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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: December 31, 2006

or



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

For the transition period fromto

Commission file number: 0-28260



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EP MedSystems, Inc.

(Exact Name of Registrant as Specified in its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|New Jersey                                                     |  | 22-3212190                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|575 Route 73 North, Bldg. D, West Berlin, NJ                   |  | 08091                               
|(Address of Principal Executive Offices)                       |  | (Zip Code)                          

(856) 753-8533

(Issuers Telephone Number, Including Area Code)



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

Securities registered under Section 12(g) of the Act: Common Stock, no par value, stated value $.001 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ̈No  x

Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.     Yes ̈No  x

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 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):



|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large accelerated filer ̈ |  | Accelerated Filer ̈ |  | Non-accelerated filer  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 common stock held by non-affiliates of the registrant, based on the closing price of the registrants common stock
on June 30, 2006 as reported on the NASDAQ Capital Market, was approximately $42,913,000. In determining the market value of the registrants common stock held by non-affiliates, shares of common stock beneficially owned by directors,
officers and holders of more than 10% of the registrants common stock have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 28, 2007, there were outstanding 30,365,236 shares of the registrants common stock, no par value, stated value $.001 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our definitive Proxy Statement for our 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of our 2006 fiscal year are incorporated by
reference into Part III of this Annual Report on Form 10-K.



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TABLE OF CONTENTS



|         |  |                                                                                                |  |     
|-------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                |  | Page
|PART 1   |  | 5                                                                                             
|Item 1.  |  | Business                                                                                       |  | 5   
|         |  |                                                                                               
|Item 1A. |  | Risk Factors                                                                                   |  | 16  
|         |  |                                                                                               
|Item 1B. |  | Unresolved Staff Comments                                                                      |  | 27  
|         |  |                                                                                               
|Item 2.  |  | Description of Properties                                                                      |  | 27  
|         |  |                                                                                               
|Item 3.  |  | Legal Proceedings                                                                              |  | 28  
|         |  |                                                                                               
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                            |  | 30  
|         | 
|PART II  |  | 31                                                                                            
|         |  |                                                                                               
|Item 5.  |  | Market for Common Equity and Related Stockholder Matters                                       |  | 31  
|         |  |                                                                                               
|Item 6.  |  | Selected Financial Data                                                                        |  | 33  
|         |  |                                                                                               
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations          |  | 34  
|         |  |                                                                                               
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                     |  | 45  
|         |  |                                                                                               
|Item 8.  |  | Financial Statements and Supplementary Data                                                    |  | 46  
|         |  |                                                                                               
|Item 9.  |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure           |  | 46  
|         |  |                                                                                               
|Item 9A. |  | Controls and Procedures                                                                        |  | 46  
|         |  |                                                                                               
|Item 9B. |  | Other Information                                                                              |  | 46  
|         | 
|PART III |  | 47                                                                                            
|         |  |                                                                                               
|Item 10. |  | Directors, Executive Officers, and Corporate Governance                                        |  | 47  
|         |  |                                                                                               
|Item 11. |  | Executive Compensation                                                                         |  | 47  
|         |  |                                                                                               
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 47  
|         |  |                                                                                               
|Item 13. |  | Certain Relationships and Related Transactions and Director Independence                       |  | 47  
|         |  |                                                                                               
|Item 14. |  | Principal Accountant Fees and Services                                                         |  | 47  
|         | 
|PART IV  |  | 48                                                                                            
|         |  |                                                                                               
|Item 15. |  | Exhibits and Financial Statement Schedules                                                     |  | 48  



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Cautionary Statement Regarding Forward-Looking Statements

Certain statements contained in or incorporated by reference into this annual report are forward-looking statements and are made to comply
with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. Matters discussed in or incorporated by reference into this annual report that relate to events or developments that are expected to occur in the
future, including managements expectations, strategic objectives, business prospects, anticipated economic performance and financial condition and other similar matters constitute forward-looking statements. Forward-looking statements are
based on managements beliefs, assumptions and expectations of our future economic performance, taking into account the information currently available to management. These statements may be identified by the use of words like
plans, expects, aims, believes, projects, anticipates, intends, estimates, will,  should, could and other expressions
that indicate future events and trends. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future
results, performance or achievements expressed or implied by such forward-looking statements. These factors include:



| |  |  | We have a history of operating losses and expect future losses;
| | - |  | ---------------------------------------------------------------



| |  |  | We may need additional funds to support operations and may need to reduce operations, sell stock or assets, or merge with another entity to continue operations;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We may need to establish collaborative agreements;
| | - |  | --------------------------------------------------



| |  |  | Our success will depend on market acceptance of our existing and new products;
| | - |  | ------------------------------------------------------------------------------



| |  |  | We are required to obtain regulatory approvals in order to manufacture and market our products;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | We are primarily engaged in the sale of capital equipment and are subject to the budgetary cycles of our customers;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | Our profitability will depend on our ability to manufacture our products efficiently and economically;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | We depend on third-party sources to manufacture certain of our products and critical components of our products;
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | Our success depends on our ability to keep pace with technological developments and marketplace changes;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | Our patents and proprietary rights might not provide sufficient protection for our intellectual property;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | If we are unable to pay royalties, we may lose our rights to use certain important technology;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | Intellectual property litigation could harm our business;
| | - |  | ---------------------------------------------------------



| |  |  | We face significant competition, and many of our competitors have greater financial, marketing and other resources than we do.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Third-party reimbursement might be reduced or denied, which may reduce our revenues;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | We may lose key personnel, sales force and/or distributors;
| | - |  | -----------------------------------------------------------



| |  |  | We are subject to product liability claims;
| | - |  | -------------------------------------------



| |  |  | We are subject to risks associated with sales in multiple countries;
| | - |  | --------------------------------------------------------------------



| |  |  | Our export controls may not be adequate to ensure compliance with United States export laws;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | We have sold, and may continue to sell, our products into countries under embargo by the United States and have incurred, and may continue to incur, significant
legal, consulting and accounting fees and place our Companys reputation at risk;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | We are the subject of investigations by certain governmental authorities relating to our sale of goods into Iran without proper governmental authorization and may
face significant costs, fines and penalties as a result; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Other factors detailed in the section entitled Risk Factors in Item 1A below.
| | - |  | -------------------------------------------------------------------------------

Forward-looking statements speak only as of the date of the document in which they are made. We disclaim any obligation or undertaking to provide any
updates or revisions to any forward-looking statement, or to reflect any change in our expectations or any change in events, conditions or circumstances on which the forward-looking statement is based.



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PART I



|Item 1. | Business.
|------- | ---------

General

We were incorporated in New Jersey in January 1993 and operate in a single industry segment. We develop, manufacture and market a broad-based line of
products for the cardiac rhythm management, or electrophysiology (EP), market which are used to diagnose, monitor, visualize and treat irregular heartbeats known as arrhythmias. Since our inception, we have acquired technology, developed
new products and begun to market various electrophysiology products, including the EP-WorkMate system electrophysiology work station, sold stand-alone or integrated with various market leaders, the EP-4 Computerized Cardiac Stimulator,
diagnostic electrophysiology catheters (including our unique one-piece catheter), the ViewMate® II intracardiac ultrasound catheter system and related disposable supplies, and the ALERT® System (including the ALERT® Companion II and ALERT® family of internal cardioversion catheters).

Cardiac electrophysiology evaluates the electrical system of the heart and is mainly concerned with studying the cause and treatment of abnormalities in the hearts rhythm. Cardiac arrhythmias are caused by disturbances in the
electrical activation of the heart muscle that ultimately cause the heart to pump less efficiently. Cardiac rhythm disorders result in more than 1.2 million hospitalizations and 400,000 deaths each year in the United States, and account for
about 20% of all chronic heart conditions. These conditions are diagnosed and treated by electrophysiologists and cardiologists who specialize in the diagnosis and treatment of cardiac arrhythmias.

We have identified the diagnosis and treatment of atrial fibrillation, a particular type of arrhythmia, as an area of interest for our ongoing
development, clinical and sales efforts. Atrial fibrillation is a condition where waves of energy collect within the atria, the upper chambers of the heart, causing erratic electrical signals that prevent the atria from providing appropriate blood
flow output. Atrial fibrillation is the most prevalent type of abnormal heart rhythm and is estimated to afflict over 5,000,000 people worldwide (of whom approximately 2,000,000 live in the United States) with an estimated 300,000 to 400,000 new
cases diagnosed each year. Although not immediately life-threatening, patients with atrial fibrillation may exhibit symptoms which include palpitations, fatigue and dizziness. Atrial fibrillation is linked to a significantly increased risk of stroke
and to a diminished lifestyle due to decreased cardiac output. We have developed three product platforms to address this and other markets.

Our core diagnostic product is the EP-WorkMate system, a computerized electrophysiology workstation that monitors, displays and stores cardiac electrical activity and arrhythmia data. The EP-WorkMate system offers, among other features,
display and storage of up to 192 intracardiac signals, real-time diagnosis, analysis and integration with our own proprietary systems, such as our EP-4 Stimulator, as well as with those of market leaders, such as Philips Medical Systems Allura
x-ray system, and with other technologies and systems. In the fourth quarter of 2006, we received market clearance from the United States Food and Drug Administration (FDA) to sell the MapMate interface in the United States. The MapMate integrates J & Js Biosense
Divisions CARTO Mapping navigation system, allowing EP studies to be more efficient and user friendly. In March of 2004, we received market clearance from the FDA to sell the EP-4 Computerized Cardiac Stimulator. The EP-4 Stimulator is a
computerized signal generator and processor which, when integrated with the EP-WorkMate system, is used to stimulate the heart with electrical impulses in order to locate arrhythmias. We believe that the EP-WorkMate system, when integrated with the
EP-4 Stimulator, offers the most advanced diagnostic computer system available to the electrophysiology market. During 2006, the EP-WorkMate system with various integrations and the EP-4 Stimulator accounted for approximately 85% of our total sales.
We also market a line of diagnostic electrophysiology catheters for stimulation and sensing of electrical signals during electrophysiology studies, which represented approximately 2% of our total sales revenues in 2006.

We also offer the ViewMate® intracardiac echo (ICE) catheter system consisting of the ViewMate® ultrasound imaging console and ViewFlex intracardiac imaging catheters. These products offer high-



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resolution, real-time ultrasound capability designed to improve a physicians or clinicians ability to visualize the inside of the chambers of the
heart. We believe that the ViewMate® ultrasound
system may play an important diagnostic role for a broad range of potential applications in electrophysiology and cardiology. Sales of the ViewMate system and related ViewFlex catheters accounted for approximately 9% of our total sales revenues in
2006. In January 2007, we announced the new ViewMate II ultrasound system based on Philips Medical Systems HDII XE platform. Philips will act as an original equipment manufacturer (OEM) with respect to the product, which will be
sold under our proprietary name ViewMate II. As part of the joint development and distribution agreement, Philips may offer the ICE option to its customers on the HDII XE ultrasound system, providing an additional customer base for our View-Flex
catheters.

We also offer a product for the treatment of atrial fibrillation known
as the ALERT System, which uses a patented electrode catheter to deliver measured, variable, low-energy, bi-phasic electrical impulses directly to the inside of the heart to convert atrial fibrillation to a normal heart rhythm. We obtained Class III
Design Examination Certification from a European Notified Body allowing us to label the ALERT System with a CE Mark, an international symbol of adherence to quality assurance standards, design reviews and hazard analysis, which permits us to sell
the ALERT System in the European Community. Sales of the ALERT System and related catheters accounted for approximately 4% of our total sales revenues in 2006. Due to limited resources and the potential of our other products, we will continue to
service the installed base of the ALERT System products, but will not expend significant company resources on this product line at this time.

Company
Strategy

The mission of EP MedSystems, Inc. is to develop, manufacture and market the most technologically advanced diagnostic,
therapeutic and visualization solutions to the cardiac rhythm management marketplace. Our strategy is to position our products as the platform of choice for electrophysiologists and cardiologists by making the systems user friendly and
technologically advanced, and by integrating the products with the latest technology. We believe that we have developed a reputation for innovation, quality and service in the area of electrophysiology.

Use core products as a platform for growth. We believe the EP-WorkMate system is a central platform for future EP technology. This diagnostic
workstation is at the center of todays EP lab, and we have over 800 WorkMates installed worldwide. Our objective is to leverage this installed base, with our new products as well as with upgrades of innovative technologies in a cost-effective
manner to hospitals around the globe.

Integrate with market leaders. Our base platforms allow for integration with the products of
other market leaders in electrophysiology. Through our MapMate product, we have integrated our EP-WorkMate system with J&Js Biosense Divisions CARTO Mapping navigation system, allowing electrophysiology studies to be more efficient
and user friendly. In April 2005, we announced a joint development agreement with Philips Medical Systems Nederland B.V. (Philips Medical Systems), a subsidiary of Koninklijke Philips Electronics N.V., to integrate its Allura X-ray
system with our EP-WorkMate system resulting in the next generation of an integrated electrophysiology lab. In the past we have also integrated our products with products from Boston Scientific Corporation, Witt and others.

Expand clinical applications of new products. We believe there are numerous potential applications for our products. Potential applications for
the ViewMate II intracardiac ultrasound catheter system include the following: advanced EP ablation procedures; minimally invasive repair or replacement of heart valves; removal of pacemaker leads; minimally invasive (catheter) repairs of atrial
septal defects; catheter closure of patent foramen ovale; minimally invasive procedures to close off the left atrial appendage; evaluation of thrombus in the heart and assistance in the optimal placement of left ventricular pacemaker leads in
treating congestive heart failure. We intend to leverage these potential applications by selling our existing products for new medical conditions and to new customers that have not traditionally been our targets.



