | ---------------------------------------------------------------



| |  |  | fraudulent action of an individual or collusion of two or more people;
| | - |  | ----------------------------------------------------------------------



| |  |  | inappropriate management override of procedures; and
| | - |  | ----------------------------------------------------



| |  |  | the possibility that any enhancements to controls and procedures may still not be adequate to assure timely and accurate financial information.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



If we fail to have effective controls and procedures for financial reporting
in place, we could be unable to provide timely and accurate financial information and be subject to Amex delisting, Securities and Exchange Commission, or SEC, investigation, and civil or criminal sanctions.



We may have warranty claims that exceed our reserves, which could adversely affect our
operating results.



The INRatio meter carries a
product warranty against defects in materials and workmanship. We have established a warranty reserve based on anticipated failure and return rates for our product. Unforeseen changes in factors affecting our estimates could occur and adversely
affect our operating results.



Our inability to adequately protect our
intellectual property could allow our competitors and others to produce products based on our technology, which could substantially impair our ability to compete.



Our success and ability to compete is dependent, in part, upon our ability to protect the INRatio System through our
intellectual property rights. We rely on a combination of patent, copyright and trademark law, trade secrets and nondisclosure agreements to protect our intellectual property. However, such methods may not be adequate to protect us or permit us to
gain or maintain a competitive advantage. Our European patent application, or any future United States or foreign application, may not issue as a patent or may issue as a patent in a form that may not be advantageous to us. Our issued patents, and
those that may issue in the future, may be challenged, invalidated or circumvented, which could limit our ability to stop competitors from marketing related products.



To protect our proprietary rights, we may in the future need to assert claims of infringement or misappropriation against
third parties. The outcome of litigation to enforce our intellectual property rights in patents, copyrights, trade secrets or trademarks is highly unpredictable, could result in substantial costs and diversion of resources, and could have a material
adverse effect on our financial condition and results of operations regardless of the final outcome of such litigation. In the event of an adverse judgment, a court could hold that some or all of our asserted intellectual property rights are not
infringed, invalid or unenforceable, and could award attorney fees to these third parties.



Despite our efforts to safeguard our unpatented and unregistered intellectual property rights, we may not be successful in doing so or the steps taken by us in this regard may not be adequate to detect or deter
misappropriation of our technology or to prevent an unauthorized third party from copying or otherwise obtaining and using our product, technology or other information that we regard as proprietary. Additionally, third parties may be able to design
around our patents. Furthermore, the laws of foreign countries may not protect our proprietary rights to the same extent as the laws of the United States. Our inability to adequately protect our intellectual property could allow our competitors and
others to produce products based on our technology, which could substantially impair our ability to compete.



We may become subject to claims of infringement or misappropriation of the intellectual property rights of others, which could be costly and harm our business.



Third parties have in the past asserted, and could in the future assert,
infringement or misappropriation claims against us with respect to our current or future products. Whether a product infringes a patent involves



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complex legal and factual issues, the determination of which is often uncertain. Therefore, we cannot be certain that we have not infringed the intellectual
property rights of others. Our competitors may assert that our product or the methods we employ in the use or manufacture of our product are covered by United States or foreign patents held by them. This risk is exacerbated by the fact that there
are numerous issued patents and pending patent applications related to our business that are held by others. For example, in April 2003, Inverness Medical Innovations filed suit against us, alleging that disposable test strips for our INRatio System
infringed certain of its patent rights. Inverness sought monetary damages and injunctive relief. In July 2004, we entered into a settlement and mutual release agreement with Inverness pursuant to which we received a license to the patent rights in
exchange for a product royalty and a lump sum payment. Additionally, in June 2005, we received a letter from Beckman Coulter claiming that our test strip includes intellectual property covered by one of their patents, United States Patent 5,418,141,
and that we could require a license to the patent. We do not believe that their patent covers our test strip or that we need to obtain a license from them.



Because patent applications may take years to issue, there may be applications now pending of which we are unaware that may later result in issued patents
that our product infringes. There could also be existing patents of which we are unaware that one or more components of our system may inadvertently infringe. As the number of competitors in the market for point-of-care and patient self-testing
systems grows, the possibility of inadvertent patent infringement by us, or a patent infringement claim against us, increases.



Any infringement or misappropriation claim, with or without merit, could cause us to strain our financial resources, divert managements attention
from our business and harm our reputation. If a third party patent were upheld as valid and enforceable and we were found to infringe such patent, we could be prohibited from selling our product unless we could obtain a license to the patent or were
able to design around the patent. We may be unable to obtain such a license on terms acceptable to us, if at all, and we may not be able to redesign our product to avoid infringement. A court could also order us to pay compensatory damages for such
infringement, plus prejudgment interest and could, in addition, treble the compensatory damages and award attorney fees. These damages could be substantial and could harm our reputation, business, financial condition and operating results. A court
also could enter orders that temporarily, preliminarily or permanently enjoin us and our customers from making, using, selling, offering to sell or importing our product, or could enter an order mandating that we undertake certain remedial
activities. Depending on the nature of the relief ordered by the court, we could become liable for additional damages to third parties.



The prosecution and enforcement of patents licensed to us by third parties are not within our control, and without these technologies, our product may not be
successful and our business would be harmed if the patents were infringed or misappropriated without action by such third parties.



We have obtained licenses from Dade Behring for a reagent and, as part of a settlement of an infringement claim, from Inverness Medical Innovations for a
material used in our INRatio test strips. These licenses allow us to use these third parties technologies in our product. We do not control the maintenance, prosecution, enforcement or strategy for the licensed patents and as such are
dependent on our licensors to maintain their viability. Without access to these technologies, our ability to conduct our business would be impaired significantly.



We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of
their former employers.



Many of our employees were
previously employed at other diagnostic companies, including our competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have used or disclosed trade secrets or other proprietary
information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we
fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to market existing or
new products, which could severely harm our business.



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We have potential exposure to environmental liabilities, including liability for contamination or other harm caused
by materials that we use, generate, dispose of, release or discharge.



Our research and development and clinical processes involve the use of potentially harmful biological materials as well as hazardous materials. We are subject to federal, state and local laws and regulations governing
the use, handling, storage, labeling, discharge, release and disposal of hazardous and biological materials and we incur expenses relating to compliance with these laws and regulations. Certain of these laws require us to obtain and operate under
permits and authorizations that are subject to periodic renewal or modification. We have evaluated our environmental health and safety practices to determine where deficiencies exist and plan to apply proceeds from our initial public offering to
improve our compliance efforts. We could be held liable for damages, penalties and costs of investigation and remedial actions in connection with violations of environmental, health and safety laws or permits. We are also subject to potential
liability for the investigation and clean up of any contamination at properties that we currently or formerly owned, operated or leased and off-site locations where we disposed of or arranged for disposal of hazardous materials. Liability for any
such contamination can be joint, strict and several without regard to comparative fault under certain environmental laws. We may also be subject to related claims by private parties alleging property damage and/or personal injury due to exposure to
hazardous materials at or in the vicinity of such properties. These expenses or this liability could have a significant negative impact on our financial condition. We may violate or have liability under environmental, health and safety laws in the
future as a result of human error, equipment failure, or other causes.



Environmental laws or permit conditions could become more stringent over time, imposing greater compliance costs, including capital investments, and increasing risks and penalties associated with violations. For example, the European
Parliament has recently finalized the Waste Electrical and Electronic Equipment Directive, or WEEE Directive, which makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and
future covered products. As a producer of electronic equipment, we will incur financial responsibility for the collection, recycling, treatment or disposal of products covered under the WEEE Directive. We expect to incur increased costs to comply
with future legislation which implements this Directive and potentially other related Directives, but we cannot currently estimate the extent of such increased costs. However, to the extent that such cost increases or delays are substantial, our
operating results could be materially adversely affected. In addition, similar legislation may be enacted in other countries, including the United States. We are also subject to potentially conflicting and changing regulatory agendas of political,
business, and environmental groups. Changes to or restrictions on permitting requirements or processes, hazardous or biological material storage or handling might require us to make an unplanned capital investment or relocation.



All of our operations are conducted at a single location. Any disruption at our
facility could adversely affect our operations and increase our expenses.



All of our operations are conducted at a single location in San Jose, California. We take precautions to safeguard our facility, including insurance, health and safety protocols. However, a natural disaster, such as a
fire, flood or earthquake, could cause substantial delays in our operations, damage or destroy our manufacturing equipment or inventory, and cause us to incur additional expenses. The insurance we maintain against fires, floods, earthquakes and
other natural disasters may not be adequate to cover our losses in any particular case.



Our success will depend on our ability to attract and retain key personnel, particularly members of management and scientific staff.



We believe our future success will depend upon our ability to attract and retain employees including scientists, members of management and other highly
skilled personnel. Our employees may terminate their employment with us at any time and are generally not subject to employment contracts. Hiring qualified scientific and management personnel will be difficult due to the limited number of qualified
professionals and the fact that competition for these types of employees is intense. If we fail to attract and retain key personnel, we may not be able to execute our business plan.



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A large number of shares issued privately, prior to our initial public offering, may be sold in the market following
expiration or early release of lock-up agreements, which may cause the price of our common stock to decline.



As of November 15, 2005, we had approximately 11,106,877 shares of common stock outstanding. Certain shares of common stock and shares of common
stock issuable upon exercise of outstanding options were subject to lock-up agreements executed in connection with our initial public offering. Lock-up agreements with certain of our stockholders were extended in connection with our
November 2005 private placement. 6,077,423 shares of common stock and 1,129,394 shares issuable upon exercise of outstanding options and warrants to purchase shares of common stock, will be available for sale in the public market as follows:



|                 |  |                              
|---------------- |  | -----------------------------
|Number of Shares |  | Date of Availability for Sale
|2,162,276        |  | December 26, 2005            
|4,458,948        |  | February 2, 2006             
|585,593          |  | February 7, 2006             



Approximately
6.3 million of the shares that will be available for sale after the expiration of the initial lock-up period will be subject to volume restrictions because they are held by our affiliates or have been held for less than two years. In addition,
the underwriters of our initial public offering may waive these lock-up restrictions prior to the expiration of the lock-up period without prior notice.



If our common stockholders sell substantial amounts of common stock in the public market, or the market perceives that these sales may occur, the market
price of our common stock could fall. The holders of approximately 5,616,022 shares of common stock have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in
registration statements that we may file for ourselves or other stockholders. Furthermore, if we were to include in a company-initiated registration statement shares held by those holders pursuant to the exercise of their registration rights, those
sales could impair our ability to raise needed capital by depressing the price at which we could sell our common stock.



The cost of public company compliance with the securities laws and regulations is substantial and recently enacted and proposed changes to these laws and
regulations will further increase our general and administrative expenses.



The cost of complying with the reporting requirements under the Securities and Exchange Act of 1934 are substantial. In addition, the Sarbanes-Oxley Act of 2002, along with other recent rules from the SEC and NASDAQ,
have required further legal and financial compliance costs, and made some corporate actions more difficult. For example, compliance with the internal control requirements of Sarbanes-Oxley Section 404 requires us to commit significant resources
to document and review the adequacy of our internal controls. While we are expending significant resources in developing the required documentation and testing procedures required by Section 404, we can provide no assurance as to conclusions by
us or our external auditors with respect to the effectiveness of our internal controls over financial reporting. If we are unable to comply with the requirements of Section 404, we will have to issue a report that our internal controls are not
effective, which could cause the market price of our stock to decline.



In addition, the changes in securities laws and regulations may make it more difficult and more expensive for us to maintain directors and officers liability insurance, and we may be required to accept reduced coverage or incur
substantially higher costs to obtain coverage. These developments also could make it more difficult for us to attract and retain qualified executive officers and members of our board of directors, particularly with regard to our audit committee.