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Execute an efficient sales channel strategy using strategic alliances. We believe entering into
strategic alliances with market leaders creates an efficient and effective sales channel for our core products and our new products in areas outside of electrophysiology, such as interventional cardiology and critical care. For example, we have a
strategic alliance with Philips Medical Systems which combines their cardiovascular x-ray technology with our EP recording and data management systems which enables us to market the integrated electrophysiology lab and our related products through
that state-of-the-art platform.

Products

Our products can be separated by technology into the categories described below for the diagnosis, treatment and visualization of cardiac arrhythmias.

Electrophysiology Computer Workstations, Stimulators and 3D Navigation and Mapping Technology

EP-WorkMate system. The EP-WorkMate system is a computerized electrophysiology workstation that monitors, displays and stores cardiac electrical activity and arrhythmia data. Electrophysiology workstations are
dedicated data management systems designed specifically for use in electrophysiology procedures to view and record procedural data, facilitate data analysis and generate customized reports. The EP-WorkMate system offers, among other features,
display and storage of up to 192 intracardiac signals, real-time analysis, including graphical and quantitative display of such data, superior ease of use and a single keyboard for all operations, as well as integration capacity with our own
proprietary products, such as the EP-4 Stimulator and other technologies and systems. The EP-WorkMate system consists of a Dual Xenon®processor with integral proprietary software, a proprietary signal-conditioning unit, two or three high-resolution LCD color monitors, an optical disk drive for data storage, a custom keyboard,
catheter and catheter interface module and a laser printer. In addition, each EP-WorkMate system has an internal modem to provide a direct link between the purchaser and EP Med, facilitating field software support. The EP-WorkMate system is
differentiated from competing products by (i) its seamless integration with the EP-4 Stimulator, (ii) its storage capacity of up to 192 intracardiac signals, (iii) its ability to process and simultaneously display both real-time and
historical electrophysiology activity, (iv) its simple, user friendly software based on a menu driven, point-and-click interface, and (v) its integration with other products in the EP lab.

EP-4 Computerized Cardiac Stimulator. Our EP-4 Stimulator is a computerized electrical pulse signal generator and processor which, when integrated
with the EP-WorkMate system, is used to stimulate the heart with electrical impulses in order to locate electrical disturbances or arrhythmias. We believe the EP-4 Stimulator is currently the only fully integrated computerized EP clinical stimulator
being sold in the United States. It features automatic synchronization and rate controls as well as the same user interface as the EP-WorkMate system. The EP-4 Stimulator can be sold as a stand-alone electrophysiology stimulator or it can be
integrated with the EP-WorkMate system. We believe that the EP-WorkMate system, when integrated with the EP-4 Stimulator, offers the most advanced computer system available to the electrophysiology market.

MapMate.In the fourth quarter of 2006, we received market clearance from the FDA to sell the MapMate interface in the United States. The MapMate
interface enables our EP-WorkMate system to share information, log data and generate a common report with the CARTO Mapping navigation system sold by J&Js Biosense Division. The combination offers more comprehensive clinical management,
enhanced efficiency and simplified records.

We have also integrated our EP-WorkMate system with Philips Medical Systems Allura x-ray
system. It is the only EP recording system on the market to integrate advanced recording, stimulation, mapping, navigation and x-ray allowing electrophyscology studies to be more efficient and user friendly.

In 2006, we derived approximately 85%, of our revenues from electrophysiology computer workstations, stimulators and 3D navigation and mapping
technologies.



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Ultrasound Products

We have identified intracardiac ultrasound imaging as a necessary adjunct to the advanced treatment of cardiac arrhythmias, especially for the treatment of atrial fibrillation and ventricular tachycardias. We also
believe that ultrasound imaging may assist in the permanent implantation of pacemaker electrodes in the left side of the heart. Fluoroscopy imaging, the primary visual image used in electrophysiology today, is unable to identify anatomic structures
of the heart (such as the ostium of the coronary sinus, the superior and inferior vena cava, pulmonary veins, valves, infarcts, and the fossa ovalis, among others) and is unable to assess lesions created by the physician. In addition, fluoroscopy
imaging is not adept at assessing catheter placement in relation to certain anatomy. We believe that intracardiac ultrasound imaging may overcome these deficiencies, and that this is important in light of the increased complexity of advanced
electrophysiology procedures.

In 2003, we began offering in the United States and Europe an intracardiac ultrasound product line, which
includes the ViewMate ultrasound imaging console and ViewFlex intracardiac imaging catheters. These products offer high resolution, real-time ultrasound capability designed to improve a physicians or clinicians ability to view the inside
of the chambers and anatomic structure of the heart safely and accurately without the need to expose patients, physicians or clinicians to repeated x-ray radiation. The increased visualization is a result of having the catheter inside the heart
itself, thereby having cardiac features in the near field or its area of highest image resolution and detail. By manipulating the catheter tip and its phased array ultrasound crystal, the physician or clinician will not only be able to visualize the
entire heart but will also be able to direct the wedge-shaped ultrasound beam at specific areas of interest. Additionally, our color Doppler mode allows verification of heart valve patency and blood flow direction and velocity. We believe the
ViewMate Ultrasound System may play an important diagnostic role for a broad range of potential applications in electrophysiology and cardiology. In 2006, we derived approximately 9% of our revenues from our ultrasound products.

In January 2007, we announced the new ViewMate II ultrasound system based on Philips Medical Systems HDII XE platform. Philips will OEM the product
to be sold under our proprietary name ViewMate II. As part of the joint development and distribution agreement, Philips may offer the ICE option to its customers on the HDII XE ultrasound system, providing an additional customer base for our
ViewFlex catheters.

Other Product lines

The ALERT System. The ALERT System employs an approach to electrical cardioversion known as low-energy internal cardioversion, which uses a patented electrode catheter to deliver measured, variable, low-energy bi-phasic electrical
impulses, programmable electrical energy, from one to 15 joules, directly to the inside of the heart to convert atrial fibrillation to normal heart rhythm. The ALERT System is comprised of a single-use proprietary electrode catheter with two
separate electrode arrays (the ALERT PA Catheter) and an external energy source (the ALERT Companion). Due to limited resources and the potential of our other products, we will continue to service the ALERT installed base,
but will not expend significant company resources on this product line at this time.

In 2006, we derived approximately 4% of our revenues
from our ALERT System products.

Diagnostic Catheter Products.We market a line of diagnostic electrophysiology catheters for
stimulation and sensing of electrical signals during electrophysiology studies. Our diagnostic catheters are similar to others sold within the industry, with the exception of our one-piece catheter design which offers the physician unique recording
capabilities. We offer numerous electrode/curve configurations of catheters. We also offer a line of deflectable diagnostic catheters, which allow the physician to deflect its tip to steer the catheter into certain vessels and areas of the heart,
which would be difficult with a fixed curve catheter.

In 2006, we derived approximately 2% of our revenues from our diagnostic catheter
products.



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Certain Patents, Trademarks and Licenses

Patents. Our success and ability to compete depend, in part, upon our ability to protect our proprietary positions. Our policy is to protect our
proprietary position by, among other methods, filing United States and select foreign patent applications to protect the technology that is important to the development of our business. Patents in force on June 8, 1995 are entitled to a patent
term of the longer of 17 years from issuance or 20 years from the earliest filing date of the patent, while patents issuing thereafter are entitled to a term of 20 years from the earliest filing date. We currently hold title, or rights under license
or similar agreements, to 27 United States patents and patent applications filed with the United States Patent and Trademark Office. The last to expire of our patents will remain in effect until December 2024. We have also obtained certain
patents in our principal overseas markets. The expiration dates on our patents range from 2013 to 2024.

We will continue to seek patents
as we deem advisable to protect our research and development efforts and to market our products. There can be no assurance that any of our patent applications or applications as to which we have acquired licenses will issue as patents, or that if
patents are issued that they will be of sufficient scope and strength to provide us with meaningful protection of our technology or any commercial advantage, or that such patents will not be challenged, invalidated or circumvented in the future.
Moreover, there can be no assurance that our competitors, many of which have substantial resources and have made substantial investments in competing technologies, do not presently have or will not seek patents that will prevent, limit or interfere
with our ability to make, use or sell our products either in the United States or in other countries. In addition, there can be no assurance that current and potential competitors have not filed or in the future will not file applications or apply
for patents or additional proprietary rights relating to devices, apparatus, materials or processes used or proposed to be used by us.

Licenses and other Technology Agreements. We are also a party to certain license agreements which provide us with rights under selected patents of third parties with regard to technology we consider important to our business. Such
license agreements are summarized below.



| |  |  | Pursuant to a license agreement with Eckhard Alt, M.D., dated as of November 1, 1995, and subsequently amended, Dr. Alt granted us an exclusive, worldwide
license relating to certain technology used in connection with the ALERT System, some of which has since become protected under four issued United States patents and one patent application pending in the European Patent Office and for which
additional patent applications and continuations have been filed. The license agreement provides that we shall pay royalties equal to 5% of quarterly net sales of all products covered by the licensed technology until the expiration of the last to
expire of any licensed patents covered by the agreement or the earlier declaration of invalidity of such patent. Under the terms of this license agreement, EP Med has the right to sublicense this technology to third parties and in such case EP Med
is obligated to pay to Dr. Alt the greater of a 2% royalty or 50% of the total sublicense royalties derived from the sublicense agreement. The term of this license agreement will continue for the life of the last to expire of the licensed
patents covered by the agreement unless earlier terminated by either party due to breach by the other party, which breach remains uncured for a period of 60 days.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In December 2005, we terminated a license agreement under which we had licensed a patent and technology used in our SilverFlex catheters because we have
decided not to commit resources to make the product commercially viable.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pursuant to an agreement, dated September 5, 2002, with Boston Scientific Corporation (BSC), we received a license from BSC to integrate their
RPM Technology with our EP-WorkMate system to make, use, sell and distribute the integrated recording system. This agreement provides that, under certain conditions, the license becomes exclusive. The agreement also provides for a royalty
payable to BSC based on the type of product sold in accordance with the agreement. The agreement terminates on the date the patent rights (a) expire, (b) are disclaimed, (c) are cancelled, or (d) are held invalid by a court of
competent jurisdiction. Otherwise, the agreement may be terminated by either party in the event of a material breach, subject to notification and cure period, and in the event of a change in control.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | In December 2003, we entered into a marketing agreement with Philips Medical Systems Nederland B.V., a subsidiary of Koninklijke Philips Electronics N.V.,
(Philips) to sell our EP-WorkMate system in combination with Philips x-ray fluoroscopy product. Pursuant to the agreement, Philips will purchase certain products and parts from us, and will then resell these products and parts to
their customers. In connection with the agreement, we granted Philips a personal, revocable, worldwide, non-exclusive right to sublicense our software and related products to customer end-users in the territory (as defined in the agreement). The
purchase by Philips of our products will also confer on Philips, its affiliates, distributors, agents and customers an irrevocable, royalty-free, non-exclusive, non-transferable license in the territory under our patent applications, patents,
copyrights, trade secrets, trademarks or other intellectual property rights we own or control, solely to market, sell, distribute or otherwise dispose of such products and service parts in accordance with the terms of the agreement. We have also
granted Philips the right to use our trademarks, trade names and service marks during the term of the agreement. The agreement was renewed for another year in December 2006, subject to annual renewal options, and can be terminated by Philips,
subject to certain notice and cure periods, for certain reasons, including, among others, non-competitiveness, change of control and cause.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In December 2005, we entered into a software development, license and distribution agreement with Biosense Webster, Inc. (Biosense) pursuant to which we
received a license to interface certain aspects of their CARTO XP Mapping System and the right to distribute the interface kit worldwide, subject to certain restrictions. Under the agreement, Biosense has the right to sell the interface hardware
component of the interface kit in post sales service calls. Under the agreement, we will pay a formula-based royalty to Biosense. The agreement has a term lasting 2 years from our first distribution of an interface kit, unless otherwise terminated
pursuant to its terms. The agreement is renewable upon the mutual agreement of Biosense and us. In the event of termination of the agreement, we may ship all backlog orders and honor all quotes up to six months following the original quote date.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In January 2007, we entered into a joint development and distribution agreement with Philips Medical Systems (PMS) pursuant to which we agreed to form
an integrated product between the HD11 XE and ViewFlex catheter and grant each other a free nonexclusive license, without right to grant sublicenses, for certain ultrasound base technologies as defined in the agreement. The distribution agreement
provides for our purchase of the PMS HD11 XE ultrasound system under our proprietary name ViewMate II and sales of those units into territories in the United States as defined in the agreement. The distribution agreement also allows for the sale by
PMS of certain of our products into territories in the United States as defined in the agreement. The purchase of PMS products confers on us the use of trade names, trademarks subject to defined limitations. The contract has a term of three years
from the effective date, subject to renewal options, with and can be terminated with notice 180 days from the end of the term. The contract includes indemnifications and provisions in the normal course of business for an OEM contract.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We also rely upon technical know-how and continuing technological innovation to develop and maintain our position in the
market, and we believe the success of operations will depend largely upon such know-how and innovation. We require employees and consultants to execute appropriate confidentiality agreements and assignments of inventions in connection with their
employment or consulting arrangement with us. There can be no assurance that trade secrets will be established, that secrecy obligations will be honored or that competition will not independently develop superior or similar technology.