Recent changes in the required accounting treatment for stock options
will have a negative impact on our financial statements and may affect our stock price.



In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123(R),
Share-Based Payment, pursuant to which we must measure all stock-based



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compensation awards, including grants of employee stock options, using a fair value-based method and record such expense in our financial statements. This
requirement to expense stock-based compensation awards is to take effect for public companies for annual periods beginning after June 15, 2005, thus we are required to adopt this standard commencing October 1, 2005. Currently, we disclose
such expenses on a pro forma basis in the notes to our financial statements, but we do not record a charge for employee stock option expense in the financial statements. The inclusion of employee stock-option expense in accordance with SFAS
No. 123(R) will cause our reported loss to increase, which may affect our stock price.



Our principal stockholder owns a significant percentage of our stock, and as a result, can take actions that may be adverse to our other stockholders interests.



MPM Capital and its affiliates own approximately 32% of our common stock.
This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. This stockholder will have the
ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, it
could dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination
that could be favorable to our other stockholders.



Our charter documents
and Delaware law may inhibit a takeover that stockholders consider favorable and could also limit the market price of your stock.



Our amended and restated certificate of incorporation and bylaws will contain provisions that could delay or prevent a change in control of our company.
Some of these provisions:



| |  |  | authorize the issuance of preferred stock which can be created and issued by the board of directors without prior stockholder approval, commonly referred to as blank
check preferred stock, with rights senior to those of common stock;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | prohibit stockholder actions by written consent; and
| | - |  | ----------------------------------------------------



| |  |  | provide for a classified board of directors.
| | - |  | --------------------------------------------



In addition, we are governed by the provisions of Section 203 of Delaware General Corporate Law. These provisions may prohibit large stockholders, in
particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These and other provisions in our amended and restated certificate of incorporation and bylaws and under Delaware law could reduce the price that
investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions.



ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Quantitative Disclosures



While we invoice our international distributors in U.S. dollars, some contract prices are stated in the customers local currency and converted to U.S. dollars at a quarterly average exchange rate. As a result, we have foreign currency
exposure with respect to our revenues from fluctuations in foreign currency exchange rates. We hold no derivative financial instruments and do not currently engage in hedging activities.



Our exposure to interest rate risk is related to the investment of our excess cash into highly liquid financial investments
with original maturities of three months or less. We invest in marketable securities with the primary objectives to preserve principal, maintain proper liquidity to meet operating needs and maximize yields while meeting specific credit quality
standards for our investments. Due to the short term nature of our investments, we have assessed that there is no material exposure to changes in interest rates



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The following table presents the future principal cash flows or amount and related weighted average
interest rates expected in fiscal 2006 for our existing cash and cash equivalents and short term investments.



|                               |  |                |       |  
|------------------------------ |  | -------------- | ----- | -
|                               |  | (in thousands) |      
|Cash, cash equivalents         |  | $              | 3,598 |  
|Short-term investments         |  | $              | 7,943 |  
|Weighted average interest rate |  |                | 3.02  | %



Qualitative Disclosures



Our primary interest rate risk exposures relate to:



| |  |  | the available for sale securities will fall in value if market interest rates increase; and
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | the impact of interest rate movements on our ability to obtain adequate debt financing to fund future operations.
| | - |  | -----------------------------------------------------------------------------------------------------------------



We have the ability to hold a significant portion of the fixed income
investments until maturity and therefore would not expect the operating results or cash flows to be affected to a significant degree by a sudden change in market interest rates on our short term marketable securities portfolio.



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ITEM  8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



|                                                                                                             |  |     
|------------------------------------------------------------------------------------------------------------ |  | ----
|                                                                                                             |  | Page
|Index to Financial Statements                                                                                |  |     
|                                                                                                             | 
|Report of Independent Registered Public Accounting Firm                                                      |  | 49  
|                                                                                                             | 
|Balance Sheets at September 30, 2005 and 2004                                                                |  | 50  
|                                                                                                             | 
|Statements of Operations for the years ended September 30, 2005, 2004 and, 2003                              |  | 51  
|                                                                                                             | 
|Statement of Changes in Stockholders Equity (Deficit) for the years ended September 30, 2005, 2004 and 2003 |  | 52  
|                                                                                                             | 
|Statements of Cash Flows for the years ended September 30, 2005, 2004 and 2003                               |  | 53  
|                                                                                                             | 
|Notes to Financial Statements                                                                                |  | 54  
|                                                                                                             | 
|Financial Statement Schedule                                                                                 |  |     
|                                                                                                             | 
|Schedule IIValuation and Qualifying Accounts                                                                |  | 73  



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and

Stockholders of HemoSense, Inc.



In our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of HemoSense, Inc. at September 30, 2005 and 2004, and the results of its operations and its
cash flows for each of the three years in the period ended September 30, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in
the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. These financial statements and financial statement schedule are the responsibility of
the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.



/s/    PRICEWATERHOUSECOOPERS LLP

San Jose, California

December 1, 2005



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HEMOSENSE, INC.



BALANCE SHEETS

(In thousands, except share data)



|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                  |  | September 30,2005 |         |   | September 30,2004 |  
|ASSETS                                                                                                                                            |  |                   |         |   |                   |   |         |  
|Current assets:                                                                                                                                   |  |                   |         |   |                   |   |         |  
|Cash and cash equivalents                                                                                                                         |  | $                 | 3,598   |   |                   | $ | 433     |  
|Short term investments                                                                                                                            |  |                   | 7,943   |   |                   |   |        |  
|Accounts receivable, net of allowance for doubtful accounts of $71 in 2005 and $0 in 2004                                                         |  |                   | 2,087   |   |                   |   | 907     |  
|Prepaid expenses and other current assets                                                                                                         |  |                   | 714     |   |                   |   | 230     |  
|Inventories                                                                                                                                       |  |                   | 2,744   |   |                   |   | 1,299   |  
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|Total current assets                                                                                                                              |  |                   | 17,086  |   |                   |   | 2,869   |  
|Property and equipment, net                                                                                                                       |  |                   | 512     |   |                   |   | 1,113   |  
|Technology licenses and prepaid royalties                                                                                                         |  |                   | 1,179   |   |                   |   | 1,964   |  
|Other assets                                                                                                                                      |  |                   | 226     |   |                   |   | 256     |  
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|Total assets                                                                                                                                      |  | $                 | 19,003  |   |                   | $ | 6,202   |  
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS EQUITY (DEFICIT)                                                            |  |                   |         |   |                   |   |         |  
|Current liabilities:                                                                                                                              |  |                   |         |   |                   |   |         |  
|Accounts payable                                                                                                                                  |  | $                 | 1,029   |   |                   | $ | 539     |  
|Accrued expenses and other liabilities                                                                                                            |  |                   | 1,159   |   |                   |   | 691     |  
|Capital lease, current portion                                                                                                                    |  |                   | 37      |   |                   |   | 38      |  
|Borrowings, current portion                                                                                                                       |  |                   | 2,000   |   |                   |   | 529     |  
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|Total current liabilities                                                                                                                         |  |                   | 4,225   |   |                   |   | 1,797   |  
|Capital lease, net of current portion                                                                                                             |  |                   | 52      |   |                   |   | 91      |  
|Borrowings, net of current portion                                                                                                                |  |                   | 4,714   |   |                   |   | 2,855   |  
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|Total liabilities                                                                                                                                 |  |                   | 8,991   |   |                   |   | 4,743   |  
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|Commitments (Note 9)                                                                                                                              |  |                   |         |   |                   |   |         |  
|Redeemable convertible preferred stock, $0.001 par valueAuthorized: 25,749,840 shares at September 30, 2004 and 10,000,000 at
September 30, 2005; |  |                   |         |   |                   |   |         |  
|Issued and outstanding: 23,635,791 shares at September 30, 2004 and none at September 30, 2005                                                    |  |                   |        |   |                   |   | 36,679  |  
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|Stockholders equity (deficit):                                                                                                                   |  |                   |         |   |                   |   |         |  
|Common stock, $0.001 par valueAuthorized: 50,000,000 shares;                                                                                      |  |                   |         |   |                   |   |         |  
|Issued and outstanding 9,604,989 and 337,347 at September 30, 2005 and September 30, 2004, respectively                                           |  |                   | 10      |   |                   |   |        |  
|Additional paidin capital                                                                                                                        |  |                   | 57,191  |   |                   |   | 220     |  
|Accumulated other comprehensive loss                                                                                                              |  |                   | (3      | ) |                   |   |        |  
|Accumulated deficit                                                                                                                               |  |                   | (47,186 | ) |                   |   | (35,440 | )
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|Total stockholders equity (deficit)                                                                                                              |  |                   | 10,012  |   |                   |   | (35,220 | )
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  
|Total liabilities, redeemable convertible preferred stock and stockholders equity (deficit)                                                      |  | $                 | 19,003  |   |                   | $ | 6,202   |  
|                                                                                                                                                  |  |                   |         |   |                   |   |         |  



The accompanying notes
are an integral part of these financial statements.



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HEMOSENSE, INC.



STATEMENTS OF
OPERATIONS

(In thousands, except per share data)



|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  
|------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                  |  | Years Ended September 30 |        
|                                                  |  | 2005                     |         |   | 2004 |   |         | 2003 | 
|Revenue                                           |  | $                        | 8,768   |   |      | $ | 3,250   |      |  | $ | 427    |  
|Cost of goods sold                                |  |                          | 9,371   |   |      |   | 5,065   |      |  |   | 1,519  |  
|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  
|Gross loss                                        |  |                          | (603    | ) |      |   | (1,815  | )    |  |   | (1,092 | )
|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  
|Operating expenses:                               |  |                          |         |   |      |   |         |      |  |   |        |  
|Research and development                          |  |                          | 1,259   |   |      |   | 1,398   |      |  |   | 1,681  |  
|Sales and marketing                               |  |                          | 6,733   |   |      |   | 5,206   |      |  |   | 3,186  |  
|General and administrative                        |  |                          | 1,962   |   |      |   | 1,499   |      |  |   | 912    |  
|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  
|Total operating expenses                          |  |                          | 9,954   |   |      |   | 8,103   |      |  |   | 5,779  |  
|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  
|Loss from operations                              |  |                          | (10,557 | ) |      |   | (9,918  | )    |  |   | (6,871 | )
|Interest income                                   |  |                          | 130     |   |      |   | 16      |      |  |   | 39     |  
|Interest expense                                  |  |                          | (1,314  | ) |      |   | (318    | )    |  |   | (67    | )
|Other expense, net                                |  |                          | (5      | ) |      |   | (41     | )    |  |   | (11    | )
|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  
|Net loss                                          |  | $                        | (11,746 | ) |      | $ | (10,261 | )    |  | $ | (6,910 | )
|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  
|Net loss per common share:                        |  |                          |         |   |      |   |         |      |  |   |        |  
|Basic and diluted                                 |  | $                        | (4.26   | ) |      | $ | (30.45  | )    |  | $ | (20.69 | )
|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  
|Shares used to compute net loss per common share: |  |                          |         |   |      |   |         |      |  |   |        |  
|Basic and diluted                                 |  |                          | 2,758   |   |      |   | 337     |      |  |   | 334    |  
|                                                  |  |                          |         |   |      |   |         |      |  |   |        |  





The accompanying notes are an integral part of these financial statements.



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HEMOSENSE, INC.



STATEMENTS OF
CHANGES IN STOCKHOLDERS EQUITY (DEFICIT)

(In thousands)



|                                                             |  |              |  |                          |    |                                   |   |        |                    |   |    |                           |  |   |         |   |  |   |         |  
|------------------------------------------------------------ |  | ------------ |  | ------------------------ | -- | --------------------------------- | - | ------ | ------------------ | - | -- | ------------------------- |  | - | ------- | - |  | - | ------- | -
|                                                             |  | Common Stock |  | AdditionalPaid-InCapital |    | AccumulatedOtherComprehensiveLoss |   |        | AccumulatedDeficit |   |    | TotalStockholdersDeficit | 
|                                                             |  | Shares       |  | Amount                   |    |                                   |   |       
|Balance at September 30, 2002                                |  | 332          |  | $                        |   |                                   | $ | 95     |                    |   |   |                           |  | $ | (18,269 | ) |  | $ | (18,174 | )
|Exercise of stock options                                    |  | 1            |  |                          |   |                                   |   |       |                    |   |   |                           |  |   |        |   |  |   |        |  
|Conversion of preferred stock into common stock              |  | 5            |  |                          |   |                                   |   | 96     |                    |   |   |                           |  |   |        |   |  |   | 96      |  
|Common stock warrants for services                           |  |             |  |                          |   |                                   |   | 12     |                    |   |   |                           |  |   |        |   |  |   | 12      |  
|Issuance of non-employee common stock options for services   |  |             |  |                          |   |                                   |   | 17     |                    |   |   |                           |  |   |        |   |  |   | 17      |  
|Net loss                                                     |  |             |  |                          |   |                                   |   |       |                    |   |   |                           |  |   | (6,910  | ) |  |   | (6,910  | )
|                                                             |  |              |  |                          |    |                                   |   |        |                    |   |    |                           |  |   |         |   |  |   |         |  
|Balance at September 30, 2003                                |  | 338          |  |                          |   |                                   |   | 220    |                    |   |   |                           |  |   | (25,179 | ) |  |   | (24,959 | )
|Net loss                                                     |  |             |  |                          |   |                                   |   |       |                    |   |   |                           |  |   | (10,261 | ) |  |   | (10,261 | )
|                                                             |  |              |  |                          |    |                                   |   |        |                    |   |    |                           |  |   |         |   |  |   |         |  
|Balance at September 30, 2004                                |  | 338          |  |                          |   |                                   |   | 220    |                    |   |   |                           |  |   | (35,440 | ) |  |   | (35,220 | )
|Exercise of stock options                                    |  | 35           |  |                          |    |                                   |   | 35     |                    |   |   |                           |  |   |        |   |  |   | 35      |  
|Issue of common stock warrants in connection with borrowings |  |             |  |                          |    |                                   |   | 264    |                    |   |   |                           |  |   |        |   |  |   | 264     |  
|Conversion of preferred stock into common stock              |  | 5,679        |  |                          | 6  |                                   |   | 40,003 |                    |   |   |                           |  |   |        |   |  |   | 40,009  |  
|Exercise of stock warrants                                   |  | 41           |  |                          |    |                                   |   | 10     |                    |   |   |                           |  |   |        |   |  |   | 10      |  
|Issuance of common stock                                     |  | 3,512        |  |                          | 4  |                                   |   | 16,659 |                    |   |   |                           |  |   |        |   |  |   | 16,663  |  
|Change in unrealized loss on short term investments          |  |             |  |                          |   |                                   |   |       |                    |   | (3 | )                         |  |   |        |   |  |   | (3      | )
|Net loss                                                     |  |             |  |                          |   |                                   |   |       |                    |   |   |                           |  |   | (11,746 | ) |  |   | (11,746 | )
|                                                             |  |              |  |                          |    |                                   |   |        |                    |   |    |                           |  |   |         |   |  |   |         |  
|Balance at September 30, 2005                                |  | 9,605        |  | $                        | 10 |                                   | $ | 57,191 |                    | $ | (3 | )                         |  | $ | (47,186 | ) |  | $ | 10,012  |  
|                                                             |  |              |  |                          |    |                                   |   |        |                    |   |    |                           |  |   |         |   |  |   |         |  





The accompanying notes are an integral part of these financial statements.



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HEMOSENSE, INC.



STATEMENTS OF
CASH FLOWS

(In thousands)



|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|---------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                                                               |  | Years Ended September 30, |        
|                                                                                               |  | 2005                      |         |   | 2004 |   |         | 2003 | 
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                          |  |                           |         |   |      |   |         |      |  |   |        |  
|Net loss                                                                                       |  | $                         | (11,746 | ) |      | $ | (10,261 | )    |  | $ | (6,910 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                    |  |                           |         |   |      |   |         |      |  |   |        |  
|Depreciation and amortization                                                                  |  |                           | 1,292   |   |      |   | 793     |      |  |   | 240    |  
|Amortization of debt issuance costs                                                            |  |                           | 329     |   |      |   | 64      |      |  |   | 1      |  
|Provision/write-off of inventories                                                             |  |                           | 138     |   |      |   | 109     |      |  |   | 89     |  
|Provision for doubtful accounts                                                                |  |                           | 71      |   |      |   |        |      |  |   |       |  
|Stock-based compensation expenses                                                              |  |                           |        |   |      |   |        |      |  |   | 29     |  
|Amortization of prepaid royalties                                                              |  |                           | 347     |   |      |   | 58      |      |  |   |       |  
|Accrued interest on note payable                                                               |  |                           | 96      |   |      |   | 18      |      |  |   |       |  
|Changes in assets and liabilities                                                              |  |                           |         |   |      |   |         |      |  |   |        |  
|Accounts receivable                                                                            |  |                           | (1,251  | ) |      |   | (773    | )    |  |   | (134   | )
|Prepaid expenses and other assets                                                              |  |                           | (506    | ) |      |   | 119     |      |  |   | (55    | )
|Inventories                                                                                    |  |                           | (1,583  | ) |      |   | (319    | )    |  |   | (146   | )
|Accounts payable                                                                               |  |                           | 490     |   |      |   | 352     |      |  |   | 71     |  
|Accrued expenses and other liabilities                                                         |  |                           | 468     |   |      |   | 322     |      |  |   | 134    |  
|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Net cash used in operating activities                                                          |  |                           | (11,854 | ) |      |   | (9,518  | )    |  |   | (6,681 | )
|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Cash flows from investing activities                                                           |  |                           |         |   |      |   |         |      |  |   |        |  
|Proceeds from sale of short term investments                                                   |  |                           | 1,000   |   |      |   |        |      |  |   |       |  
|Purchases of short term investments                                                            |  |                           | (8,943  | ) |      |   |        |      |  |   |       |  
|Acquisition of property and equipment                                                          |  |                           | (270    | ) |      |   | (429    | )    |  |   | (397   | )
|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Net cash used in investing activities                                                          |  |                           | (8,213  | ) |      |   | (429    | )    |  |   | (397   | )
|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Cash flows from financing activities                                                           |  |                           |         |   |      |   |         |      |  |   |        |  
|Proceeds from issuance of common stock                                                         |  |                           | 16,663  |   |      |   |        |      |  |   |       |  
|Proceeds from exercise of warrants and options                                                 |  |                           | 45      |   |      |   |        |      |  |   |       |  
|Proceeds from issuance of preferred stock, net of issuance costs                               |  |                           | 3,330   |   |      |   | 3,008   |      |  |   | 6,395  |  
|Principal payments on capital lease obligation                                                 |  |                           | (40     | ) |      |   | (44     | )    |  |   | (34    | )
|Proceeds from borrowings                                                                       |  |                           | 6,093   |   |      |   | 2,907   |      |  |   | 991    |  
|Repayment of borrowings                                                                        |  |                           | (2,859  | ) |      |   | (936    | )    |  |   | (105   | )
|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Net cash provided by financing activities                                                      |  |                           | 23,232  |   |      |   | 4,935   |      |  |   | 7,247  |  
|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Net increase (decrease) in cash and cash equivalents                                           |  |                           | 3,165   |   |      |   | (5,012  | )    |  |   | 169    |  
|Cash and cash equivalents at beginning of year                                                 |  |                           | 433     |   |      |   | 5,445   |      |  |   | 5,276  |  
|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Cash and cash equivalents at end of year                                                       |  | $                         | 3,598   |   |      | $ | 433     |      |  | $ | 5,445  |  
|                                                                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Supplemental disclosure of cash flow information                                               |  |                           |         |   |      |   |         |      |  |   |        |  
|Cash paid during the period for interest                                                       |  | $                         | 1,314   |   |      | $ | 318     |      |  | $ | 68     |  
|Non-cash investing activities                                                                  |  |                           |         |   |      |   |         |      |  |   |        |  
|Property and equipment acquired under capital leases                                           |  | $                         |        |   |      | $ |        |      |  | $ | 99     |  
|Non-cash financing activities                                                                  |  |                           |         |   |      |   |         |      |  |   |        |  
|Issuance of preferred stock in exchange for supply and license agreement and prepaid royalties |  | $                         |        |   |      | $ | 565     |      |  | $ | 1,245  |  
|Issuance of warrants in connection with debt                                                   |  | $                         | 264     |   |      | $ | 354     |      |  | $ | 24     |  
|Conversion of preferred stock to common stock                                                  |  | $                         | 40,009  |   |      | $ |        |      |  | $ | 95     |  



The accompanying notes
are an integral part of these financial statements.



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HEMOSENSE, INC.



NOTES TO
FINANCIAL STATEMENTS



1. Formation and Business of the Company



Description of the Company



HemoSense, Inc., (the Company) was incorporated in the state of
Delaware on March 4, 1997 to develop, manufacture and sell easy-to-use, handheld blood coagulation monitoring systems for use by healthcare professionals and patients in the management of warfarin medication. The Company began selling its first
product, the INRatio meter and related test strips, in March 2003. Prior to that date, the Company was in the development stage and had been primarily engaged in developing its product technology and raising capital.



Liquidity



The Company has incurred significant losses and negative cash flows from operations since its inception. At
September 30, 2005, the Company had an accumulated deficit of $47.2 million. Management intends to raise additional funds through sales of the Companys products and external financings and to eventually achieve positive cash flows.
Although management continues to pursue these plans, there is no assurance that they will be successful. As is further discussed in note 17, on November 5, 2005 the Company closed a private equity offering of $9.3 million. Management believes that
existing cash and short-term investments, as augmented by the proceeds received from the private placement will provide sufficient capital through at least September 2006.



If at any time sufficient capital is not available, either through existing capital resources or through raising additional
funds, the Company may be required to delay, reduce the scope of, eliminate or divest one or more of its sales and marketing programs, research and development programs or its entire business. The company may raise additional funds through public or
private offerings, debt financings, capital leases, corporate collaborations or other means. Due to the uncertainty of financial markets, financing may not be available to the Company when needed on acceptable terms or at all. Therefore, the Company
may raise additional capital from time to time when market conditions are favorable, or if strategic considerations require the Company to do so, even if it has sufficient funds for planned operations.



2. Summary of Significant Accounting Policies



Use of estimates



The preparation of financial statements in conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those estimates. These estimates and assumptions include reserves and write-downs related to accounts receivables and inventories, the recoverability of long-lived assets,
deferred tax assets and related valuation allowances and valuation of equity instruments.



Certain risks and uncertainties



Any future products developed by the Company will require approval from the United States Food and Drug Administration (FDA) or foreign regulatory agencies prior to commercial sales and are subject to continued regulations once
approved. There can be no assurance that the Companys future products will receive the necessary approvals. If the Company is denied such approvals or such approvals are delayed, it could have a material adverse effect on the Company.



A portion of the Companys sales occur outside of the
United States, principally in Europe. As a result, the Company must comply with a wide variety of foreign laws and regulations. In particular, the Company may be



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



materially adversely affected by changes in the political, social and economic conditions in these countries, and by changes in government policies with
respect to such matters as laws and regulations, method to address inflation, currency conversion and restrictions and rate and method of taxation.