Trademarks. We use various trademarks in association with marketing and sale of our products. The following trademarks include those which have
been registered with the United States Patent and Trademark Office, and those which are unregistered trademarks of EP Med:

Registered
Trademarks: EP-WorkMate system®, ALERT® System, SilverFlex®, ViewMate®, Ice Cubed®

Unregistered Trademarks:
EP-3 Stimulator, EP-4 Computerized Cardiac Stimulator, MapMate Interface and ViewFlex, NurseMate, Remote Review and Charting WorkStation



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The market for medical devices for the treatment of cardiovascular disease has been characterized by
frequent litigation regarding patent and other intellectual property rights. In the event that claims of infringement of a third-partys rights are made and upheld, we could be prevented from exploiting the technology or other intellectual
property involved, or could be required to obtain licenses from the owners of such intellectual property. Alternatively, we could be forced to redesign our products or processes to avoid infringement. There can be no assurance that such licenses
from the owners of such intellectual property would be available or, if available, would be on terms acceptable to us or that we would be successful in any attempt to redesign our products or processes to avoid infringement. Litigation may be
necessary to defend against claims of infringement, to enforce patents issued to us or to protect trade secrets and could result in substantial cost to, and diversion of effort by, us.

Research and Development

The electrophysiology market is characterized by rapid technological
change, new product introductions and evolving industry standards. To compete effectively in this environment, we engage in the continuous development of products by (i) conducting internal research and development or contracting with third
parties for specific research and development projects, (ii) licensing new technology, and (iii) acquiring products incorporating technology that could not otherwise be developed as quickly using internal resources.

Our expenditures for research and development (which include expenditures for regulatory affairs and engineering) totaled approximately $2,738,000,
$2,374,000, and 2,470,000 for the years ending December 31, 2006, 2005, and 2004, respectively. Expenditures in 2004, consisted primarily of upgrades to existing product lines. Expenditures in 2005 consisted primarily of additional headcount in
the regulatory and quality assurance departments. Additionally, other research and development efforts are ongoing to enhance existing products and lower production costs and integrate our products with others in the industry. Expenditures in 2006
consisted primarily of costs associated with the integration of Philips HDII XE with our ViewFlex catheters, testing of catheters and additional compensation costs associated with a higher head count and the expensing of share-based compensation.

Sales, Marketing and Distribution Methods

Domestic. We primarily utilize our own direct sales and marketing force to sell and promote our products in the United States market. Within each hospital, the sales and marketing effort is directed at those physicians, primarily
electrophysiologists, most likely to use our products. We entered into group purchasing organization (GPO) contracts with Broadlane and Premier, Inc. These GPOs are an alliance of various hospital networks and the contracts allow us access to
their hospitals to market to their physicians. We expect to concentrate our marketing efforts on the roll out of our new products, including the EP-WorkMate system integrated with various market leaders, and the ViewMate II Intracardiac ultrasound
system. To support these sales, we intend to employ physician/clinician training and education, clinical trials, promotional materials, sample products, demo and service equipment and increased direct sales and marketing efforts, among others.

Strategic Alliances. We believe entering into strategic alliances with market leaders creates an efficient and effective sales
channel for our core products and our new products in areas outside of electrophysiology, such as interventional cardiology and critical care. To build these sales channels, we have entered into alliance agreements with Philips Medical Systems and
Biosense Webster. See Certain Patents, Trademarks and Licenses. There can be no assurances that those relationships will continue indefinitely or that strategies for these companies will not change, possibly impacting our business.

International. We utilize a network of independent distributors to sell our products internationally. The distributor agreements
specify territory, terms, products and minimum sales and can be terminated by both sides as agreed in the contract. While we do not consider any single distributor arrangement to be material to our business, we might not be able to replace existing
distributors on a timely basis if present relationships are



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terminated. Further, we might not be able to make arrangements with new distributors to access new international markets and both current and future
distributors might not be successful in actively and effectively marketing our products. We have branch offices in France and the United Kingdom which are staffed with a sales manager and an office manager, respectively. We also utilize our own
direct sales and marketing force, as well as sales agents, to sell and promote our products in France. We feel this favorably impacts distributor relationships and European service needs in a shorter response time and assists in promotion of our
products in Europe.

No assurance can be given that either we or our distributors can successfully sell the EP-WorkMate system integrated
or stand alone, EP-4 Stimulator, ViewMate II or ALERT or ViewFlex catheters or other products in Europe or elsewhere on terms acceptable to us, or at all. Foreign sales are subject to certain significant risks, including exchange rate fluctuations,
local medical reimbursement issues, duties, tariffs and taxes, import restrictions, United States export control licensing requirements and related restrictions, laws and regulations, and other regulations, each of which could have a material
adverse impact on our business, financial condition and results of operations.

Customers

We sell our products directly to medical institutions and physicians in the United States and France which then bill various third-party payers, such as
government programs and private insurance plans. See the Section entitled Third-Party Reimbursement. Outside of the United States and France we sell to a network of distributors. Our distributors are located in Europe, the Middle East
and Asia. We derived approximately $4,354,000, $3,752,000 and $3,618,000 of our revenues in 2006, 2005 and 2004, respectively, from customers located in countries other than the United States.

Manufacturing and Sources of Supply

We assemble and
test our products at our West Berlin, New Jersey facility, which is certified to the ISO-13485 Quality System Standard that is recognized by the regulatory bodies in the European Union, Canada and other countries. Although we believe that we have
sufficient capacity to satisfy our current manufacturing needs, we have no experience in large-scale manufacturing and there can be no assurance that we would be successful in manufacturing products in significant volume. Certain critical components
of our products are obtained from outside sources, such as computers, high-resolution monitors and laser printers that are typically available from more than one vendor. We also rely on third-party sources to manufacture critical components for the
EP-4 Stimulators, ViewMate II and its ViewFlex catheter, and EP-WorkMate system. Any interruption in the supply of such products or components would have a material adverse effect on our ability to deliver those products or the products in which
such components are used and could materially adversely impact our sales and gross margins. If any interruption were to occur, we may not be able to reach an acceptable arrangement with an alternative source of supply on a timely basis, which could
have a material adverse effect on our business, results of operations and financial condition. During 2006, we discovered non-conforming material from a supplier of a critical component for our ViewFlex catheter. We expect to resolve this issue in
the second quarter of 2007.

Government Regulation

United States

Our West Berlin, New Jersey facility and the quality assurance procedures in effect at that facility are
subject to good manufacturing practices (GMP) regulations and quality system regulations promulgated by the FDA.

We have
market approval from the FDA for the marketing and sale of the EP-WorkMate system EP-4 Stimulator, ViewMate, ViewMate II, ViewFlex Catheter, MapMate, NurseMate products, as well as other products in the United States.



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The process of obtaining and maintaining required regulatory approvals can be expensive, uncertain and
lengthy, and there can be no assurance that we will ever obtain the approvals we seek. If such approvals are obtained, there can be no assurance that we will be able to maintain them. Delays in receipt of, or failure to receive, such approvals, the
loss of previously received approvals, or failure to comply with existing or future regulatory requirements would have a material adverse effect on our business, financial condition and results of operations. Changes in existing requirements or
adoption of new requirements also could have a material adverse effect on our business, financial condition, and results of operations.

In
addition, there can be no assurance that the FDA will not impose strict labeling requirements, onerous operator training requirements or other requirements as a condition of its pre-market approval, any of which could limit our ability to market our
products.

We initiated a field action recall for its stimulator product in March 2006. This field action consists of an upgrade of the
installed base in a phased process and consisted of bringing the units in-house and making certain modifications.

In addition, the FDA
performed an audit of the subject facility and issued us a report containing several observations and we have responded to this report. As a result of this audit, the FDA sent us a Warning Letter that identified certain issues with respect to our
conformity with the FDAs quality system regulations and certain reporting requirements. The FDA requested a written plan outlining the steps to address the issues identified in the letter. We have undertaken steps toward addressing the
observations from the FDAs audit of our Companys facility and have responded to the FDAs request for a written plan. Failure to promptly address these issues may result in regulatory action including but not limited to seizure,
injunction and/or civil monetary penalties. Subject to confirmation by a follow-up inspection by the FDA, we believe that we can fully address the concerns of the FDA without a material impact to our business.

International

In order to market products in Europe
and certain other foreign jurisdictions, we must obtain required regulatory approvals and clearances and otherwise comply with extensive regulations regarding safety and manufacturing processes and quality. These regulations, including the
requirements for approvals or clearance to market and the time required for regulatory review, vary 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. Foreign countries also often have extensive regulations regarding safety, manufacturing processes and quality that differ from those in the United States and must be met in order to continue sale of a product within the
country. The European Economic Community has instituted the requirement that all medical products sold into the European Union comply with the Medical Device Directive which requires that all such products be labeled with the CE Mark. The CE Mark
designation allows us to market that product in countries that are members of the European Union and the European Free Trade Association. There can be no assurance that we will be successful in maintaining the CE Mark certifications that we
currently have or that we will be able to obtain the CE Mark certification on newly developed products.

There can be no assurance that we
will obtain regulatory approvals in countries that require compliance with the laws of that country or that we will not be required to incur significant costs in obtaining or maintaining our foreign regulatory approvals. Delays in the receipt of
approvals to market our products or failure to maintain these approvals could have a material adverse impact on our business, financial condition or results of operations.

Other Regulation

We are also subject to numerous federal, state and local laws relating to such
matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. We have not incurred significant costs to date in order to comply with such



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laws. There can be no assurance that we will not be required to incur significant costs to comply with such laws and regulations in the future or that such
laws and regulations will not have a materially adverse effect upon our ability to do business.

Third-Party Reimbursement

In the United States, our products are marketed to medical institutions and physicians that then bill various third-party payers, such as government
programs (principally Medicare and Medicaid) and private insurance plans, for the healthcare services provided to their patients using our products. Third-party payers are increasingly challenging the prices charged for medical products and
services, and substantial uncertainty exists as to third-party reimbursement for newly approved products. Government agencies, private insurers and other payers generally reimburse medical institutions for medical treatment at a fixed rate per
patient or based on the procedures performed. The fixed rate reimbursement is unrelated to the specific devices used in treatment. If a procedure is not covered, payers may deny reimbursement. In addition, some payers may deny reimbursement if they
determine that the device used in the treatment was unnecessary, inappropriate or not cost-effective, or if it was experimental or was used for a non-approved indication, even if it has approval from the FDA. Because the amount of the reimbursement
is fixed, to the extent a physician uses more expensive devices, the amount of potential profit relating to the procedure is reduced. Accordingly, medical institutions must determine that the clinical benefits of more expensive equipment justify the
additional cost. Additionally, even if a procedure is eligible for reimbursement, the level of reimbursement may not be adequate.

Our
ViewFlex intracardiac ultrasound catheter could be considered an expensive catheter and may, depending on the procedure, add significant costs to that procedure. We may be required to economically justify the additional costs of using the
ViewFlex by demonstrating the benefits to healthcare providers and payers in terms of such factors as patient procedural efficiencies, more desirable images, improved patient outcomes and lower overall costs with respect to other methods of
visualizing the internal anatomy of the heart.

Reimbursement systems in international markets vary significantly by country and by region
within some countries, and reimbursement approvals must be obtained on a country-by-country basis. Many international markets have government managed health care systems that control reimbursement to medical institutions and physicians for new
products and procedures. In most markets, there are private insurance systems as well as government managed systems. Market acceptance of our products will depend on the availability and level of reimbursement in targeted international markets.
There can be no assurance that our products will obtain reimbursement in any country within a particular time, for a particular time, for a particular amount, or at all.

We believe less-invasive catheter-based procedures generally provide a more cost-effective overall treatment when compared to conventional drug, surgical, and other treatments. Many hospital administrators and
physicians justify the use of our products by the attendant cost saving and clinical benefits that they believe will be derived from the use of our products. However, we cannot provide assurance that these cost-savings and clinical benefit
assumptions will, in fact, be realized. Reimbursement for our products is not assured in some international markets under either government or private reimbursement system, and health care providers may not advocate reimbursement for procedures
using our products. Failure by hospitals in the United States or in international markets and other users of our products to obtain reimbursement from third-party payers, or changes in government and private third-party payers policies toward
reimbursement for procedures employing our products, would have a material adverse effect on the Companys business, financial condition and results of operations. Moreover, we are unable to predict what additional legislation or regulation, if
any, relating to the health care industry or third-party coverage and reimbursement may be enacted in the future, or what effect such legislation or regulation would have on the Company.

Political, economic and regulatory influences are subjecting the health care industry in the United States to increased scrutiny. We anticipate that
Congress, state legislatures and the private sector will continue to review and assess alternative health care delivery and payment systems. Potential approaches that have been considered



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include mandated basic health care benefits, controls on health care spending through limitations on the growth of private health insurance premiums and
Medicare and Medicaid spending, greater reliance on prospective payment systems, the creation of large insurance purchasing groups, price controls and other fundamental changes to the health care delivery system. Legislative debate is expected to
continue in the future, and market forces are expected to demand reduced costs. We cannot predict what impact the adoption of any federal or state health care reform measures, future private sector reform or market forces may have on our business.
There can be no assurance that substantial reimbursement will be or will remain available for our products or that, even if reimbursement is available, payers reimbursement policies will not adversely affect our ability to sell our products on
a profitable basis.

Competition

The
medical device market, particularly in the area of cardiac electrophysiology, is highly competitive, as the market is characterized by rapid product development and technological change. Our present or future products could be rendered obsolete or
uneconomic by technological advances by one or more of our present or future competitors or by other therapies. Our future success will depend upon our ability to remain competitive with other developers of such medical devices and therapies. We
believe that our existing products compete primarily on the basis of features, effectiveness, quality, ease and convenience of use, customer service and cost effectiveness.

In the computerized electrophysiology workstation and electrophysiology stimulator market, our main competitors are Marquette-Prucka (a division of
General Electric) and C.R. Bard Inc. In intracardiac ultrasound, we compete with Siemens Medical Solutions, but others may enter this market. Our primary competitors in the markets for EP catheters and disposable accessories are C.R. Bard Inc., EP
Technologies, Inc. (a subsidiary of Boston Scientific Corporation), Medtronic, Inc., Biosense Webster, Inc. and Daig Corporation (a subsidiary of St. Jude Medical, Inc.).