The Company currently has three single source suppliers which produce reagents used in test strip manufacturing and meters. Because of the custom nature
of the components and the FDA requirements for validation and verification of significant changes, any interruption or delay in the supply of these materials could impair the Companys ability to meet the demand of customers and could have a
material adverse effect on the Company, including the need to obtain additional regulatory approval.



Cash and cash equivalents



The Company considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents.



Short-term investments



All marketable securities as of September 30, 2005 are considered to be available-for-sale short term investments and are carried at fair value.
Available-for-sale securities are classified as current assets when they have scheduled maturities of less than one year. Available-for-sale securities are classified as non current assets when they have scheduled maturities of more than one year.
Unrealized holding gains or losses on such securities are reported as a separate component of stockholders equity (deficit) until realized. Realized gains and losses on sales of all such securities are reported in interest and other income and
are computed using the specific identification cost method.



Fair value of
financial instruments



The carrying amount of the
Companys financial instruments, including cash and cash equivalents, accounts payable and accrued liabilities approximate fair values due to their short maturities. Based on the borrowing rates currently available to the Company for loans with
similar terms, the carrying value of the loan, debt payable and capital lease obligations approximate their fair values.



Concentration of Credit Risk



Financial instruments which potentially subject the Company to concentrations of risk consist principally of cash and cash equivalents and accounts
receivable. The Companys cash is invested in deposits with one financial institution. At times, cash deposits may be in excess of insured limits. Management believes that the financial institution which holds the Companys cash and cash
equivalents is financially sound and, minimal credit risk exists with respect to these investments.



Significant revenue concentrations are as follows (in thousands):



|           |  |                           |       |                        |      |   |         |      |                        |  |    |         |  |                        |     |  |    |  
|---------- |  | ------------------------- | ----- | ---------------------- | ---- | - | ------- | ---- | ---------------------- |  | -- | ------- |  | ---------------------- | --- |  | -- | -
|           |  | Years Ended September 30, |      
|           |  | 2005                      |       |                        | 2004 |   |         | 2003 |                       
|           |  | Revenue                   |       | Percentof TotalRevenue |      |   | Revenue |      | Percentof TotalRevenue |  |    | Revenue |  | Percentof TotalRevenue |    
|Customer A |  | $                         | 2,100 |                        | 24   | % |         | $    | 1,008                  |  | 31 | %       |  | $                      | 178 |  | 42 | %
|Customer B |  | $                         | 1,654 |                        | 19   | % |         | $    | 860                    |  | 26 | %       |  |                        |    |  |   |  
|Customer C |  | $                         | 1,105 |                        | 13   | % |         | $    |                       |  |   |         |  |                        |    |  |   |  



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



Significant accounts receivable concentrations are as follows (in thousands):



|           |  |                           |     |                             |      |   |                   |   |                             |  |    |   |  |  |  | 
|---------- |  | ------------------------- | --- | --------------------------- | ---- | - | ----------------- | - | --------------------------- |  | -- | - |  |  |  | 
|           |  | Years Ended September 30, |     |                             |      |   |                  
|           |  | 2005                      |     |                             | 2004 |   |                   |   |                             | 
|           |  | ReceivableBalance         |     | Percent of TotalReceivables |      |   | ReceivableBalance |   | Percent of TotalReceivables |  |    |   |  | 
|Customer A |  | $                         | 747 |                             | 36   | % |                   | $ | 279                         |  | 31 | % |  |  |  | 
|Customer B |  |                           | *   |                             | *    |   |                   |   | 229                         |  | 25 | % |  |  |  | 
|Customer C |  |                           | *   |                             | *    |   |                   |   | 126                         |  | 14 | % |  |  |  | 

---

|* | Accounts receivable at year end was less than 10% of total receivables.
|- | -----------------------------------------------------------------------



Inventories



Inventories are stated at the lower of cost or market, cost being determined under a standard cost method, which approximates first-in, first-out basis.



The manufacturing cost of test strips previously exceeded
their selling price. As a result, the Company recorded a charge to cost of goods sold on test strips inventory equal to the amount by which the manufacturing cost exceeds the average market selling price. For the years ended September 30, 2005,
2004 and 2003, the Company increased its inventory reserve by $0, $284,000 and $223,000, respectively, for the cost of the test strips, which is recorded as a component of cost of goods sold.



Property and equipment



Property and equipment are stated at cost less accumulated depreciation and amortization. Property and equipment are
depreciated on a straight-line basis over their estimated useful lives, which is generally three to five years. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the useful life or remaining lease
terms. Upon sale or retirement, the assets cost and related accumulated depreciation and amortization are removed from the accounts and any related gain or loss is reflected in statements of operations. Repairs and maintenance costs are
charged to expenses as incurred.



Impairment of long-lived assets



The Company reviews long-lived assets, including property
and equipment and intangibles, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted
future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value.
The Company considers various valuation factors, principally discounted cash flows, to assess the fair values of long-lived assets. To date, the Company has not recorded any impairment losses.



Intangible Assets



Intangible assets are comprised of licensed technologies, carried at cost less accumulated amortization. Amortization is
computed using a straight-line method over the shorter of the estimated useful lives or the term of the license agreements.



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



Revenue Recognition



We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, title has transferred to our customers, the price
is fixed and determinable and collection is reasonably assured. Provisions for discounts to customers, returns or other adjustments are recorded as a reduction of revenue and provided for in the same period that the related product sales are
recorded based upon analysis of historical discounts and returns. When terms of sale are Freight on Board, or FOB, shipping point, revenue is recognized at time of shipment and when the terms of sale are FOB receiving point, revenue is recognized
when the products have reached the destination point and other criteria for revenue recognition have been met. Shipping and handling charges are invoiced to customers based on the amount of products sold. Shipping and handling fees are recorded as
revenue and the related expense as cost of goods sold.



We
offer an early payment discount to certain customers. We provide certain customers product return rights in limited circumstances. To date, we have experienced no product returns and have determined that a reserve for product returns is not
necessary. Future changes in our experience with product returns may cause us to make changes in our reserve for product returns. Our inability to accurately estimate product returns in the future may cause us to defer recognition of revenue. We
will, from time to time, provide free products to customers. The cost of these free products are charged to cost of goods sold.



Accounts Receivable and Allowance for Doubtful Accounts



Accounts receivable are recorded at the invoiced amount and do not bear interest. While the Company has not had material bad debts written-off in the
past, we analyze the collectibility of its accounts receivable, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends, and changes in customer payment terms in evaluating whether an allowance needs to be
made during the period. Account balances are charged off against the allowance when it is probable that the receivable will not be recovered.



Research and development



Research and development costs are charged to operations as incurred and consist primarily of personnel costs, consultants and supplies.



Warranties



The Company records an accrual for estimated warranty costs when revenue is recognized. Warranty covers replacement costs of
defective meters and related test strips. The warranty period is one year. The Company has processes in place to estimate accruals for warranty exposure. The processes include estimated failure rates and replacement costs, and known design changes.
Although the Company believes it has the ability to reasonably estimate warranty expenses, unforeseen changes in factors impacting the estimate for warranty could occur and such changes could cause a material change in the Companys warranty
accrual estimate. Such a change would be recorded in the period in which the change was identified. Changes in the Companys product warranty liability during the fiscal year ended September 30, 2005, 2004 and 2003 were as follows (in
thousands):



|                                                 |  |   |     |  
|------------------------------------------------ |  | - | --- | -
|Balance, October 1, 2002                         |  | $ |    |  
|Accruals for warranties issued during the year   |  |   | 2   |  
|                                                 |  |   |     |  
|Balance, September 30, 2003                      |  |   | 2   |  
|Accruals for warranties issued during the year   |  |   | 11  |  
|Settlement made in kind during this year         |  |   | (7  | )
|                                                 |  |   |     |  
|Balance, September 30, 2004                      |  |   | 6   |  
|Accruals for warranties issued during the period |  |   | 118 |  
|Settlement made in kind during this year         |  |   | (65 | )
|                                                 |  |   |     |  
|Balance, September 30, 2005                      |  | $ | 59  |  
|                                                 |  |   |     |  



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



Advertising Expense



Advertising costs, included in sales and marketing expenses, are expensed as incurred. Advertising cost were $404,000, $290,000 and $186,000 for the
years ended September 30, 2005, 2004 and 2003, respectively.



Income
taxes



The Company accounts for income taxes under the
liability method. Under this method, deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.



Net loss per common share



Basic net loss per common share is computed by dividing net loss
attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed by giving effect to all potential dilutive common shares, including options, warrants
and redeemable convertible preferred stock.



The following
outstanding options, redeemable convertible preferred stock and warrants were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an antidilutive effect (in thousands):



|                                                            |  |                           |  |       |  |      
|----------------------------------------------------------- |  | ------------------------- |  | ----- |  | -----
|                                                            |  | Years Ended September 30,
|                                                            |  | 2005                      |  | 2004  |  | 2003 
|Redeemable convertible preferred stock (as if converted)    |  |                          |  | 5,909 |  | 5,337
|Options to purchase common stock                            |  | 1,028                     |  | 817   |  | 596  
|Warrants to purchase redeemable convertible preferred stock |  |                          |  | 98    |  | 8    
|Warrants to purchase common stock                           |  | 182                       |  | 45    |  | 45   



Accounting for stock-based
compensation



The Company accounts for stock-based
compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. The Companys policy is to grant options with an exercise price
equal to the estimated fair value of the Companys stock on the grant date. Accordingly, no compensation cost has been recognized in the Companys statement of operations for employee stock options. The Company provides additional pro
forma disclosures as required under Statement of Financial Accounting Standard No. 123 (SFAS 123), Accounting for Stock-Based Compensation, as amended by SFAS No 148, Accounting for stock-based compensation, transition and
disclosure.



Under APB Opinion No. 25, compensation
expense is based on the difference, if any, on the date of the grant, between the estimated fair value of the Companys stock and the exercise price. SFAS No. 123 defines a fair value based method of accounting for an employee
stock option or similar equity instrument.



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



Had compensation cost for options granted to employees under the Plan been determined based on the
fair value of the options at the grant date for awards, under the provisions prescribed by SFAS No. 123, as amended by SFAS No. 148, the Companys net loss would have been as follows (in thousands, except per share data):



|                                                                                                                |  |                           |         |   |      |   |         |      |  |   |        |  
|--------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                                                                                |  | Years Ended September 30, |        
|                                                                                                                |  | 2005                      |         |   | 2004 |   |         | 2003 | 
|Net loss as reported                                                                                            |  | $                         | (11,746 | ) |      | $ | (10,261 | )    |  | $ | (6,910 | )
|Less: total stock-based employee compensation expenses, determined under fair value based method for all awards |  |                           | (51     | ) |      |   | (56     | )    |  |   | (46    | )
|                                                                                                                |  |                           |         |   |      |   |         |      |  |   |        |  
|Adjusted net loss                                                                                               |  | $                         | (11,797 | ) |      | $ | (10,317 | )    |  | $ | (6,956 | )
|                                                                                                                |  |                           |         |   |      |   |         |      |  |   |        |  
|Net loss per common share, basic and diluted:                                                                   |  |                           |         |   |      |   |         |      |  |   |        |  
|As reported                                                                                                     |  | $                         | (4.26   | ) |      | $ | (30.45  | )    |  | $ | (20.69 | )
|As adjusted                                                                                                     |  | $                         | (4.28   | ) |      | $ | (30.61  | )    |  | $ | (20.83 | )



The fair value of each
stock option is estimated on the date of the grant using the minimum value method for grants made prior to the filing of the Registration Statement on Form S-1 and the Black-Scholes method for grants made subsequently, with the following weighted
average assumptions:



|                                               |  |                          |      |   |      |   |      |      |  |   |      |  
|---------------------------------------------- |  | ------------------------ | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                               |  | Year ended September 30, |     
|                                               |  | 2005                     |      |   | 2004 |   |      | 2003 | 
|Expected volatility                            |  |                          | 62   | % |      |   | 0    | %    |  |   | 0    | %
|Risk-free interest rate                        |  |                          | 3.96 | % |      |   | 4.89 | %    |  |   | 2.36 | %
|Dividend yield                                 |  |                          | 0    | % |      |   | 0    | %    |  |   | 0    | %
|Expected life (in years)                       |  |                          | 5    |   |      |   | 5    |      |  |   | 5    |  
|Weighted average fair value of options granted |  | $                        | 1.52 |   |      | $ | 0.28 |      |  | $ | 0.28 |  



The Company accounts
for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods or Services which requires that such equity instruments are recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying
equity instruments vest.