Many of our competitors have substantially greater financial and other resources, larger research and development staffs, and more experience and
capabilities in conducting research and development, testing products in clinical trials and manufacturing, marketing and distributing products than we do. Competitors may develop newer and more effective technologies than we do, bring products to
market before we do and introduce products that are more effective than our new or existing products. In addition, competitive products may be manufactured and marketed more successfully than our products. Our business will depend upon our ability
to remain competitive with other developers of such medical devices and therapies.

Product Liability and Insurance

The manufacture and sale of our products involves the risk of product liability claims. Our products are highly complex and some are, or will be, used in
relatively new medical procedures and in situations where there is a potential risk of serious injury, adverse side effects or death. Misuse or reuse of catheters may increase the risk of product liability claims. Currently, we maintain product
liability insurance with coverage limits of $5,000,000 per occurrence and $5,000,000 in the aggregate per year; however, there can be no assurance that this coverage will be adequate. Such insurance is expensive and may not be available in the
future on acceptable terms, if at all. A successful claim against or settlement by EP Med in excess of our insurance coverage, or our inability to maintain insurance in the future, could have a material adverse effect on our business and financial
condition.

Employees

At
December 31, 2006, EP Med had 86 full-time employees and one part-time employee, of whom 20 were dedicated to manufacturing and logistics, 14 represented executive management and administration, 32 were



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engaged in sales, marketing, clinical applications and customer service, and 20 were engaged in research and development, regulatory affairs, and quality
assurance. We believe our employee relations are satisfactory.



|Item 1A. | Risk Factors
|-------- | ------------

In addition to the other
information set forth in this annual report, you should carefully consider the following factors that could materially affect our business, financial condition or future results. The risks and uncertainties described below are not the only risks and
uncertainties that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also impair our business, financial condition and results of operations.

Risks Related to Our Business

We have a history of operating
losses and expect future operating losses.

We were incorporated in January 1993 and completed the initial public offering of our common
stock in June 1996. We have incurred substantial operating losses in each year since our incorporation.

At December 31, 2006, we had
an accumulated deficit of approximately $54.8 million. Our net sales revenue of $15.6 million, less cost of sales, did not cover our operating expenses of approximately $16.2 million for the year ended December 31, 2006. At December 31,
2005, we had an accumulated deficit of approximately $48.3 million. Our net sales revenue of $16.7 million, less cost of sales, did not cover our operating expenses of approximately $16.3 million for the year ended December 31, 2005. We expect
that our operating expenses will continue to exceed our revenues, and as such, we will likely continue to incur operating losses unless and until revenue from newer products covers our costs.

We may need additional funds to support our operations and we may need to reduce our operations, sell stock or assets, or merge with another entity to continue our
operations.

Our operations to date have consumed substantial capital resources, and we will continue to expend substantial and
increasing amounts of capital for research, product development and testing to establish commercial-scale manufacturing capabilities, and to market potential and approved products. Our future capital requirements will depend on many factors,
including:



| |  |  | continued scientific progress in our research and development programs;
| | - |  | -----------------------------------------------------------------------



| |  |  | the size and complexity of our research and development programs;
| | - |  | -----------------------------------------------------------------



| |  |  | the scope and results of testing and trials of our products;
| | - |  | ------------------------------------------------------------



| |  |  | the time and costs involved in applying for regulatory approvals;
| | - |  | -----------------------------------------------------------------



| |  |  | the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | competing technological and market developments;
| | - |  | ------------------------------------------------



| |  |  | our ability to establish and maintain collaborative research and development arrangements;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | the cost of manufacturing scale-up and product commercialization;
| | - |  | -----------------------------------------------------------------



| |  |  | our ability to create an effective sales channel for our products; and
| | - |  | ----------------------------------------------------------------------



| |  |  | the costs of being a public company.
| | - |  | ------------------------------------

We may need to raise additional funds in order to satisfy these and other future capital requirements. If we are not able to do so, we may not be able to fund our future operations. We expect that our existing capital resources, including
the capital previously raised through the sale of common stock and the issuance of



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convertible notes under our existing revolving credit facility, will be sufficient to fund our activities as currently planned through the end of the fourth
quarter of 2007. However, in the event our sales do not meet budgeted amounts, our capital expenditures increase over our estimates, we are unable to convert our outstanding notes into shares of our common stock and/or we are unable to borrow
additional funds under our existing revolving credit facility, it is likely that we will need additional financing sooner than currently expected. In the future, it is possible that we will not have adequate resources to support our business
activities.

We may seek additional funding, including public and private financings. Our choice of financing alternatives may vary from
time to time depending upon various factors, including the market price of our securities, conditions in the financial markets, and the interest of other entities in strategic transactions with us. There can be no guarantee that additional financing
will be available on acceptable terms, whether through borrowings, collaborative arrangement, issuance of securities, or otherwise. If adequate funds are not available, we may be required to delay, scale back or eliminate one or more of our research
and development programs or other initiatives. We may also need to obtain funds through arrangements with collaborative partners or others that require us to relinquish rights to certain technologies or potential products. Any such delay, scale
back, partnership or similar arrangement could have a negative impact on our ability to develop products, or to achieve profitability if our products are brought to market. If additional financing is not available to us on acceptable terms, or at
all, it would have a material adverse effect on our business, financial condition, prospects and results of operations.

Our success will depend on
continued market acceptance of the EP-WorkMate system and market acceptance of our EP-4 Stimulator, MapMate, ViewMate II and other product offerings.

Our ability to increase revenues over the next several years will depend on the continued market
acceptance by electrophysiologists of our EP-WorkMate system computerized monitoring and analysis workstation integrated with various market leaders, and market acceptance of our ViewMateII product offerings. Sales of our EP-WorkMate system, its integrated EP-4 stimulator, accounted for 85%, 85%, and 89% of our sales in the year ended
December 31, 2006, 2005, and 2004, respectively. Because the EP-WorkMate system has a list price of approximately $200,000 with an integrated EP-4 Stimulator, each sale of an EP-WorkMate system represents a significant portion of our net sales.

Acceptance and use of our products by physicians and other clinicians is critical to our success. Physician and clinician acceptance will
depend upon, among other things, substantial favorable clinical experience, advantages over alternative treatments, cost effectiveness and favorable reimbursement policies of third-party payors, such as insurance companies, Medicare and other
governmental programs. Decreased or flat sales or low market acceptance of our EP-WorkMate system products or low market acceptance of our recently approved products could have a material adverse effect on our business, results of operations and
financial condition.

We are primarily engaged in the sale of capital equipment, which is sensitive to fluctuations in our customers budgets.

Our primary source of revenue is the sale of capital goods and, as a result, are subject to the budgetary cycles of our customers.
These cycles can cause fluctuations in our quarterly revenue as our customers manage their capital budgets based on available cash to pay for equipment.

We have limited manufacturing experience and manufacturing capacity, which may affect our ability to produce commercially viable products economically and in sufficient quantities.

Our profitability will depend on our ability to manufacture our products efficiently and economically. We have limited manufacturing experience,
particularly with respect to our catheter products. Our failure to obtain efficiency in our manufacturing processes will affect our profitability and could have a material adverse effect on our business, results of operations and financial
condition.



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We have limited experience in manufacturing any of our products in volumes necessary for us to achieve
commercial profitability. We may not be able to establish or maintain reliable, high-volume, cost-effective manufacturing capacity, which is critical to our future profitability.

We cannot assure you that we will be able to maintain or establish outsourcing arrangements on acceptable terms. We also cannot assure you that we will
be able to successfully manufacture our products in volumes sufficient for us to be profitable or that we can successfully increase our manufacturing capacity.

We may need to establish collaborative agreements, and this could have a negative effect on our freedom to operate our business, fund new product development or profit fully from sales of our products.

We may seek to collaborate with other medical device companies to gain access to their research and development, manufacturing, marketing, distribution
capabilities and financial resources. However, we may not be able to negotiate arrangements with any collaborative partners on acceptable terms. Any collaborative relationships that we enter into may include restrictions on our freedom to operate
our business or to profit fully from the sales of our products.

Once a collaborative arrangement is established, our partner may
discontinue its funding of any particular program or may, either alone or with others, pursue alternative technologies for the medical conditions our products are intended to treat. If a partner were to develop, or to establish an economic interest
in, a competing product, such partner may withdraw financial or technological resources from the development of our collaborative product or technology.

Without collaborative arrangements, we must fund our own research and development activities, accelerating the depletion of our capital and requiring us to develop our own marketing capabilities. Therefore, if we are
unable to establish and maintain collaborative arrangements on acceptable terms, we could experience a material adverse effect on our ability to develop products and, once developed, to market them successfully.

We depend on third-party sources to manufacture certain of our products and critical components for our products.

We rely on third-party sources to manufacture critical components for the EP-4 Stimulators, ViewMate II and its ViewFlex catheter, EP-WorkMate system and
other products. Any interruption by these third-party sources in the supply of such products or components would have a material adverse effect on our ability to deliver those products or the products in which such components are used and could
materially adversely impact our sales and gross margins. If any interruption were to occur, we may not be able to reach an acceptable arrangement with an alternative source of supply on a timely basis or on acceptable terms. Our failure to find
alternative manufacturing sources could have a material adverse effect on our business, results of operations and financial condition. During 2006, we discovered non-conforming material from a supplier of a critical component for our ViewFlex
catheter. We expect to resolve this issue in the second quarter of 2007.

Our success depends in part on our ability to keep pace with technological
developments and marketplace changes.

The electrophysiology market is characterized by rapidly changing technology, new products and
dynamic industry standards. Accordingly, our ability to compete depends on our ability to develop new products and improve existing products to keep pace with technological and marketplace changes. The research and development necessary for new
products and for product refinements can take longer and require greater expenditures than we expect, and our efforts may not be successful. Moreover, any new products or refinements to existing products may not be accepted by physicians or
patients. If we are unable to successfully respond to technological developments or changes in the marketplace in which we compete, our business, financial condition and prospects may be materially adversely affected.



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Our patents and proprietary rights might not provide sufficient intellectual property protection for our products.

Our success and ability to compete effectively in the electrophysiology marketplace depends on our ability to protect our patents,
proprietary technology and other intellectual property. We have acquired, and will seek to acquire, patents in the United States and certain foreign countries. We also have entered into license agreements to obtain rights, including patent rights,
of third parties that we consider important to our business. We cannot assure you that patents will be issued on our patent applications and applications for which we have acquired licenses. Further, if pending or future patents are issued, they may
not be sufficient to provide us with meaningful protection or a commercial advantage. Additionally, patents we hold or may hold in the future may be challenged, invalidated or circumvented. Moreover, our competitors, many of whom have substantial
resources and have made substantial investments in competing technologies, may presently have or may seek patents that will prevent, limit or interfere with our ability to make, use or sell our products in the United States and other countries.

In addition to patents, we rely on a combination of trade secrets, copyrights and trademarks to protect our intellectual property rights.
For example, our software (which is an integrated component in the EP-WorkMate system and EP-4 Stimulator) is copyrighted; however, existing copyright laws offer only limited practical protection from misappropriation. As a result, our competitors
may independently develop substantially equivalent proprietary technology.

If we are unable to pay royalties or license fees, we may lose our rights to
use certain important technology.

We have entered into several technology and licensing agreements which require us to pay royalties,
including, in some cases, minimum annual royalties. If we do not pay these royalties, we may be in breach of our technology agreements and could lose the rights granted to us under these agreements. The loss of these rights would affect our ability
to make, market and sell the MapMate, RPM and ALERT product lines, which could have a material adverse affect on our business, results of operations, financial condition and prospects.

Intellectual property litigation could harm our business.

We operate in an industry that is
susceptible to significant patent and intellectual property litigation and, in recent years, it has been common for companies in the medical device field to aggressively challenge the rights of other companies to prevent the marketing of new
devices. We may have to defend against third party intellectual property claims or initiate litigation against third parties that are infringing on our patents or other intellectual property rights. The result of such litigation could cause us to
cancel or delay shipments of any products found to be employing another partys intellectual property rights, require us to develop alternative technology or require us to enter into costly royalty or licensing agreements. Further, if necessary
licenses are not available to us on satisfactory terms, we may not be able to redesign our products or processes to avoid any alleged infringement of a third partys intellectual property rights. Accordingly, we could be prevented from
manufacturing and selling some of our products.

Any litigation, with or without merit, to defend against third party patents and other
intellectual property claims and litigation initiated by us to protect our patents and other intellectual property rights may be costly for us and time consuming to our management. Such costs may be prohibitive and may affect our ability to defend
against or initiate patent and other intellectual property claims. In addition, any litigation of this type might require our management to focus on matters outside of the day-to-day operations of our business. Our inability to defend against any
type of intellectual property claim or protect our own intellectual property may have a material adverse effect on our business, results of operations and financial condition.



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We face significant competition, and many of our competitors have greater financial, marketing and other resources
than we do, which may affect our future success.

The medical device market, particularly in the area of electrophysiology products, is
highly competitive and is characterized by rapid product development and technological change. Many of our competitors have access to significantly greater financial, marketing and other resources than we do. The greater resources of our competitors
could enable them to develop competing products more quickly so as to make it difficult for us to develop a share of the market for these products. By having greater resources, our competitors may also be able to respond more quickly to technology
changes in the marketplace may be able to better market their products and may be able to obtain regulatory approval for products more quickly than we can. Our future success will depend on our ability to remain competitive with other developers of
medical devices and therapies.

Third-party reimbursement might be denied, might ultimately be at levels which effectively reduce our prices, or might
be unavailable for some of our products, resulting in a reduction in revenue from the sale of our products.

Our products are generally
purchased by physicians or medical institutions. In the United States, third-party payors, such as Medicare, Medicaid and private insurers, are billed for the healthcare services provided to patients using those products. Similar reimbursement
arrangements exist in several European countries. Third-party payors are increasingly challenging the prices charged for medical products and services and are putting pressure on medical equipment suppliers to reduce prices. Initiatives to limit the
growth of healthcare costs, including price regulation, are also underway in several countries in which we do business. Implementation of healthcare reforms in the United States and other countries may limit the price of, or the level at which,
reimbursement is provided for our products and adversely affect both our pricing flexibility and the demand for our products.

Certain
procedures involving our products, including ViewFlex catheters, currently are eligible for reimbursement at varying levels, some of which will need to increase for us to continue to increase revenues. Maintaining and increasing levels of
third-party payor reimbursement will likely be tied to economic benefits realized through use of our products and patient outcomes and resulting market acceptance of those products. We cannot assure you that significant economic benefits from the
use of our products can or will be realized or that patient outcomes from the use of our products will be significantly improved. In addition, changes in FDA regulations or in third-party payor policies could limit or reduce reimbursement or make
reimbursement unavailable for procedures using our products. In any of those events, or if third-party reimbursement does not become available for products we may develop in the future, our business, results of operations and financial condition
could be materially adversely affected.

The success of our business is dependent on our key personnel and the loss of any of these personnel could have
a material adverse effect on our business, results of operations and financial condition.

The success of our business is dependent, to
a significant extent, upon the abilities and continued efforts of our senior management team, including David I. Bruce, our President and Chief Executive Officer, David A. Jenkins, our Chairman of our Board of Directors and C. Bryan Byrd, our Vice
President of Engineering and Manufacturing. Our success also depends upon certain of our research and development and other scientific personnel. We currently maintain key-man life insurance on Mr. Byrd, but there can be no assurance that this
policy will be maintained or renewed. The loss of any of these persons and the inability to quickly attract replacements for these key personnel could have a material adverse effect on our business, results of operations and financial condition. We
believe our future success will depend substantially upon our ability to attract and retain highly qualified technical and management personnel. We believe that there is and will continue to be intense competition for qualified personnel in this
industry.



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We might not be able to attract, manage and retain our sales force and third-party distributors, which may affect our
ability to promote and sell our products.

We utilize our own direct sales and marketing force to sell and promote our products in the
United States and France. We may not be able to continue to attract, manage and retain a qualified sales and marketing force that can successfully promote our products, which could materially adversely affect our business, results of operations and
financial condition.

We generate sales throughout the rest of the world through a network of independent third-party distributors. While
we do not consider any single distributor to be material to our business, we might not be able to replace existing distributors on a timely basis, or do so on terms which are commercially reasonable if present relationships are terminated. Further,
we might not be able to make arrangements with new distributors to access new international markets. If our current or future distributors are not successful in actively and effectively marketing our products, it could have a material adverse effect
on our business and prospects.

Our business could be subject to product liability claims, which, if successful, could have a material adverse effect on
our business and financial condition.

We face an inherent business risk of exposure to product liability and other claims and lawsuits
in the event that our technologies or products are alleged to have resulted in adverse effects. We may not be able to avoid significant liability exposure as our products are highly complex and some are or will be used in relatively new medical
procedures and in situations where there is a potential risk of serious injury, adverse side effects or death. In addition, misuse of these products, including the misuse or reuse of our catheters, may increase the risk of a patient experiencing
adverse effects and, as a result, the risk of product liability claims.

We may not have sufficient insurance coverage, and we may not be
able to obtain sufficient coverage at a reasonable cost. We currently maintain product liability insurance with coverage limits of $5,000,000 per occurrence and $5,000,000 in the aggregate per year. We cannot assure you that this coverage is or will
be adequate to cover future claims. This insurance is expensive and may not be available to us in the future. An inability to obtain or maintain product liability insurance at acceptable costs or to otherwise protect against potential product
liability claims could prevent or inhibit the commercialization of some or all of our products. A successful claim against us or settlement by us in excess of our insurance coverage or our inability to maintain insurance, could have a material
adverse effect on our business, results of operations and financial condition.

We are subject to risks associated with sales in multiple countries.

We derive a significant portion of our revenues from sources outside the United States. In 2006, 2005, and 2004, approximately 28%,
23%, and 22%, respectively, of our net sales were derived from sales outside the United States. We expect international sales will continue to represent a significant percentage of our total sales. We sell our products in Europe, Japan, Turkey,
Saudi Arabia and China, among others. While we attempt to mitigate risks associated with international sales, as a result of the significant portion of our revenues derived from such international sales, we are subject to associated risks,
including:



| |  |  | United States export license requirements and unauthorized re-export of our products to non-United States approved jurisdictions, non-compliance with which, or the
occurrence of which can result in fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of foreign sales and criminal prosecution, among other things;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | currency devaluations and fluctuations in currency exchange rates, particularly in Europe in connection with the euro and pounds sterling;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | imposition of, or increases in, customs duties and other tariffs;
| | - |  | -----------------------------------------------------------------



| |  |  | inability to definitively determine or satisfy legal requirements;
| | - |  | ------------------------------------------------------------------



| |  |  | foreign tax laws and potential increased costs associated with overlapping tax structures;
| | - |  | ------------------------------------------------------------------------------------------



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| |  |  | inability to effectively enforce contract or legal rights;
| | - |  | ----------------------------------------------------------



| |  |  | inability to obtain complete financial, end-user and other information under local legal, judicial, regulatory, disclosure and other systems or from foreign
distributors;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | unexpected changes in regulatory requirements;
| | - |  | ----------------------------------------------



| |  |  | nationalization and other risks, which could result from a change in government or other political, social or economic instability;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | extended collection periods for accounts receivable;
| | - |  | ----------------------------------------------------



| |  |  | potentially inadequate protections of intellectual property rights;
| | - |  | -------------------------------------------------------------------



| |  |  | restrictions on repatriation of earnings; and
| | - |  | ---------------------------------------------



| |  |  | the effects of terrorism, wars or other geopolitical events which, directly or indirectly, impact the demands for products manufactured or sold by United States
companies or the global economy generally.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These risks could have a material adverse effect on our ability to maintain
and expand foreign sales. Our failure to maintain and expand foreign sales would have a material adverse effect on our business, results of operations and financial condition.

Our export controls may not be adequate to ensure compliance with United States export laws, especially when we sell our products to distributors over which we have limited control.

The United States government has declared an embargo that restricts the export of products and services to a number of countries, including Iran, Syria,
Sudan and Cuba, for a variety of reasons, including the support by these countries of terrorism. We sell our products through distributors in Europe, Asia and the Middle East, and in such circumstances, the distributor is responsible for interacting
with the end user of our products, including to assist in the set up of any products purchased by such end user. In order to comply with United States export laws, we have instituted export controls including training for our personnel in export
restrictions and requirements, appointing an export control officer to oversee our export procedures, executing agreements with our distributors that include defining their territory for sale and requirements pertaining to United States export laws,
obtaining end user information from our distributors and screening it to restricted party lists maintained by the United States government. While we believe that these procedures are adequate to prevent the export or re-export of our products into
countries under embargo by the United States government, we cannot assure you that our products will not be exported or re-exported by our distributors into such restricted countries. In particular, our control over what our distributors do with our
products is necessarily limited, and we cannot assure you that they will not sell our products to an end user in a country in violation of United States export laws. Any violation of United States export regulations could result in substantial
legal, consulting and accounting costs, and significant fines and/or criminal penalties. In the event that our products are exported to countries under a United States trade embargo in violation of applicable United States export laws and
regulations, such violations, costs and penalties or other actions that could be taken against us could adversely affect our reputation and/or have an adverse effect on our business, financial condition, prospects or results of operations.

We have sold and may continue to sell, with a license, our products into countries that are under embargo by the United States and as a result have
incurred and may continue to incur significant legal, consulting and accounting fees and may place our reputation at risk.

United
States export laws permit the sale of medical products to certain countries under embargo by the United States government if the seller of such products obtains a license to do so, which requirements are in place because the United States has
designated such countries as state sponsors of terrorism. Certain of our



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products have been sold in Syria under license through a distribution agreement with an independent distributor. In addition, certain of our products were
distributed in Iran without United States governmental authorization. The aggregate revenue generated by sales of our products into Syria and Iran have been immaterial to our business and results of operations.

We may continue to supply medical devices to Syria and other countries that are under embargo by the United States government upon obtaining all
necessary licenses. We do not believe, however, that our sales into such countries will be material to our business or results of operations. There are risks we face in selling to countries under United States embargo, including, but not limited to,
possible damage to our reputation for sales to countries that are deemed to support terrorism, and failure of our export controls to limit sales strictly to the terms of the relevant license, which failure may result in civil and criminal penalties.
In addition, we may incur significant legal, consulting and accounting costs in ensuring compliance with our export licenses to countries under embargo.

Any damage to our reputation from such sales, failure to comply with the terms of our export licenses or the additional costs we incur in making such sales could have a material adverse impact on our business,
financial condition, prospects or results of operations.

Sales of our products into Iran were under investigation by the United States Department of
Treasury and the Department of Commerce and continues to be under investigation by the Securities and Exchange Commission, and we cannot assure you that such investigation will not result in significant fines or penalties that could have a material
adverse effect on the Companys business, financial condition, prospects, or results of operations.

The United States Department
of Treasury and Department of Commerce have concluded an investigation into certain sales of our products into Iran. In addition, the Commission is conducting an informal inquiry to determine whether there have been violations of certain provisions
of the federal securities laws in connection with financial and accounting reporting, including relating to disclosures the Company made in its Form 8-K filed with the Commission on August 12, 2005 regarding the ongoing government investigation
of sales by the Company of its products into Iran. We are cooperating fully with the federal government in connection with these matters. We closed out the Department of Commerce investigation in the fourth quarter of 2006.

Based on the Companys investigation of these matters to date, management believes that a limited number of the Companys heart monitor systems
were distributed to medical facilities in Iran without United States governmental authorization. We believe the aggregate revenues generated by these transactions were not material to the Companys cumulative financial results during the period
in which the transactions occurred. At this time, we do not have a license to sell products in Iran and have not entered into any agreements with distributors to distribute our products in Iran. We have incurred legal, consulting and accounting
expenses associated with the investigations by the United States Department of the Treasury, Department of Commerce and the Commission, amounting to $911,000 in the third quarter of 2005 and $519,000 in the fourth quarter of 2005. In 2006, we have
incurred $210,000 associated with these investigations and negotiations. In the fourth quarter of 2006, the Company made a settlement offer to Treasury, which orally indicated the maximum penalty would be $44,000 with no restrictions on commercial
export activities. We have received a settlement agreement from Treasury in which the penalty is $33,000 and includes certain other requirements. The Company executed the agreement, paid the fine and forwarded it to Treasury. This issue is deemed to
be closed. We cannot assure you that the ongoing informal inquiry by the Commission will not result in significant costs, fines or penalties that could have a material adverse effect on our business, financial condition, prospects, or results of
operations. See Item 3. Legal Proceedings and Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for more information regarding these investigations and their effects on us.



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Our business and financial condition are subject to various risks and uncertainties arising from domestic and
international laws and regulations which may require us to obtain regulatory approvals in order to manufacture and market our products.

United States. In the United States, the development, testing, manufacture, labeling, marketing, promotion and sale of medical devices is regulated principally by the FDA under the Federal Food, Drug and Cosmetic Act. The FDA has
broad discretion in enforcing compliance with that statute and its regulations. Our ability to continue to sell our products commercially is subject to continuing FDA oversight of the ongoing design, manufacturing, packaging, labeling, storage and
quality of our medical devices. While we believe we are currently in full compliance with the FDA, we are subject to additional inspections by the FDA and cannot assure you that we will be in full compliance during any future FDA inspections,
particularly with respect to facilities maintained by any third party with which we have an agreement to manufacture our catheters or components of our other products. Noncompliance can result in fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure to grant pre-market clearance or pre-market approval for devices, withdrawal of manufacturing or marketing approvals and criminal prosecution, any of which could have a material
adverse effect on our business, results of operations and financial condition.

We expect to seek FDA approval and approval by a European
Notified Body for various products as well as improvements to our current products. Approval of these products and product improvements by the FDA and European Notified Body is based upon, among other things, the results of clinical trials that
demonstrate the safety and efficacy of such products. Our failure to obtain regulatory approval or the delay in the approval of these products from either regulatory body could have a material adverse effect on our business results of operations and
financial condition.

International. In order for us to market our products in Europe and certain other foreign jurisdictions, we
must obtain required regulatory approvals and clearances and otherwise comply with extensive regulations regarding safety and manufacturing processes and quality. These regulations, including the requirements for approvals or clearance to market and
the time required for regulatory review, vary from country to country. Foreign countries also often have extensive regulations regarding safety, manufacturing processes and quality that differ from those in the United States and must be met in order
to continue sale of a product within that country. We may not be able to obtain regulatory approvals in such countries or we may be required to incur significant costs in obtaining or maintaining our foreign regulatory approvals. Failure to obtain
approvals or delays in the receipt of approvals to market our products and/or failure to maintain the approvals we currently have and those which we may receive in the future would have a material adverse effect on our business, results of
operations, financial condition and prospects. Presently, we are permitted to sell some of our products in countries that are members of the European Union. However, there can be no assurances that we will be successful in maintaining that
permission.

We are subject to new corporate governance requirements, and our costs of compliance with, or our failure to comply with, existing and
future requirements could adversely affect our business.