Comprehensive loss



Comprehensive loss is comprised of net loss and changes in unrealized losses
on short term investments. There were no material differences between net loss and comprehensive loss for the year ended September 30, 2005. There were no comprehensive losses for the years ended September 30, 2004 and 2003.



Recent accounting pronouncements



In December 2004, the FASB issued SFAS No. 123R, Share-Based
Payment, which will replace SFAS No. 123 and APB 25. SFAS No. 123R addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or
liabilities that are based on the fair value of the companys equity instruments or that may be settled by the issuance of such equity instruments. Under SFAS No. 123R, companies will no longer be able to account for share-based
compensation transactions using the intrinsic method in accordance with APB 25, but will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of earnings. SFAS No. 123R
is effective at the beginning of fiscal 2006.



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



In March 2005, the SEC issued Staff Accounting Bulletin No. (SAB) 107,
Share-Based Payment. SAB 107 provides guidance on the initial implementation of SFAS 123R. In particular, the statement includes guidance related to share-based payment awards for non-employees, valuation methods and selecting
underlying assumptions such as expected volatility and expected term. SAB 107 also gives guidance on the classification of compensation expense associated with such awards and accounting for the income tax effects of those awards upon the adoption
of SFAS 123R. We are currently assessing the guidance provided in SAB 107 in connection with the implementation of SFAS 123R.



Adoption of this statement is expected to have a significant impact on our financial statements as we will be required to expense the fair value of our
stock option grants rather than disclose the impact on our net loss within our footnotes, as is our current practice. The full impact of SFAS 123R on our financial statements and related disclosures is still being evaluated by management but is
expected to be material to our results of operations. Our actual share-based compensation expense in 2006 will be dependent on a number of factors, including the amount of awards granted and the fair value of those awards at the time of grant.



In June 2005, the FASB issued as final FSP No. FAS 150-5
Issuers Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares that are Redeemable. The FSP clarifies that freestanding warrants and similar instruments on shares that are
redeemable should be accounted for as liabilities under FASB Statement No. 150 Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity regardless of the timing of the redemption feature or
price, even though the underlying shares may be classified as equity. The FSP is effective for the first reporting period beginning after June 30, 2005. Although the Company does have outstanding warrants, the shares issued upon exercise of the
warrants are not redeemable; consequently, the adoption of FSP No. FAS 150-5 has no impact on the Companys results of operations or financial condition.



On June 7, 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20,
Accounting Changes, and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. FAS No. 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle. Previously, most
voluntary changes in accounting principles were required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. FAS 154 requires retrospective application to prior periods financial
statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. FAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the
Statement does not change the transition provisions of any existing accounting pronouncements. We do not believe that the adoption of FAS 154 will have a material effect on the Companys financial position, results of operations or cash flows.



3. Short Term Investments



The cost and fair market value of available-for-sale securities at
September 30, 2005 are as follows (in thousands):



|                                 |  |      |       |                  |   |    |            |  |               |       |  |                             
|-------------------------------- |  | ---- | ----- | ---------------- | - | -- | ---------- |  | ------------- | ----- |  | ----------------------------
|                                 |  | Cost |       | Unrealized(Loss) |   |    | Fair Value |  | Maturity Date
|Short-term marketable securities |  |      |       |                  |   |    |            |  |               |       |  |                             
|Commercial paper                 |  | $    | 5,965 |                  | $ | (2 | )          |  | $             | 5,963 |  | October 2005  January 2006 
|Government agency                |  |      | 1,981 |                  |   | (1 | )          |  |               | 1,980 |  | December 2005  January 2006
|                                 |  |      |       |                  |   |    |            |  |               |       |  |                             
|                                 |  | $    | 7,946 |                  | $ | (3 | )          |  | $             | 7,943 |  |                             
|                                 |  |      |       |                  |   |    |            |  |               |       |  |                             



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##### Table of Contents

HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



4. Inventories



Inventories consist of the following (in thousands)



|                 |  |               |       |      |   |      
|---------------- |  | ------------- | ----- | ---- | - | -----
|                 |  | September 30,
|                 |  | 2005          |       | 2004
|Raw materials    |  | $             | 881   |      | $ | 773  
|Work-in-progress |  |               | 1,138 |      |   | 292  
|Finished goods   |  |               | 725   |      |   | 234  
|                 |  |               |       |      |   |      
|                 |  | $             | 2,744 |      | $ | 1,299
|                 |  |               |       |      |   |      



5. Plant Property and Equipment,
net



Property and equipment consist of the following (in
thousands),:



|                                               |  |               |        |   |      |   |        |  
|---------------------------------------------- |  | ------------- | ------ | - | ---- | - | ------ | -
|                                               |  | September 30, |       
|                                               |  | 2005          |        |   | 2004 |  
|Lab equipment                                  |  | $             | 326    |   |      | $ | 326    |  
|Manufacturing equipment                        |  |               | 2,112  |   |      |   | 1,881  |  
|Computer equipment                             |  |               | 357    |   |      |   | 263    |  
|Furniture and equipment                        |  |               | 217    |   |      |   | 210    |  
|Leasehold improvements                         |  |               | 2      |   |      |   |       |  
|Equipment in progress                          |  |               |       |   |      |   | 66     |  
|                                               |  |               |        |   |      |   |        |  
|                                               |  |               | 3,014  |   |      |   | 2,746  |  
|Less accumulated depreciation and amortization |  |               | (2,502 | ) |      |   | (1,633 | )
|                                               |  |               |        |   |      |   |        |  
|                                               |  | $             | 512    |   |      | $ | 1,113  |  
|                                               |  |               |        |   |      |   |        |  



Included in property
and equipment at September 30, 2005 and 2004 is equipment acquired under capital leases totaling $240,000 and related accumulated amortization of $229,000 and $177,000, respectively.



Depreciation expense for the years ended September 30, 2005, 2004 and 2003 was $871,000, $546,000 and $239,000,
respectively.



6. Accrued Liabilities



Accrued liabilities consist of the following (in thousands)



|                             |  |               |       |      |   |    
|---------------------------- |  | ------------- | ----- | ---- | - | ---
|                             |  | September 30,
|                             |  | 2005          |       | 2004
|Payroll and related expenses |  | $             | 619   |      | $ | 424
|Consulting                   |  |               | 119   |      |   | 25 
|Accrued inventory payables   |  |               | 244   |      |   |   
|Other liabilities            |  |               | 177   |      |   | 242
|                             |  |               |       |      |   |    
|                             |  | $             | 1,159 |      | $ | 691
|                             |  |               |       |      |   |    



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##### Table of Contents

HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



7. Technology Licenses and Prepaid Royalties



Technology licenses consist of the following (in thousands):



|                               |  |               |       |   |      |   |       |  
|------------------------------ |  | ------------- | ----- | - | ---- | - | ----- | -
|                               |  | September 30, |      
|                               |  | 2005          |       |   | 2004 |  
|Dade Behring License           |  | $             | 1,245 |   |      | $ | 1,245 |  
|Inverness License              |  |               | 122   |   |      |   | 122   |  
|                               |  |               |       |   |      |   |       |  
|                               |  |               | 1,367 |   |      |   | 1,367 |  
|Less: Accumulated amortization |  |               | (685  | ) |      |   | (247  | )
|                               |  |               |       |   |      |   |       |  
|                               |  | $             | 682   |   |      | $ | 1,120 |  
|                               |  |               |       |   |      |   |       |  



The licenses are
amortized over their contractual lives of approximately 3-4 years. Amortization expense was $438,000, $247,000 and $0 for the years ended September 30, 2005, 2004 and 2003, respectively.



Estimated amortization of the technology licenses are $438,000, $196,000,
$23,000 and $25,000 for the years ending September 30, 2006, 2007, 2008 and 2009, respectively.



Prepaid royalties related to technology licenses consist of the following (in thousands):



|                     |  |               |     |      |   |    
|-------------------- |  | ------------- | --- | ---- | - | ---
|                     |  | September 30,
|                     |  | 2005          |     | 2004
|Dade Behring License |  | $             | 260 |      | $ | 534
|Inverness License    |  |               | 237 |      |   | 310
|                     |  |               |     |      |   |    
|Total                |  | $             | 497 |      | $ | 844
|                     |  |               |     |      |   |    



In May 2003, the
Company extended an existing non-exclusive Supply and License Agreement with Dade Behring Inc. (the Dade Behring License) in exchange for 787,919 shares of the Companys Series C-1 preferred stock valued at $1.58 per share
(Note 11). The Dade Behring License also provides for quarterly payment of royalties based on net revenue on certain product sales and expires in March 2007, unless extended.



In June 2004, the Company received a credit for prepayment of $1.0 million for future royalties under the Dade Behring
License in exchange for 357,570 shares of the Companys Series C-2 preferred stock valued at $565,000. The value of the preferred stock was capitalized as a royalty prepayment and will be amortized as revenues are generated, subject to the
terms of the royalty agreement.



On April 29, 2003,
Inverness Medical Switzerland GmbH (Inverness) filed a complaint in the United States District Court for the District of Massachusetts, alleging that disposable test strips for the Companys INRatio System infringes certain issued
patents. Inverness sought monetary damages and injunctive relief. On July 16, 2004, a settlement and mutual release agreement was signed between the Company and Inverness whereby the Company received a fully paid up license to the Inverness
patent (the Inverness License), subject to a royalty to be accrued commencing July 16, 2006 and issued to Inverness a secured subordinated note in the amount of $1.0 million as payment in lieu of any alleged past damages, costs,
expenses and legal fees.



The total value of the note payable
was estimated to be $459,000 (Note 8). Of this amount, $337,000 was accounted for as prepaid royalties to be amortized over the initial free period in the Inverness agreement. The remaining portion of $122,000 was accounted for as a technology
license to be amortized over the remaining life of the patent which ends in November 2009.



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



8. Borrowings



The Companys borrowings consist of the following (in thousands):



|                                                           |  |               |       |      |   |      
|---------------------------------------------------------- |  | ------------- | ----- | ---- | - | -----
|                                                           |  | September 30,
|                                                           |  | 2005          |       | 2004
|Lighthouse Capital loan payable                            |  | $             | 6,141 |      | $ | 2,907
|Inverness note payable net of unamortized discount of $427 |  |               | 573   |      |   | 477  
|                                                           |  |               |       |      |   |      
|Total                                                      |  | $             | 6,714 |      | $ | 3,384
|                                                           |  |               |       |      |   |      



Lighthouse Capital
Loan Payable



In March 2004, the Company obtained a
secured loan commitment of $7.5 million from partnerships of Lighthouse Capital. The Company was entitled to draw against the loan commitment through March 1, 2005. During the drawdown period interest was paid monthly a rate equal to prime plus
7.5% which was 12.0% at September 30, 2004. Beginning March 1, 2005, principal and interest payments are made over a 36 month period at a rate equal to 3.1% of the total amounts borrowed, based on prime of 4.0%, subject to adjustment as of
this date due to changes in prime. A final payment, equal to 12.5% of the amounts borrowed is due March 1, 2008. The effective interest rate during the repayment period is 16.4%. In addition, the Company will also pay a facility fee of
1.0% per annum, quarterly, on the average unused portion of the loan through March 1, 2005. During 2005, the Company had drawn down the entire $7.5 million and repaid $1.4 million during the year. Future minimum payments under the secured
loan are as follows (in thousands):



|                                   |  |   |      
|---------------------------------- |  | - | -----
|For the years ending September 30, |  |   |      
|2006                               |  | $ | 2,000
|2007                               |  |   | 2,353
|2008                               |  |   | 1,788
|                                   |  |   |      
|Total                              |  | $ | 6,141
|                                   |  |   |      



The Company is
permitted to prepay the amounts borrowed for a fee of 2.0% to 3.0% of the outstanding loan balance.