We face new corporate governance requirements under the Sarbanes-Oxley Act of
2002, as well as new rules and regulations subsequently adopted by the Commission, the Public Company Accounting Oversight Board and NASDAQ. These laws, rules and regulations continue to evolve and may become increasingly stringent in the future and
we expect that our legal and financial compliance costs will increase. We also expect that these new requirements may make it more difficult and expensive for us to obtain director and officer liability insurance. In particular, we will be required
to include the management report on internal control as part of our annual report for the year ended December 31, 2007, pursuant to Section 404 of the Sarbanes-Oxley Act. We are in the process of evaluating and implementing our internal
controls structure to provide reasonable assurance that our public disclosure would be accurate and complete and to help ensure that we will be able to comply with Section 404 of the Sarbanes-Oxley Act. However, due to the inherent limitations
of control systems, we cannot assure you that we will be able to fully comply with these laws, rules and regulations. Our failure to



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comply with these laws, rules and regulations may materially adversely affect our reputation, our financial condition and the value of our securities.

Our operations are subject to environmental, health and safety laws and regulations that could require us to incur material costs.

We are subject to various federal, state, and local environmental protection and health and safety laws and regulations, and we incur costs to comply with
those laws. Environmental laws hold current or previous owners or operators of businesses and real property potentially liable for contamination on that property, even if they did not know of and were not responsible for the contamination.
Environmental laws may also impose liability on any person who disposes or arranges for the disposal of hazardous substances for contamination at the disposal site, regardless of whether the disposal site is owned or operated by such person.
Although we do not currently anticipate that the costs of complying with environmental laws, including costs for remediation of contaminated properties, if any, will be material, we cannot ensure that we will not incur material costs or liabilities
in the future due to the discovery of new facts or conditions, the occurrence of new releases of hazardous materials or a change in environmental laws.

Risks Relating to Our Securities and Significant Shareholders

Our principal shareholders have the ability to control us and their
interests may conflict with the interests of our other shareholders.

As a result of our prior private placement financings, we have
shareholders who hold a large percentage of our outstanding shares of common stock. David A. Jenkins, Chairman of our Board of Directors, beneficially owns, either directly or indirectly through entities in which he has ownership, approximately
3,162,000 shares of our common stock, or 10% of the outstanding shares of our common stock, assuming currently exercisable warrants held directly or indirectly by him are fully exercised. Abhijeet Lele, one of our directors, beneficially owns,
either directly or indirectly through limited partnerships of which he has management control, approximately 2,622,000 shares of our common stock, or 9% of the outstanding shares of our common stock, assuming currently exercisable warrants held
directly or indirectly by him are fully exercised. To the extent that these shareholders exercise their voting rights in concert, they may have the ability to appoint new management and to control the outcome of matters submitted to a vote of the
holders of our common stock. In addition, because our certificate of incorporation does not provide for cumulative voting with respect to election of directors, these shareholders and their affiliates may be able to control the election of members
of our Board of Directors. The interests of these equity holders may at times conflict with the interests of our other shareholders.

Our common stock
price is volatile and may decline even if our business is doing well.

The market price of our common stock has been, and is likely to
continue to be, highly volatile. Market prices for securities of medical device companies, including ours, have historically been highly volatile, and the market has from time to time experienced significant price and volume fluctuations that are
unrelated to the operating performance of particular companies. The following factors can have a significant effect on the market price of our common stock:



| |  |  | announcements of technological innovations or new products by us or others,
| | - |  | ---------------------------------------------------------------------------



| |  |  | clinical trial results,
| | - |  | -----------------------



| |  |  | developments concerning agreements with collaborators,
| | - |  | ------------------------------------------------------



| |  |  | government regulation,
| | - |  | ----------------------



| |  |  | developments in patent or other proprietary rights,
| | - |  | ---------------------------------------------------



| |  |  | public concern as to the safety of electrophysiology products developed by us or others,
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | future sales of substantial amounts of our common stock by existing shareholders, and
| | - |  | -------------------------------------------------------------------------------------



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| |  |  | comments by securities analysts and general market conditions.
| | - |  | --------------------------------------------------------------

The realization of any of the risks described in these Risk Factors could have a negative affect on the market price of our common stock.

Our common stock trades on the NASDAQ Capital Market quotation system. In the future, our common stock may be removed from listing on the NASDAQ Capital Market quotation system and may not qualify for listing on
any stock exchange, in which case it may be difficult to find a market in our common stock.

Our common stock trades on the NASDAQ
Capital Market. NASDAQ has several requirements for companies to meet for continued listing, including minimum stockholders equity. If we fail to demonstrate compliance with all requirements for continued listing on the NASDAQ Capital Market,
our common stock could be delisted from the NASDAQ Capital Market. There can be no assurance that we will satisfy the requirements for continued listing on The NASDAQ Capital Market.

If our common stock is no longer traded on The NASDAQ Capital Market, it may be more difficult for holders of our common stock to sell any shares that
they own and the price of our common stock may be negatively affected. As a result, there is a risk that holders of our common stock may not be able to obtain accurate price quotes or be able to correctly assess the market price of our common stock.
Increases in volatility could also make it more difficult to pledge shares of our common stock as collateral, if holders sought to do so, because a lender might be unable to accurately value our common stock.

If we fail to maintain our listing on the NASDAQ Capital Market for any reason, our common stock will be traded on the NASDAQ Over the Counter Bulletin
Board (OTCBB) or may be considered a penny stock under regulations of the Commission and trade on the pink sheets, each of which would impose additional sales practice requirements on broker-dealers who buy and sell our
securities. The additional burdens imposed upon broker-dealers by these requirements could discourage broker-dealers from effecting transactions in our common stock, which could severely limit the market liquidity of our common stock and the ability
of the holders of our common stock to sell our securities in the secondary market. This also could limit our ability to raise additional financing.

Future sales of our common stock by existing shareholders could negatively affect the market price of our common stock and make it more difficult for us to sell shares of our common stock in the future.

Sales of our common stock in the public market, or the perception that such sales could occur, could result in a drop in the market price of our
securities and make it more difficult for us to complete future equity financings. We have outstanding the following shares of common stock:



| |  |  | Approximately 30,365,000 shares of common stock are either freely tradable in the public markets or are eligible for sale in the public markets.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | As of March 28, 2007, there is an aggregate of approximately 3,386,000 shares of common stock that may be issued on the exercise of outstanding stock options
granted under our 1995 Long Term Incentive Plan, our 1995 Director Option Plan, our 2002 Stock Option Plan, our 2006 Stock Option Plan, our 2006 Director Plan, and other agreements pursuant to which nonqualified options were granted at a weighted
average exercise price of $2.25 per share.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | As of March 28, 2007, there is an aggregate of approximately 338,000 shares of common stock that may be issued on the exercise of outstanding warrants.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have in effect a registration statement under the Securities Act registering approximately 505,000 shares of our common stock which may be issued upon conversion
of our secured convertible note issued by us to Laurus Master Fund, Ltd.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We have a number of shareholders that own
significant blocks of our common stock. Such concentration of ownership could affect the liquidity of our common stock and have an adverse effect on the price of our common



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stock. If these shareholders sell large portions of their holdings in a relatively short time, for liquidity or other reasons, the market price of our common
stock could drop significantly.

Potential issuance of preferred stock may delay, defer or prevent corporate takeover.

Our Board of Directors has the authority to issue up to 5,000,000 shares of undesignated preferred stock and to determine the rights, preferences,
privileges and restrictions of such shares without any further vote or action by the shareholders. Our Board of Directors, without shareholder approval, can issue preferred stock with voting and conversion rights, which could adversely affect the
voting power of the holders of our common stock. We have no present intention to issue shares of preferred stock. The potential future issuance of preferred stock under certain circumstances may have the effect of delaying, deferring or preventing a
change in control of us or otherwise adversely affecting the rights of the holders of common stock.

Our certificate of incorporation does not provide
for cumulative voting, but does provide for a staggered board, which could delay or prevent a change of control.

Our certificate of
incorporation does not provide for cumulative voting with respect to the election of directors, but does provide for staggered elections of directors. As a result, shareholders who have large holdings of our common stock may be able to control the
election of members of our Board of Directors, which may have the effect of delaying or preventing a change in control of us, including transactions in which our shareholders might otherwise receive a premium for their shares over current market
prices. The staggered board provision makes it more difficult for shareholders to change the majority of directors even when the only reason for the change may be the performance of the present directors. Such provisions are applicable to all
elections of directors, not only elections occurring after a change in control.

Certain provisions of our by-laws, other agreements, and applicable
state laws may have anti-takeover effects.

Our by-laws provide that only our Board of Directors, the Chairman of our Board of Directors
or our President may call a special meeting of the shareholders and that shareholders may not take action by written consent without a meeting. These provisions limit the ability of a potential acquirer or shareholders favoring a change of control
to act quickly by special meeting or without a meeting.

In the event of a change in control of our company, the vesting of all options
granted pursuant to our 1995 Long Term Incentive Plan, 1995 Director Option Plan, 2002 Stock Option Plan, 2006 Stock Option Plan, 2006 Director Plan and other agreements accelerate immediately prior to such change in control. Currently,
approximately 1,294,000 shares are issuable upon the exercise of vested options and approximately 2,092,000 shares are issuable upon the exercise of unvested options granted pursuant to these plans and agreements.

Section 14A:10A of the New Jersey Business Corporation Act (also known as the New Jersey Shareholders Protection Act) provides
that, with certain exceptions, an interested stockholder is prohibited from engaging in a business combination with the company for five years following the date the stockholder first became interested unless the
companys board approved the particular business combination before the acquirer became an interested stockholder. After five years have elapsed, the interested stockholder may engage in a business combination if certain conditions are met.



|Item 1B. | Unresolved Staff Comments.
|-------- | --------------------------

Not applicable.



|Item 2. | Properties.
|------- | -----------

We own and operate a facility
comprising approximately 15,000 square feet in West Berlin, New Jersey. The operations of this facility are predominantly manufacturing and assembly of hardware and catheter products.



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This facility also houses administration, engineering, catheter research and development and warehousing. We also lease an additional 5,000 square feet of
space adjacent to our West Berlin, New Jersey facility for customer service, research and development and warehousing at approximately $3,400 per month. At December 31, 2006, the facility owned by us in West Berlin was encumbered by a mortgage
securing a convertible note issued by us in a financing transaction.

EP MedSystems UK Ltd. has an office in Kent, England under a lease
for approximately 400 square feet on a month-to-month basis with a six month notification of termination. The lease provides for monthly rental payments of U.S. $1,100. We also lease storage space in the UK on a month-to-month lease with rental
payments of $700. In addition, EP MedSystems France S.A.R.L. leases 400 square feet of office and storage space in Aix en Provence, France. The lease provides for monthly rental payments of U.S. $1,100. Lastly, we lease office space in Oss, in the
Netherlands at approximately U.S. $1,300 per month. All of our leases are subject to yearly CPI increases.

We evaluate our facilities in
regular time intervals to insure they are sufficient to meet our expected needs for at least the next twelve months. We believe that our facilities are adequately covered by insurance.



|Item 3. | Legal Proceedings.
|------- | ------------------

During the second quarter of
2005, the Company received an Administrative Subpoena from the Bureau of Industry and Security of the United States Department of Commerce (the Department of Commerce) seeking production of records and documents relating to the sale
and/or export of the Companys products to Iran and to Syria. In the third quarter of 2005, the Company was informed that the United States Attorneys Office for the District of New Jersey had commenced a criminal investigation into the
same matter. In March 2006, the United States Attorneys Office informed the Company that it will not prosecute the Company in connection with this matter.

In a letter dated August 16, 2005, the Company was informed by the Philadelphia District Office of the Securities and Exchange Commission (the SEC District Office) that the Commission is conducting a
confidential, informal inquiry to determine whether there have been violations of certain provisions of the federal securities laws in connection with the Companys financial and accounting reporting, including relating to disclosures the
Company made in its Form 8-K filed with the Commission on August 12, 2005 regarding ongoing government investigations of sales by the Company of its products to Iran.

The Company is cooperating fully with the federal government in connection with these matters.

Based on the Companys investigation of these matters to date, management believes that a limited number of the Companys heart monitor systems
were distributed to medical facilities in Iran without United States governmental authorization. We believe the aggregate revenues generated by these transactions were not material to the Companys cumulative financial results during the period
in which such transactions occurred, and the Company has taken steps to implement certain control procedures designed to prevent the Companys products or services from being provided to any foreign countries in violation of applicable law.

The fact that certain of the Companys heart monitor systems were distributed to medical facilities in Iran without United States
government authorization was voluntarily disclosed by the Company in 2003 to the Department of Commerce and to the Office of Foreign Assets Control of the United States Treasury Department. The federal government is also investigating the accuracy
and completeness of those voluntary disclosures.

Separately, the Audit Committee of the Companys Board of Directors conducted an
independent investigation into these matters and retained outside counsel to assist it. In the third quarter of 2005, the Company incurred approximately $911,000 in legal, consulting and accounting expenses associated with the governmental and Audit
Committee investigations. Additional amounts in the third quarter over previously estimated costs were associated with the additional resource requirement for the Commissions inquiry,



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additional document review, additional interviews and the termination of Reinhard Schmidt, our former President, Chief Executive Officer and Chief Operating
Officer. In the fourth quarter of 2005, the Company incurred $474,000 in legal, consulting and accounting expenses associated with the governmental and Audit Committee investigations and $45,000 associated with the Companys defense and
negotiations with the government. For the year ended December 31, 2006, the Company incurred approximately $210,000 in connection with negotiations with various governmental entities. Management cannot predict whether such fees and other
expenses will be significantly higher as these costs, as well as possible additional penalties and fines, as more fully described below, are not completely estimable at this time.