In connection with the secured loan commitment, the Company issued warrants to purchase shares of the Companys Series C-2 Preferred Stock at an
exercise price of $1.58 per share, which were subsequently exchanged for Series C-3 Preferred Stock. On July 1, 2005 the warrants to purchase preferred stock were converted to warrants to purchase common stock of the Company. The number of
shares underlying these warrants are based on the total amount drawn under the loan commitment. The warrants are immediately exercisable. As the Company drew against the loan commitment, the fair value of the warrants were recorded as an asset and
amortized to interest expense over the life of the loan using the effective interest method. As of September 30, 2005, the warrants were exercisable into 118,670 shares.



The fair value of the warrants granted was estimated on the date of the grant using the following assumptions:



|                        |  |             
|----------------------- |  | ------------
|Risk-free interest rate |  | 3.49%- 4.68%
|Volatility              |  | 60%         
|Expected life           |  | 7 years     
|Dividend yield          |  | 0%          



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##### Table of Contents

HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



Inverness Note Payable



The note payable in the amount of $1.0 million to Inverness issued in conjunction with the litigation settlement was
recorded at its estimated net present value of $459,000 based on an 18.5% estimated incremental borrowing rate. This amount is being accreted up to the amount due on July 16, 2009. The accretion is recorded as interest expense in the statement
of operations. The note accrues interest at 5% per annum. However, no interest accrues or is due prior to July 16, 2006. The Company may at any time, prepay all or any portion of the principal amount and accrued interest, if any. Of the
total value of the note payable, $337,000 was recorded as prepaid royalties and the remaining amount of $122,000 was capitalized as a license.



9. Commitments



Capital Leases



The Company leases certain equipment under capital leases which expire through March 2008.



Future minimum lease payments under capital lease agreements are as follows
(in thousands):



|                                                  |  |   |     |  
|------------------------------------------------- |  | - | --- | -
|For the years ending September 30,                |  |   |     |  
|2006                                              |  | $ | 46  |  
|2007                                              |  |   | 40  |  
|2008                                              |  |   | 17  |  
|                                                  |  |   |     |  
|Total minimum lease payments                      |  |   | 103 |  
|Less: Amount representing interest                |  |   | (14 | )
|                                                  |  |   |     |  
|Present value of minimum lease payments           |  |   | 89  |  
|Less: Current portion of capital lease obligation |  |   | (37 | )
|                                                  |  |   |     |  
|Long-term portion of capital lease obligation     |  | $ | 52  |  
|                                                  |  |   |     |  



Operating Leases



The Company rents its facility under a non-cancelable
operating lease, which expires in April 2009, unless extended. Future minimum lease payments under the non-cancelable operating lease agreement are as follows (in thousands):



|                                   |  |   |    
|---------------------------------- |  | - | ---
|For the years ending September 30, |  |   |    
|2006                               |  | $ | 143
|2007                               |  |   | 153
|2008                               |  |   | 162
|2009                               |  |   | 90 
|                                   |  |   |    
|                                   |  | $ | 548
|                                   |  |   |    



Rent expense for the
years ended September 30, 2005, 2004 and 2003 was $143,000, $189,000 and $190,000, respectively.



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



The Company rents office equipment under a non-cancelable operating lease which expires in
September 8008 unless extended. Future minimum payments under the non-cancelable operating lease agreement are as follows (in thousands):



|                                   |  |   |   
|---------------------------------- |  | - | --
|For the years ending September 30, |  |   |   
|2006                               |  | $ | 8 
|2007                               |  |   | 8 
|2008                               |  |   | 7 
|                                   |  |   |   
|                                   |  | $ | 23
|                                   |  |   |   



Purchase
Commitments



In 2005, the Company entered into purchase
commitments containing cancelable and non-cancelable components. At September 30, 2005 the Company has $2.7 million of cancelable commitments and $504,000 of non-cancelable commitments.



Indemnifications



In the normal course of business, the Company enters into contracts and
agreements that contain a variety of representations and warranties and provide for general indemnifications. The Companys exposure under these agreements is unknown because it involves future claims that may be made against the Company in the
future, but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations, and accordingly, the Company has not accrued any amounts for such indemnification
obligations. However, the Company may record charges in the future as a result of these indemnification obligations.



10. Redeemable Convertible Preferred Stock



Under the Companys Certificate of Incorporation, as amended, the Company is authorized to issue preferred stock in series. The Companys Board
of Directors is authorized to determine the rights, preferences and terms of each series. On July 1, 2005 in conjunction with our initial public offering the Company converted all 21,956,251 shares of preferred stock into 5,489,045 shares of
common stock. On February 7, 2005 the Company converted 3,803,758 shares of preferred stock into 190,185 shares of common stock. As of September 30, 2005 there is no preferred stock outstanding.



As of September 30, 2004, the redeemable convertible preferred stock
consisted of the following (in thousands, except per share data):



|                         |  |                                        |  |                                      |  |                                                       |        |                          |   |                  |  |                                   |        |  |      
|------------------------ |  | -------------------------------------- |  | ------------------------------------ |  | ----------------------------------------------------- | ------ | ------------------------ | - | ---------------- |  | --------------------------------- | ------ |  | -----
|                         |  | Number ofSharesDesignatedandAuthorized |  | Number ofSharesIssued andOutstanding |  | Proceeds ofPreferred Stock, net/fair value ofwarrants |        | RedemptionValue perShare |   | LiquidationValue |  | CommonStockReserved forConversion
|Series A-2               |  | 1,430                                  |  | 1,430                                |  | $                                                     | 1,403  |                          | $ | 1.00             |  | $                                 | 1,430  |  | 357  
|Series B-2               |  | 3,813                                  |  | 3,813                                |  |                                                       | 6,008  |                          | $ | 1.58             |  |                                   | 6,025  |  | 953  
|Series C-2               |  | 20,507                                 |  | 18,393                               |  |                                                       | 28,890 |                          | $ | 1.58             |  |                                   | 58,122 |  | 4,598
|Preferred stock warrants |  |                                       |  | 392                                  |  |                                                       | 378    |                          | $ |                 |  |                                   |       |  | 98   
|                         |  |                                        |  |                                      |  |                                                       |        |                          |   |                  |  |                                   |        |  |      
|                         |  | 25,750                                 |  | 24,028                               |  | $                                                     | 36,679 |                          |   |                  |  | $                                 | 65,577 |  | 6,006
|                         |  |                                        |  |                                      |  |                                                       |        |                          |   |                  |  |                                   |        |  |      



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##### Table of Contents

HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



In February 2005, the Company raised approximately $3.4 million by issuing 2,124,218 shares of
Series C-3 preferred stock at $1.58 per share. As a result, participating holders of the Series A-2, B-2 and C-2 preferred stock converted to Series A-3, B-3 and C-3 preferred stock, respectively. 3,803,758 shares of non-participating
preferred stock converted into 190,185 shares of common stock.



11.
Stockholders Equity (Deficit)



Preferred stock



The Company is authorized to issue 10,000,000 shares of
preferred stock. The board of directors has authority to issue the preferred stock in one or more series and to fix the price, rights preferences, privileges and restrictions thereof, including the dividend rights, dividend rates, conversion rights,
voting rights terms of redemption, redemption prices, liquidation preferences and the number of shares constituting a series or the designation of such series, without any further vote or action by the Companys stockholders. In accordance with
the Companys stockholder rights plan, 25,000 shares of the preferred stock have been designated as Series A participating preferred stock. None of the shares of Series A participating preferred stock were issued and outstanding as of
September 30, 2005.



Initial Public Offering



The Company registered the initial public offering of its
common stock, par value $0.001 per share, on a Registration Statement on Form S-1 (Registration No. 333-123705), which was declared effective on June 28, 2005. On July 1, 2005 the Company closed the initial public offering of the
Companys common stock by selling 3.5 million shares at $5.50 per share. Additionally on July 27, 2005, the underwriters exercised their over-allotment option to purchase 12,207 shares at $5.50 per share. Gross proceeds from the
offering were $19.3 million. Total expenses from the offering were $2.6 million, which included underwriting discounts and commissions of $1.3 million, and $1.3 million in other offering-related expenses. Net offering proceeds, after deducting total
expenses were $16.7 million. Upon the closing of the IPO, all of the outstanding shares of the Companys redeemable convertible preferred stock converted into 5,489,045 shares of the Companys common stock. Also, warrants issued to
purchase 507,912 shares of the Companys redeemable convertible preferred stock were converted into warrants to purchase 126,977 shares of the Companys common stock.



Common Stock



Each share of common stock is entitled to one vote. The holders of common stock are also entitled to receive dividends whenever funds are legally
available and when declared by the Board of Directors, subject to the prior rights of holders of all classes of stock outstanding. To date, no dividends have been declared.



Reverse Stock Split



On May 4, 2005, the Company effected a one-for-four reverse stock split of the Companys common stock and as a result the conversion ratio of
the Companys preferred stock automatically adjusted to one-for-four. All share and per share amounts contained in the financial statements are retroactively adjusted accordingly.



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##### Table of Contents

HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



Common Stock Warrants



Common stock warrants outstanding as of September 30, 2005 are as follows:



|                              |  |                 |  |                         |  |               |      |                |            |            |   |        
|----------------------------- |  | --------------- |  | ----------------------- |  | ------------- | ---- | -------------- | ---------- | ---------- | - | -------
|                              |  | Date ofIssuance |  | Number ofWarrantsIssued |  | ExercisePrice |      | ExpirationDate |            | Fair Value
|Notes Payable                 |  | April 2005      |  | 54,542                  |  | $             | 5.50 |                | April 2010 |            | $ | 149,000
|Loan agreement                |  | March 2004      |  | 118,670                 |  | $             | 6.32 |                | March 2011 |            | $ | 470,000
|Equipment Financing agreement |  | July 2003       |  | 8,307                   |  | $             | 6.32 |                | July 2010  |            | $ | 24,000 
|                              |  |                 |  |                         |  |               |      |                |            |            |   |        
|Total                         |  |                 |  | 181,519                 |  |               |      |                |            |            |   |        
|                              |  |                 |  |                         |  |               |      |                |            |            |   |        



As of
September 30, 2005, all of these warrants were vested and none have been exercised. The fair values of these warrants were determined using Black-Scholes model and they have been recorded as an expense over the life of the loan.



12. Stock Option Plans



1997 Stock Option Plan



In 1997, the Company adopted the 1997 Stock Option Plan (the 1997 Plan), as amended, under which 1.1 million shares of the Companys
common stock have been reserved for issuance to employees, directors and consultants. Options granted under the 1997 Plan may be incentive stock options or non-statutory stock options. Stock purchase rights may also be granted under the 1997 Plan.
Incentive stock options may only be granted to employees. Options granted or stock purchased under the 1997 Plan must become exercisable or the Companys right to repurchase lapse no less than 20% after one year and ratably over 4 years
thereafter. In addition, there were 463,375 options granted under the 1997 plan to certain employees in which the vesting will fully accelerate upon the occurrence of a change in control. Included in these options are 527,500 options granted to
certain employees of which 20% became vested on an accelerated basis on the IPO effective date. The exercise price of incentive stock options and non-statutory stock options shall be no less than 100% and 85%, respectively, of the fair value per
share of the Companys common stock on the grant date, as determined by the Board of Directors. The term of the options is ten years. Since the implementation of the 2005 Equity Incentive Plan, no additional options will be granted from this
plan and the plan will terminate when all the shares have been either exercised, cancelled or expire.



2005 Equity Incentive Plan



In March 2005, the Companys board of directors and stockholders approved the 2005 Equity Incentive Plan (the 2005 Plan), which
became effective upon completion of its initial public offering on July 1, 2005. The Company has reserved a total of 50,000 shares of its common stock for issuance under the 2005 Plan, all of which are available for future grant. In addition,
any unused shares in or any unvested shares under the 1997 Plan as of the effective date of an initial public offering has been added to the 2005 Plan.



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



Activity under both plans is as follows (in thousands except weighted average exercise price):



|                             |  |                           |   |  |                              |   |  |   |     
|---------------------------- |  | ------------------------- | - |  | ---------------------------- | - |  | - | ----
|                             |  | Shares Availablefor Grant |   |  | Outstanding Options         
|                             |  | Number ofShares           |   |  | WeightedAverageExercisePrice
|Balance, September 30, 2002  |  | 119                       |   |  | 487                          |   |  | $ | 0.96
|Options granted              |  | (112                      | ) |  | 112                          |   |  | $ | 0.80
|Options exercised            |  |                          |   |  | (1                           | ) |  | $ | 0.80
|Options cancelled            |  | 2                         |   |  | (2                           | ) |  | $ | 2.13
|                             |  |                           |   |  |                              |   |  |   |     
|                             |  |                           |  
|Balance, September 30, 2003  |  | 9                         |   |  | 596                          |   |  | $ | 0.93
|Additional shares authorized |  | 262                       |   |  |                             |   |  |   |     
|Options granted              |  | (313                      | ) |  | 313                          |   |  | $ | 0.80
|Options cancelled            |  | 92                        |   |  | (92                          | ) |  | $ | 0.83
|                             |  |                           |   |  |                              |   |  |   |     
|                             |  |                           |  
|Balance, September 30, 2004  |  | 50                        |   |  | 817                          |   |  | $ | 0.89
|Additional shares authorized |  | 238                       |   |  |                             |   |  |   |     
|Options granted              |  | (377                      | ) |  | 377                          |   |  | $ | 2.30
|Options exercised            |  |                          |   |  | (35                          | ) |  | $ | 1.00
|Options cancelled            |  | 131                       |   |  | (131                         | ) |  | $ | 1.14
|                             |  |                           |   |  |                              |   |  |   |     
|Balance, September 30, 2005  |  | 42                        |   |  | 1,028                        |   |  | $ | 1.37
|                             |  |                           |   |  |                              |   |  |   |     



The options
outstanding and exercisable by exercise price at September 30, 2005 are as follows (in thousands, except per share amounts):



|                |  |                   |  |                                                 |  |                   |  |                                 |      
|--------------- |  | ----------------- |  | ----------------------------------------------- |  | ----------------- |  | ------------------------------- | -----
|Exercise Prices |  | NumberOutstanding |  | WeightedAverageRemainingContractualLife (Years) |  | NumberExercisable |  | WeightedAverageExercisablePrice
|$0.10 - $0.70   |  | 34                |  | 2.23                                            |  | 34                |  | $                               | 0.62 
|$0.70 - $0.80   |  | 896               |  | 7.87                                            |  | 559               |  | $                               | 0.80 
|$0.80 - $2.00   |  | 2                 |  | 3.97                                            |  | 2                 |  | $                               | 2.00 
|$2.00 - $3.00   |  | 11                |  | 4.12                                            |  | 11                |  | $                               | 2.80 
|$3.00 - $7.00   |  | 27                |  | 9.65                                            |  |                  |  | $                               | 0.00 
|$7.01 - $8.00   |  | 39                |  | 9.83                                            |  |                  |  | $                               | 0.00 
|$8.00 - $9.00   |  | 19                |  | 9.85                                            |  |                  |  | $                               | 0.00 
|                |  |                   |  |                                                 |  |                   |  |                                 |      
|                |  | 1,028             |  |                                                 |  | 606               |  | $                               | $0.83
|                |  |                   |  |                                                 |  |                   |  |                                 |      



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



At September 30, 2004, there were 817,000 options with the weighted average exercise price of $0.95
per share. There were no stock options granted to employees with exercise prices below estimated fair market value on the date of grant.



13. Employee 401(k) Plan



In January 2001, the Company adopted a defined contribution retirement plan (the 401k Plan), which qualifies under Section 401(k) of
the Internal Revenue Code of 1996. The 401k Plan covers all employees in the United States with a minimum of three months of service. The Company has made no contributions to date.



14. Income Taxes



A reconciliation of income taxes at the statutory federal income tax rate to income tax expense in the statement of operations is as follows (in
thousands):



|                                  |  |      |         |   |      |   |         |      |  |   |        |  
|--------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                  |  | 2005 |         |   | 2004 |   |         | 2003 | 
|Pretax loss                       |  | $    | (11,746 | ) |      | $ | (10,261 | )    |  | $ | (6,910 | )
|                                  |  |      |        
|Benefit at federal statutory rate |  |      | (3,993  | ) |      |   | (3,489  | )    |  |   | (2,350 | )
|State, net of federal benefit     |  |      | (697    | ) |      |   | (428    | )    |  |   | (349   | )
|Meals and entertainment           |  |      | 18      |   |      |   | 13      |      |  |   | 8      |  
|Non-cash interest expense         |  |      |         |   |      |   |        |      |  |   | 18     |  
|Research and development credit   |  |      | (92     | ) |      |   | 17      |      |  |   | (286   | )
|Other                             |  |      | (153    | ) |      |   | (258    | )    |  |   | 289    |  
|Valuation allowance               |  |      | 4,917   |   |      |   | 4,145   |      |  |   | 2,670  |  
|                                  |  |      |         |   |      |   |         |      |  |   |        |  
|Provision for taxes               |  | $    |        |   |      | $ |        |      |  | $ |       |  
|                                  |  |      |         |   |      |   |         |      |  |   |        |  



At September 30,
2005, the Company had net operating loss carryforwards of approximately $45.5 million and $40.4 million available to reduce future taxable income, if any, for both federal and California state income tax purposes, respectively. The net operating
loss carryforwards will begin to expire in 2007 and will completely expire in 2025.



The Company also has research and development tax credit carryforwards of approximately $789,000 and $756,000 for federal and state income tax purposes, respectively. If not utilized, the federal carryforwards expire
in 2025. The state tax credits can be carried forward indefinitely.



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



Under the Tax Reform Act of 1986, the amounts of and benefits from net operating loss carryforwards
may be impaired or limited in certain circumstances. Events which cause limitations in the amounts of net operating losses that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%,
as defined, over a three year period.



The tax effects of
temporary differences and carryforwards that give rise to significant portions of the deferred tax assets are as follows (in thousands):



|                                 |  |                         |         |   |      |   |         |  
|-------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                 |  | Year EndedSeptember 30, |        
|                                 |  | 2005                    |         |   | 2004 |  
|Deferred tax assets              |  |                         |         |   |      |   |         |  
|Fixed assets                     |  | $                       | 280     |   |      | $ | 214     |  
|Reserves and accruals            |  |                         | 582     |   |      |   | 341     |  
|Net operating loss carryforwards |  |                         | 17,812  |   |      |   | 13,294  |  
|Research and development credits |  |                         | 1,288   |   |      |   | 1,196   |  
|                                 |  |                         |         |   |      |   |         |  
|                                 |  |                         | 19,962  |   |      |   | 15,045  |  
|Less: Valuation allowance        |  |                         | (19,962 | ) |      |   | (15,045 | )
|                                 |  |                         |         |   |      |   |         |  
|                                 |  | $                       |        |   |      | $ |        |  
|                                 |  |                         |         |   |      |   |         |  



The Company has
established a 100% valuation allowance against its deferred tax assets due to the uncertainty surrounding the realization of such assets. Annually, management evaluates the recoverability of the deferred tax assets and the amount of the required
valuation allowance. At such time as it is determined that it is more likely than not that deferred tax assets are realizable the valuation allowance will be reduced.



15. Related Party Transactions



During the year ended September 30, 2003, the Company paid Innovative Medical Products GmbH (IMed Pro), a services company in Germany
affiliated with Gregory Ayers, a Board member, $436,000 for clinical trials consulting and distribution services. During the year ended September 30, 2004, the Company paid IMed Pro for distribution services of $560,000. The agreements between
the Company and IMed Pro were terminated effective January 1, 2005. Since January 2005 I-Med-Partner GmbH (IMedPartner) has served as a distributor in Germany and purchased $416,000 of product. IMed Pro is a shareholder of
IMedPartner.



Edward Brennan, Ph.D., one of the Companys
directors, has provided consulting services to the Company not directly related to his service as a board member. During the past three fiscal years, payments were made to Dr. Brennan of $23,000 in 2005, $58,750 in 2004 and $15,000 in 2003 for
these consulting services.



The Company paid Dade Behring Inc.,
a stockholder which had a representative on the Companys Board of Directors, $8,000 and $102,000 of license royalties for the years ended September 30, 2003 and 2004, respectively. Also, as discussed in Note 7, in May 2003 the
Company issued 787,919 shares of preferred stock valued at $1,245,000 to Dade Behring Inc. to extend the Dade Behring License, and in June 2004, the Company issued 357,570 shares of preferred stock valued at $565,000 to Dade Behring Inc. for the
prepayment of $1.0 million of future license royalties.



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HEMOSENSE, INC.



NOTES TO FINANCIAL STATEMENTS(Continued)



16. Segment Information



The Company derives significant revenue from outside the United States, primarily in Europe. Revenue by geographic areas,
based on the customer shipment location, was as follows (in thousands):



|              |  |                           |       |      |   |       |  |   |    
|------------- |  | ------------------------- | ----- | ---- | - | ----- |  | - | ---
|              |  | Years Ended September 30,
|              |  | 2005                      |       | 2004 |   | 2003 
|United States |  | $                         | 6,473 |      | $ | 2,556 |  | $ | 323
|Germany       |  |                           | 1,227 |      |   | 556   |  |   | 93 
|Spain         |  |                           | 564   |      |   |      |  |   |   
|Other         |  |                           | 504   |      |   | 138   |  |   | 11 
|              |  |                           |       |      |   |       |  |   |    
|              |  | $                         | 8,768 |      | $ | 3,250 |  | $ | 427
|              |  |                           |       |      |   |       |  |   |    



17. Subsequent Event



On November 5, 2005 the Company closed a private
equity offering of 1,481,482 shares of the Companys common stock at $6.75 per share and issued warrants to purchase 740,741 shares of the Companys common stock at $8.165 per share. Gross proceeds from the offering were $10.0 million.
Total expenses from the offering were approximately $850,000 which included underwriting discounts and commissions of $600,000.