Violations of applicable law may result in civil, administrative or criminal fines or penalties, but due primarily to the ongoing nature of the
investigations referred to above, it is not possible at this time to predict the outcome of these investigations or the impact of costs of ultimately resolving this matter on our results of operations or financial condition. However, any fees or
expenses or any fines or penalties which might be incurred by the Company in connection with these matters may have a material impact on the Companys results of operations and financial condition. The Company has made no provision for any
future costs associated with the investigations or any costs associated with the Companys defense or negotiations with the various governmental entities to resolve these outstanding issues. In November 2005, the Company met with various
governmental agencies to review the results of the investigation. Since that time there have been numerous conversations and meetings with various governmental agencies with which we have been cooperating fully.

On October 9, 2005, the Board of Directors terminated Reinhard Schmidts employment as its President, Chief Executive Officer and Chief
Operating Officer for cause. Mr. Schmidts termination resulted from his certification and authorization of statements to the Department of Commerce, some of which the Audit Committee has determined in its independent investigation to have
been inaccurate or incomplete. Mr. Schmidts termination was not a result of the discovery of any financial or accounting irregularity by the investigation. Pursuant to Mr. Schmidts employment agreement, his position as a
director of the Company ceased upon the termination of his employment.

At this time, Mr. Schmidt has not contested this termination,
but it is possible he could contest it at a later time. The likelihood of such a contest, if any, or results of any arbitration or adjudication, cannot be estimated at this time.

In the fourth quarter of 2005, we terminated our agreements with our Armenian and German distributors. The German distributor was contesting the
termination, which was settled with no cash payment to the ex-distributor.

On July 20, 2006, the Company received a proposed charging
letter stating that the Department of Commerce has reason to believe that the Company violated export control regulations arising out of sales between October 1999 and January 2004 of cardiac equipment to end-users in Iran without the required U.S.
Government authorization, and that the disclosures made by the Company and certified by Reinhard Schmidt, then the Companys Chief Executive Officer, regarding these transactions in October and November 2003 were false and misleading. The
proposed charging letter set forth possible administrative sanctions which may be imposed, which include civil penalties of up to $407,000, denial of export privileges and/or exclusion from practice before the Department of Commerce. The Company has
signed a settlement agreement to settle this matter prior to issuance of a formal charging letter with the payment of $244,000 in civil penalties, which was accrued at September 30, 2006 and paid in the fourth quarter of 2006, with no
restrictions on commercial or export activities. The Company had accrued $345,000 as of June 30, 2006 based on the proposed charging letter at that time.

In the fourth quarter of 2006, the Company made a settlement offer to Treasury, which orally indicated the maximum penalty would be $44,000 with no restrictions on commercial or export activities. We have received a
settlement agreement from Treasury in which the penalty is $33,000. The agreement included certain other requirements. The Company has executed the agreement, forwarded it to Treasury and paid the fine. This issue is



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deemed to be closed. However, we cannot assure that the ongoing informal inquiry by the Commission will not result in other significant costs, fines or
penalties that could, in the aggregate, have a material adverse effect on our business, financial condition, prospects or results of operations. The Company has made no provision for any future costs associated with these investigations or any costs
associated with the Companys defense or negotiations with the Commission to resolve this final outstanding issue.



|Item 4. | Submission of Matters to a Vote of Security Holders.
|------- | ----------------------------------------------------

We held our Annual Meeting of Shareholders on December 21, 2006. The following were the matters voted upon at the meeting:

1. Election of Directors.

Paul Ray and David I Bruce were elected to serve as directors at the Annual
Meeting. The number of votes cast for and withheld from the directors are as follows:



|               |  |                 |  |         |  |          |  |             |  |                
|-------------- |  | --------------- |  | ------- |  | -------- |  | ----------- |  | ---------------
|               |  | Number of Votes
|               |  | For             |  | Against |  | Withheld |  | Abstentions |  | BrokerNon-Votes
|Paul Ray       |  | 16,082,521      |  |        |  | 622,501  |  |            |  |               
|David I. Bruce |  | 15,898,590      |  |        |  | 806,432  |  |            |  |               

David A. Jenkins, Richard Williams and Abhijeet Lele continued as directors after
the meeting.



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PART II



|Item 5. | Market for Common Equity and Related Stockholder Matters.
|------- | ---------------------------------------------------------

Market Information

Our common stock is listed and traded on the NASDAQ Capital Market.

The following table sets forth the high and low sale prices for our common stock for the periods indicated.



|               |  |      |      |     |   |     
|-------------- |  | ---- | ---- | --- | - | ----
|Period         |  | High |      | Low
|2005           |  |      |      |     |   |     
|First Quarter  |  | $    | 3.82 |     | $ | 2.99
|Second Quarter |  | $    | 3.30 |     | $ | 2.49
|Third Quarter  |  | $    | 3.62 |     | $ | 2.60
|Fourth Quarter |  | $    | 3.04 |     | $ | 2.28
|               |  |     
|2006           |  |      |      |     |   |     
|First Quarter  |  | $    | 2.87 |     | $ | 2.43
|Second Quarter |  | $    | 2.72 |     | $ | 1.72
|Third Quarter  |  | $    | 1.80 |     | $ | 1.29
|Fourth Quarter |  | $    | 1.66 |     | $ | 1.12

Holders

As of March 28, 2007, there were approximately 60 registered holders of record of our common stock. This number excludes individual shareholders holding stock under nominee security position listings because many
of such shares are held by brokers and other institutions on behalf of shareholders. As a result, we are unable to estimate the total number of shareholders represented by these record holders, but we believe that the amount is in excess of 400.

Dividend Policy

Historically, we have
not paid any dividends to our shareholders, and we do not expect to pay any dividends in the foreseeable future.



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Stock Performance Graph

The following line graph and table compare, for the five most recently concluded fiscal years, the yearly percentage change in the cumulative total stockholder return, assuming reinvestment of dividends, on the
Companys common stock with the cumulative total return of companies on the NASDAQ Stock Market and an index comprised of certain companies in similar service industries (the Selected Peer Group Index).

COMPARISON OF CUMULATIVE TOTAL RETURN AMONG EP MEDSYSTEMS, INC RUSSELL 3000 INDEX AND NASDAQ MARKET INDEX

LOGO

COMPARISON OF CUMULATIVE TOTAL RETURN OF ONE OR MORE

COMPANIES, PEER GROUPS, INDUSTRY INDEXES AND/OR BROAD MARKETS



|                     |  |                    |  |            |  |            |  |            |  |            |  |           
|-------------------- |  | ------------------ |  | ---------- |  | ---------- |  | ---------- |  | ---------- |  | ----------
|                     |  | FISCAL YEAR ENDING
|COMPANY/INDEX/MARKET |  | 12/31/2001         |  | 12/31/2002 |  | 12/31/2003 |  | 12/31/2004 |  | 12/30/2005 |  | 12/29/2006
|EP Medsystems Inc    |  | 100.00             |  | 100.00     |  | 121.60     |  | 150.00     |  | 116.40     |  | 53.60     
|Russell 3000 Index   |  | 100.00             |  | 77.19      |  | 99.37      |  | 109.39     |  | 114.06     |  | 129.80    
|NASDAQ Market Index  |  | 100.00             |  | 69.75      |  | 104.88     |  | 113.70     |  | 116.19     |  | 128.12    

Equity Compensation Plan Information

The following table sets forth, as of December 31, 2006, information about outstanding options and rights to purchase our common stock granted to
participants in our equity compensation plans and the number of shares of our common stock remaining available for issuance under such equity compensation plans:



|                                                               |  |                                                                                           |  |                                                                            |      |                                                                                                                                       |          
|-------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------------------------------------------------------------------- | ---------
|Plan Category                                                  |  | Number of Securities to beIssued Upon Exercise ofOutstanding Options,Warrants, and
Rights |  | Weighted-Average Exercise Price ofOutstanding Options,Warrants, and Rights |      | Number of SecuritiesRemaining Available forFuture Issuance
UnderEquity compensation Plans(Excluding SecuritiesReflected in column (a)
|                                                               |  | (a)                                                                                       |  | (b)                                                                        |      | (c)                                                                                                                                  
|Equity compensation plans approved by security holders (1)     |  | 2,431,208                                                                                 |  | $                                                                          | 2.42 |                                                                                                                                       | 1,437,000
|Equity compensation plans not approved by security holders (2) |  | 955,000                                                                                   |  | $                                                                          | 1.81 |                                                                                                                                       |         
|                                                               |  |                                                                                           |  |                                                                            |      |                                                                                                                                       |          
|Total                                                          |  | 3,386,208                                                                                 |  | $                                                                          | 2.25 |                                                                                                                                       | 1,437,000
|                                                               |  |                                                                                           |  |                                                                            |      |                                                                                                                                       |          



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---

|(1) | Consists of our (i) 1995 Long Term Incentive Plan, (ii) 1995 Director Option Plan, (iii) 2002 Stock Option Plan, (iv) 2006 Stock Option Plan, and (v) 2006
Directors Stock Option Plan.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | These compensation plans or arrangements consist of options approved by our Board of Directors and granted to certain employees, directors and outside consultants from time to time
to incentivize such persons in connection with our business.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Sales of Unregistered Securities

On December 12, 2006, we granted Matthew C. Hill, our Chief Financial Officer, an incentive stock option to purchase 30,000 shares of common stock
pursuant to the 2006 Stock Option Plan at an exercise price of $1.22 per share. The options vest over 5 years, subject to acceleration upon a change of control (as defined) of our company, and have a term of 10 years.

On December 12, 2006, we granted C. Bryan Byrd, our Vice President, Engineering and Manufacturing, an incentive stock option to purchase 30,000
shares of common stock pursuant to the 2006 Stock Option Plan at an exercise price of $1.22 per share. The options vest over 5 years, subject to acceleration upon a change of control (as defined) of our company, and have a term of 10 years.

On August 16, 2006, upon the start of his employment as our President and CEO, we granted David I. Bruce the following options:



|                  |  |                 |  |                   |  |                |     
|----------------- |  | --------------- |  | ----------------- |  | -------------- | ----
|Plan              |  | Date            |  | Number of Options |  | Exercise Price
|2002 Plan         |  | August 16, 2006 |  | 50,000            |  | $              | 1.44
|2006 Plan         |  | August 16, 2006 |  | 250,000           |  | $              | 1.44
|Nonqualified plan |  | August 16, 2006 |  | 500,000           |  | $              | 1.44

The options vest over 5 years, subject to acceleration upon a change of control (as defined) of our company, and
have a term of 10 years.

In addition, we granted Mr. Bruce an nonqualified stock option to purchase 200,000 shares of common stock
pursuant to a separate agreement at an exercise price of $1.34. The options vest over 2 years associated with meeting operating goals for our company. The options have a term of 10 years.

On March 27, 2006, we completed a $10,000,000 private placement of our common stock to a number of accredited investors. We issued 3.78 million
shares of our common stock at a purchase price of $2.25 per share. In addition, FatBoy Capital, LP purchased approximately 617,000 shares of common stock at a price of $2.43 per share in accordance with NASDAQ marketplace rules. David Jenkins, our
Chairman is a managing member of FatBoy Capitals general partner.

On January 7, 2007, in connection with his appointment to the
Board of Directors, we granted Gerard Michel an incentive stock option to purchase 60,000 shares of common stock pursuant to the 2006 Director Plan at an exercise price of $1.43. The options vest monthly over 5 years subject to acceleration upon
change of control (as defined) of our company and have a term of 10 years.

All other information required by this Item 5 may be found
under the sections captioned Executive Compensation and Related Matters in our Proxy Statement for our Annual Meeting of Stockholders which is expected to be mailed to shareholders on or around May 20, 2007, which is
incorporated herein by reference.



|Item 6. | Selected Financial Data.
|------- | ------------------------

The information below was derived from
our Consolidated Financial Statements included in this report and in reports we have previously filed with the Commission. This information should be read together with those



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financial statements and the Notes to the Consolidated Financial Statements. For more information regarding this financial data, see Item 7.
Managements Discussion and Analysis of Financial Condition and Results of Operations section also included in this report.