18. Quarterly Financial Data (unaudited)



|                                             |  |                                   |        |   |               |   |        |              |  |   |               |   |  |                |        |   |               |   |        |               |  |   |               |   |  |   |        |   |  |   |        |  
|-------------------------------------------- |  | --------------------------------- | ------ | - | ------------- | - | ------ | ------------ |  | - | ------------- | - |  | -------------- | ------ | - | ------------- | - | ------ | ------------- |  | - | ------------- | - |  | - | ------ | - |  | - | ------ | -
|                                             |  | Quarter Ended                     |       
|                                             |  | Sept. 30, 2005                    |        |   | Jun. 30, 2005 |   |        | Mar 31, 2005 |  |   | Dec. 31, 2004 |   |  | Sept. 30, 2004 |        |   | Jun. 30, 2004 |   |        | Mar. 31, 2004 |  |   | Dec. 31, 2003 |  
|                                             |  | (In thousands, except share data) |       
|                                             |  | (unaudited)                       |       
|Revenue                                      |  | $                                 | 2,897  |   |               | $ | 2,454  |              |  | $ | 1,800         |   |  | $              | 1,617  |   |               | $ | 1,094  |               |  | $ | 889           |   |  |   | 733    |   |  | $ | 534    |  
|Gross profit (loss)                          |  |                                   | 352    |   |               |   | (33    | )            |  |   | (539          | ) |  |                | (383   | ) |               |   | (551   | )             |  |   | (622          | ) |  |   | (355   | ) |  |   | (287   | )
|Loss from operations                         |  |                                   | (2,598 | ) |               |   | (2,425 | )            |  |   | (2,898        | ) |  |                | (2,636 | ) |               |   | (2,663 | )             |  |   | (2,824        | ) |  |   | (2,459 | ) |  |   | (1,972 | )
|Net loss                                     |  | $                                 | (2,834 | ) |               | $ | (2,947 | )            |  | $ | (3,119        | ) |  | $              | (2,846 | ) |               | $ | (2,812 | )             |  | $ | (2,951        | ) |  | $ | (2,513 | ) |  | $ | (1,985 | )
|Net loss per common share, basic and diluted |  | $                                 | (0.30  | ) |               | $ | (5.29  | )            |  | $ | (7.15         | ) |  | $              | (8.35  | ) |               | $ | (8.34  | )             |  | $ | (8.76         | ) |  | $ | (7.46  | ) |  | $ | (5.89  | )



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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE



Not applicable.



ITEM 9A. CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-15(e) of the Exchange Act of 1934, as amended) as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our
disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms.



Changes in Internal Control Over Financial Reporting. There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the period
covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



ITEM 9B. OTHER INFORMATION



Not
applicable.



PART III



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



The information required by this Item is incorporated by reference to the definitive proxy statement for our 2006 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days
after the end of our 2005 fiscal year, or the 2006 Proxy Statement.



Mr. Richard P. Powers failed to timely file a Form 3 related to his appointment as a director.



ITEM 11. EXECUTIVE COMPENSATION



The information required by this Item is incorporated by reference to the 2006 Proxy Statement.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS



The information required by this Item is incorporated by reference to the 2006 Proxy Statement.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



The information required by this Item is incorporated by reference to the 2006 Proxy Statement.



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES



The information required by this Item is incorporated by reference to the 2006 Proxy Statement.



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PART IV



ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS



| | (a)(1) | Financial Statements.
| | ------ | ---------------------



|                              |  |     
|----------------------------- |  | ----
|                              |  | Page
|Index to Financial Statements |  | 48  



| | (2) | Financial Statement Schedule.
| | --- | -----------------------------



Schedule IISchedule of Valuation and Qualifying Accounts



|                                 |  |                              |        |                   |   |                            |  |   |                        |   |  |   |       
|-------------------------------- |  | ---------------------------- | ------ | ----------------- | - | -------------------------- |  | - | ---------------------- | - |  | - | ------
|                                 |  | Balance atBeginningof Period |        | Charges toExpense |   | Write-OffsNet ofRecoveries |  |   | Balance atEnd ofPeriod
|Accounts receivable reserve      |  |                              |        |                   |   |                            |  |   |                        |   |  |   |       
|Year ended September 30, 2003    |  | $                            |       |                   | $ |                           |  | $ |                       |   |  | $ |      
|Year ended September 30, 2004    |  |                              |       |                   |   |                           |  |   |                       |   |  |   |      
|Year ended September 30, 2005    |  |                              |       |                   |   | 106                        |  |   | (35                    | ) |  |   | 71    
|Inventory reserve                |  |                              |        |                   |   |                            |  |   |                        |   |  |   |       
|Year ended September 30, 2003    |  | $                            |       |                   | $ | 89                         |  |   |                       |   |  |   | 89    
|Year ended September 30, 2004    |  |                              | 89     |                   |   | 109                        |  |   | (29                    | ) |  |   | 169   
|Year ended September 30, 2005    |  |                              | 169    |                   |   | 138                        |  |   | (299                   | ) |  |   | 8     
|Deferred Tax Valuation Allowance |  |                              |        |                   |   |                            |  |   |                        |   |  |   |       
|Year ended September 30, 2003    |  | $                            | 8,230  |                   | $ | 2,670                      |  |   |                       |   |  | $ | 10,900
|Year ended September 30, 2004    |  |                              | 10,900 |                   |   | 4,145                      |  |   |                       |   |  |   | 15,045
|Year ended September 30, 2005    |  |                              | 15,045 |                   |   | 4,917                      |  |   |                       |   |  |   | 19,962



All other schedules
are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.



(3) Exhibits.



|       |  |                                                                                                                                                 
|------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|3.2*   |  | Form of Amended and Restated Certificate of Incorporation as currently in effect.                                                               
|       | 
|3.4*   |  | Form of Amended and Restated Bylaws as currently in effect.                                                                                     
|       | 
|4.1*   |  | Specimen Common Stock Certificate.                                                                                                              
|       | 
|4.2*   |  | Amended and Restated Investor Rights Agreement dated February 7, 2005 by and among the Company and certain of its stockholders.                 
|       | 
|4.3**  |  | Form of Securities Purchase Agreement dated November 1, 2005 by and between the Company and each of the investors in its 2005 private placement.
|       | 
|4.4**  |  | Form of Warrant to Purchase Common Stock.                                                                                                       
|       | 
|10.1*  |  | Form of Indemnification Agreement by and between the Company and each of its directors and officers.                                            
|       | 
|10.2*  |  | 1997 Stock Plan, as amended.                                                                                                                    
|       | 
|10.3*  |  | 2005 Equity Incentive Plan.                                                                                                                     
|       | 
|10.4*  |  | Lease by and between the Company and Montague Oaks Associates Phase I & II dated February 11, 2004.                                             
|       | 
|10.5* |  | Physician Plus Agreement dated August 15, 2004 by and between the Company and Cardinal Health 200, Inc., as amended.                            



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|        |  |                                                                                                                               
|------- |  | ------------------------------------------------------------------------------------------------------------------------------
|        | 
|10.6*  |  | Distribution Agreement dated June 30, 2004 by and between the Company and Medline Industries, Inc.                            
|        | 
|10.7*  |  | Amended and Restated Distribution Agreement dated March 1, 2005 by and between the Company and Quality Assured Services, Inc. 
|        | 
|10.8*  |  | INR PST Supplier Agreement dated April 2, 2004 by and between the Company and Raytel Cardiac Services.                        
|        | 
|10.9*  |  | Manufacture and Supply Agreement dated March 7, 2005 by and between the Company and Haematologic Technologies, Inc.           
|        | 
|10.10* |  | Professional Service Agreement dated October 29, 2003 by and between the Company and Plexus Services Corp.                    
|        | 
|10.11* |  | Supply and License Agreement dated March 5, 1999 by and between the Company and Dade Behring Inc., as amended.                
|        | 
|10.12*  |  | Loan and Security Agreement No. 3821 dated March 5, 2004 by and between the Company and Lighthouse Capital Partners V, L.P.   
|        | 
|10.13*  |  | Settlement Agreement and Mutual Release dated July 16, 2004 by and between the Company and Inverness Medical Switzerland GmbH.
|        | 
|10.14*  |  | Consulting Agreement dated May 17, 2002 by and between the Company and Innovative Medical Product Consultants, GmbH.          



74



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##### Table of Contents

|        |  |                                                                                                                                                                                
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|        | 
|10.15*  |  | Non-Exclusive Sales Representative and Services Agreement dated November 12, 2002 by and between the Company and Innovative Medical Product Consultants, GmbH.                 
|        | 
|10.16* |  | Distribution Agreement dated April 1, 2003 by and between the Company and Inamed KG.                                                                                           
|        | 
|10.17*  |  | Employment Agreement dated June 3, 2002 by and between the Company and James D. Merselis.                                                                                      
|        | 
|10.18*  |  | Form of Change of Control Severance Agreement by and between the Company and its officers.                                                                                     
|        | 
|10.19*  |  | Consulting Agreement dated May 6, 2003 by and between the Company and Edward F. Brennan.                                                                                       
|        | 
|10.20*  |  | Amended and Restated Employment Agreement by and between the Company and James D. Merselis effective as of June 1, 2005.                                                       
|        | 
|10.21*  |  | Amended and Restated Management Retention Plan.                                                                                                                                
|        | 
|10.22*  |  | Form of Employment Agreement by and between the Company and its officers.                                                                                                      
|        | 
|10.23* |  | Letter Agreement by and between the Company and I-Med-Partner GmbH effective as of January 1, 2005.                                                                            
|        | 
|23.1    |  | Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm.                                                                                          
|        | 
|24.1    |  | Power of Attorney (see page 76)                                                                                                                                                
|        | 
|31.1    |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                            
|        | 
|31.2    |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                            
|        | 
|32.1    |  | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.

---

|* | Incorporated by reference from our Registration Statement on Form S-1 (Registration No. 333-123705), which was declared effective on June 28, 2005.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------

|** | Incorporated by reference from our Current Report on Form 8-K dated November 8, 2005.
|-- | -------------------------------------------------------------------------------------

| | Portions of the exhibit have been omitted pursuant to a request for confidential treatment. The confidential portions have been filed with the SEC.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                       |  |                 |  |                                                               
|---------------------- |  | --------------- |  | --------------------------------------------------------------
|                       |  | HEMOSENSE, INC.
|                       |  |                
|                       |  | By:             |  | /s/    JAMES
MERSELIS                                         
|                       |  |                 |  | James Merselis President, Chief Executive Officer and Director
|Date: December 2, 2005 |  |                 |  |                                                               



POWER OF ATTORNEY



KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints James Merselis and Paul Balsara, and each of them, his or her true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, to sign any and all amendments
(including post-effective amendments) to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact
and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby
ratifying and confirming all that said attorneys-in-fact and agents, or their substitute or substitutes, or any of them, shall do or cause to be done by virtue thereof.



Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates indicated:



|                                                      |  |                                                                                                 |  |                 
|----------------------------------------------------- |  | ----------------------------------------------------------------------------------------------- |  | ----------------
|Signature                                             |  | Title                                                                                           |  | Date            
|/s/    JAMES MERSELIS(James Merselis)                 |  | President, Chief Executive Officer and Director (Principal Executive Officer)                   |  | December 2, 2005
|                                                      |  |                                                                                                
|/s/    PAUL BALSARA(Paul Balsara)                     |  | Vice President of Finance, Chief Financial Officer (Principal Financial and Accounting Officer) |  | December 2, 2005
|                                                      |  |                                                                                                
|/s/    EDWARD F. BRENNAN(Edward F. Brennan, Ph.D)     |  | Director                                                                                        |  | December 2, 2005
|                                                      |  |                                                                                                
|/s/    GREGORY M.
AYERS(Gregory M. Ayers, M.D.,
Ph.D) |  | Director                                                                                        |  | December 2, 2005
|                                                      |  |                                                                                                
|/s/    RICHARD P.
POWERS(Richard P.
Powers)           |  | Director                                                                                        |  | December 2, 2005
|                                                      |  |                                                                                                
|/s/    ROBERT B.
ULRICH(Robert D. Ulrich,
Ph.D)       |  | Director                                                                                        |  | December 2, 2005
|                                                      |  |                                                                                                
|/s/    KURT C. WHEELER(Kurt C. Wheeler)               |  | Director                                                                                        |  | December 2, 2005



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