Statement of
Operations Data:



|                                              |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|--------------------------------------------- |  | ---------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                              |  | Year ended December 31,                  |       
|                                              |  | 2006                                     |        |   | 2005 |   |        | 2004 |  |   | 2003   |   |  | 2002 |       
|                                              |  | (In thousands, except share information) |       
|Revenues:                                     |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net sales                                     |  | $                                        | 15,558 |   |      | $ | 16,669 |      |  | $ | 16,368 |   |  | $    | 10,003 |   |  | $ | 12,420 |  
|Cost of revenues:                             |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Cost of products sold                         |  |                                          | 6,125  |   |      |   | 6,420  |      |  |   | 6,663  |   |  |      | 4,763  |   |  |   | 5,708  |  
|                                              |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Gross Profit                                  |  |                                          | 9,433  |   |      |   | 10,249 |      |  |   | 9,705  |   |  |      | 5,240  |   |  |   | 6,712  |  
|Sales and marketing expenses                  |  |                                          | 9,683  |   |      |   | 8,485  |      |  |   | 8,346  |   |  |      | 5,563  |   |  |   | 4,975  |  
|Research and development expenses             |  |                                          | 2,738  |   |      |   | 2,374  |      |  |   | 2,470  |   |  |      | 2,566  |   |  |   | 3,289  |  
|General and administrative expenses           |  |                                          | 3,737  |   |      |   | 5,397  |      |  |   | 3,034  |   |  |      | 2,566  |   |  |   | 2,604  |  
|Offering costs                                |  |                                          |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   | 1,119  |  
|Mortgage conversion expense                   |  |                                          |       |   |      |   |       |      |  |   |       |   |  |      | 222    |   |  |   |       |  
|                                              |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Loss from operations                          |  |                                          | (6,725 | ) |      |   | (6,007 | )    |  |   | (4,145 | ) |  |      | (5,677 | ) |  |   | (5,275 | )
|Interest expense                              |  |                                          | (258   | ) |      |   | (256   | )    |  |   | (210   | ) |  |      | (485   | ) |  |   | (231   | )
|Debt conversion interest expense              |  |                                          |       |   |      |   |       |      |  |   | (582   | ) |  |      | (1,000 | ) |  |   |       |  
|Change in valuation of warrants               |  |                                          |       |   |      |   |       |      |  |   |       |   |  |      | (211   | ) |  |   |       |  
|Interest and other income                     |  |                                          | 419    |   |      |   | 200    |      |  |   | 66     |   |  |      | 26     |   |  |   | 20     |  
|                                              |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Loss before income tax benefit                |  |                                          | (6,564 | ) |      |   | (6,063 | )    |  |   | (4,871 | ) |  |      | (7,347 | ) |  |   | (5,486 | )
|Income tax benefit                            |  |                                          | 87     |   |      |   | 290    |      |  |   | 461    |   |  |      | 398    |   |  |   | 438    |  
|                                              |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net loss                                      |  | $                                        | (6,477 | ) |      | $ | (5,773 | )    |  | $ | (4,410 | ) |  | $    | (6,949 | ) |  | $ | (5,048 | )
|Basic and diluted loss per share              |  | $                                        | (.22   | ) |      | $ | (.22   | )    |  | $ | (.19   | ) |  | $    | (.38   | ) |  | $ | (.34   | )
|                                              |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Weighted average number of shares outstanding |  |                                          | 29,330 |   |      |   | 25,802 |      |  |   | 23,515 |   |  |      | 18,378 |   |  |   | 14,849 |  
|                                              |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  



|                                             |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|-------------------------------------------- |  | -------------- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                                             |  | December 31,  
|                                             |  | 2006           |        | 2005 |   | 2004   |  | 2003 |        | 2002
|                                             |  | (In thousands)
|Balance Sheet Data (at end of period):       |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|Working capital                              |  | $              | 12,033 |      | $ | 7,758  |  | $    | 12,756 |      | $ | 12,543 |  | $ | 3,860 
|Intangible assets, net                       |  | $              | 529    |      | $ | 532    |  | $    | 500    |      | $ | 355    |  | $ | 358   
|Total assets                                 |  | $              | 18,311 |      | $ | 15,131 |  | $    | 20,003 |      | $ | 21,661 |  | $ | 10,928
|Long-term debt, including current maturities |  | $              | 1,990  |      | $ | 1,980  |  | $    | 1,959  |      | $ | 5,647  |  | $ | 3,950 
|Stockholders equity                         |  | $              | 12,189 |      | $ | 8,353  |  | $    | 13,351 |      | $ | 11,626 |  | $ | 1,703 
|                                             |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       



|Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations.
|------- | --------------------------------------------------------------------------------------

Except for historical information, the following Managements Discussion and Analysis contains forward-looking statements based upon current
expectations that involve certain risks and uncertainties. Forward-looking statements include the words plans, expects, aims, believes, projects, anticipates,
intends, will, should, could and other expressions that indicate future events and trends. These forward-looking statements generally relate to plans and objectives for future operations and are based
upon managements estimates of future results or trends. Although we believe that the plans and objectives reflected in or suggested by such forward-looking statements are reasonable, such plans or objectives may not be achieved. Our actual
results could differ materially from those reflected in these forward-looking statements as a result of certain factors that



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include, but are not limited to, the risks discussed in the section of this annual report entitled Item 7. Risk Factors. Please see the
statements contained under the Section entitled Cautionary Statement Regarding Forward-Looking Statements above.

Overview

We were incorporated in January 1993 and operate in a single industry segment. We develop, manufacture, market and sell a line of products for the
cardiac rhythm management, or electrophysiology (EP), market used to diagnose, monitor, visualize and treat irregular heartbeats known as arrhythmias. Since our inception, we have acquired technology and marketing rights, have developed new products
and have begun marketing various electrophysiology products, including our EP-WorkMate system computerized electrophysiology workstation, the MapMate navigation mapping integration with Biosense Websters CARTO system, our EP-4 Computerized
Cardiac Stimulator, diagnostic electrophysiology catheters (including our unique one-piece catheter), ViewMate II intracardiac ultrasound catheter system and related disposable supplies and our ALERT System (including the ALERT Companion II and
ALERT family of internal cardioversion catheters).

Our core diagnostic product is the EP-WorkMate system, a computerized electrophysiology
workstation that monitors displays and stores cardiac electrical activity and arrhythmia data. The EP-WorkMate system offers, among other features, display and storage of up to 192 intracardiac signals, real-time diagnosis, analysis and integration
with our own proprietary systems, such as our EP-4 Stimulator, as well as with those of market leaders, such as Biosense Websters CARTO mapping navigation system, Philips Medical Systems Allura x-ray system and with other technologies
and systems. We also are integrated with Boston Scientific Corporations RPM navigation system. Due to lack of support for this product by Boston Scientific, this will not be a significant contribution to our revenue in the future. The EP-4
Stimulator is a computerized signal generator and processor which, when integrated with the EP-WorkMate system, is used to stimulate the heart with electrical impulses in order to locate arrhythmia. During 2006, the EP-WorkMate system, stand alone
or integrated and the EP-4 Stimulator accounted for approximately 85% of our total sales. We also market a line of diagnostic electrophysiology catheters for stimulation and sensing of electrical signals during electrophysiology studies, which
represented approximately 2% of our total sales revenues in 2006.

We have also developed the ViewMate intracardiac echo catheter system
including the ViewMate ultrasound imaging console and ViewFlex intracardiac imaging catheters. These products offer high-resolution, real-time ultrasound capability designed to improve a physicians or clinicians ability to visualize
inside the chambers of the heart. We believe the ViewMate Ultrasound System may play an important role for a broad range of potential applications in electrophysiology and cardiology. Sales of the ViewMate system and related ViewFlex catheters
accounted for approximately 9% of our total sales revenues in 2006. In January 2007, we announced the new ViewMate II ultrasound system based on Philips Medical Systems HDII XE platform. Philips will OEM the product to be sold under our
proprietary name ViewMate II. As part of the joint development and distribution agreement, Philips may offer the ICE option to its customers on the HDII XE ultrasound system, providing an additional sales channel for our ViewFlex catheters.

We have also developed a product for the treatment of atrial fibrillation known as the ALERT System, which uses a patented electrode
catheter to deliver measured, variable, low-energy electrical impulses directly to the inside of the heart to convert atrial fibrillation to a normal heart rhythm. We have obtained Class III Design Examination Certification from a European Notified
Body allowing us to label the ALERT System with a CE Mark, an international symbol of adherence to quality assurance standards, design reviews and hazard analysis, which permits us to sell the ALERT System in the European Community. Sales of the
ALERT System and related catheters accounted for approximately 4% of our total sales revenues in 2006. Due to limited resources and the potential of our other products, we will continue to service our installed base, but will not expend significant
company resources on this product line at this time.



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Critical Accounting Policies

Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. The Commission indicated that a
critical accounting policy is one which is important to the portrayal of the companys financial condition and results and requires managements most difficult, subjective or complex judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain. Note 2 of our Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated
Financial Statements. In addition, Financial Reporting Release No. 61 requires all companies to include a discussion to address, among other things, liquidity, off-balance sheet arrangements, contractual obligations and commercial commitments.
The information provided below describing our debt and future commitments is provided to facilitate a review of our liquidity and capital resources. The following is a brief discussion of the more significant accounting policies and methods used by
us.

General

The preparation of
financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.
Judgments and assessments of uncertainties are required in applying the Companys accounting policies in the valuation of accounts receivable, valuation of inventory, valuation of goodwill intangibles, and other long-term assets, income taxes
and share-based compensation. The Company bases its judgments and estimates on historical experience and other assumptions that it believes are reasonable. Although these estimates are based upon managements knowledge of current events, the
estimates may ultimately differ from actual results.

Revenue Recognition

We ship products to our customers based on FOB shipping point and, as such, recognize product sales on the date of shipment. Installation of the products
is considered perfunctory. Payments received in advance of shipment of product are deferred until such products are shipped. We do not have royalty agreements that result in revenue to EP Med and we do not provide distributors or end-users with a
general right to return products purchased.

We have three sales channels: Direct sales to customers, sales to independent distributors,
and sales to alliance partners. Our products do not require installation in the traditional sense, but the EP-WorkMate system does require a set up. For distributors, the distributor is responsible for all set-up of all electronic
hardware products, and we have no obligation after shipment of products to the distributors. For direct sales, while the customer can perform the set-up on its own, EP Med personnel generally will assist customers in this process. The set-up
process, which takes approximately 1-2 hours to complete, is usually performed shortly after shipment and primarily consists of assembling the workstation cart and plugging in the monitors, printer, isolation transformer, and the EP-4 Stimulator to
the main computer. This process does not impact our standard payment terms. For sales to distributors, payment terms are defined in the distributor agreements as 100% of the purchase price being due 30 to 60 days after shipment. For direct sales,
payment terms are agreed in advance of the sale and generally require a 50% deposit prior to shipment, with the balance due 30 to 60 days after shipment.

We provide a standard one-year warranty on all of our products, and in accordance with Statement of Financial Accounting Standard (SFAS) No. 5, Accounting for Contingencies, we accrue the
estimated cost of providing the warranty at the time of sale. The estimates of the future costs are based on historical data.

We also sell
various types of warranty contracts to our customers. These contracts range in term from one to five years. Revenue is recognized on these contracts on a straight-line basis over the life of the contract.



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Valuation of Accounts Receivable

We continuously monitor customers balances, collections and payments, and maintain a provision for estimated credit losses based upon our historical experience, changes in the financial condition of our
customers, and any specific customer collection issues that we have identified. As these factors change, our allowance for doubtful accounts may change in subsequent accounting periods. In addition, due to the significant average selling price of
our equipment, any single write-off of a customer balance could be substantial. We may request letters of credit from our customers when we believe that there is a significant risk of credit loss. While such credit losses have historically been
within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.

Valuation of Inventory

We value our inventory at the lower of cost or market, with cost being
determined on a first-in, first-out basis. We continually monitor our slow-moving items, and establish reserve amounts on a specific identification basis, as necessary. In addition, due to the fact that our business is dependent on the latest
computer technology, we continually monitor our inventory and products for obsolescence. If we determine market value to be less than cost, we write down the cost to that value. Additional reserves are sometimes established as a result of lack of
marketability or changes in customer consumption patterns. Managements judgment is necessary in determining the realizable value of those products to arrive at the proper obsolescence reserve. Generally, we do not experience significant
writedowns, losses, etc. with the valuation of our inventory; however, these reserves are estimates, which could change significantly, either favorably or unfavorably, depending on market and competitive conditions.

Valuation of Goodwill, Intangible Assets, and Other Long-Lived Assets

We assess the impairment of identifiable intangibles, long-lived assets and enterprise level goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we
consider important which could trigger an impairment review include the following:



| |  |  | significant underperformance relative to expected historical or projected future operating results;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | significant negative industry or economic trends;
| | - |  | -------------------------------------------------



| |  |  | significant decline in our stock price for a sustained period; and
| | - |  | ------------------------------------------------------------------



| |  |  | our market capitalization relative to net book value.
| | - |  | -----------------------------------------------------

When we determine that the carrying value of intangibles, long-lived assets and related goodwill and enterprise level goodwill may not be recoverable based upon the existence of one or more of the above indicators of
impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.

Income Taxes

We account for our income taxes under
the liability method. Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be
in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. We have fully reserved our deferred tax asset given our past history of operating losses.

Accounting for Stock-Based Compensation.

We had
elected to measure our stock-based compensation expense relating to grants to employees under our stock option plans using the intrinsic value method. Under this method, we record no compensation expense



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when we grant stock options to employees if the exercise price for a fixed stock option award to an employee is equal to the fair value of the underlying
common stock at the date we grant the stock option.

A different method for accounting for employee stock option grants is the fair value
method. Under the fair value method, a company is required to determine the fair value of options granted to employees based on an option pricing model which incorporates such factors as the current stock price, exercise prices of the options,
expected volatility of future movements in the price of the underlying stock, risk-free interest rates, the term of the options and any dividends expected to be paid. The fair value determined under this method is then amortized over the vesting
period of the related options. Had we chosen to account for employee stock options using the fair value method, we would have recorded additional stock based compensation expense of approximately $754,000 and $560,000 for the years ended
December 31, 2005 and 2004, respectively.

On December 16, 2004 the Financial Accounting Standards Board (FASB)
issued SFAS No. 123(R), Share-Based Payment, which is an amendment to SFAS No. 123, Accounting for Stock-Based Compensation. This new standard eliminates the ability to account for share-based compensation transactions using Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires such transactions to be accounted for using a fair-value-based method and the resulting cost recognized in our financial
statements. This new standard was effective beginning in the first fiscal year beginning after June 15, 2005. We adopted this new standard effective for the first quarter of 2006.

We used the modified prospective method and therefore did not restate prior period results. Under the modified prospective method, awards
granted, modified, or settled after the date of adoption should be measured and accounted for in accordance with SFAS No. 123R. Unvested equity-classified awards that were granted prior to the effective date should continue to be accounted for
in accordance with SFAS 123 except that amounts must be recognized in the consolidated statements of income. We have not accelerated or modified the existing stock option plans to eliminate the recording of stock option expense as required by SFAS
No. 123R.

The unrecognized compensation expense associated with unvested stock options was approximately $2,247,000 as of
December 31, 2006, which will be amortized over an average period of approximately 5 years. Our 2007 fiscal results are expected to include approximately $853,000 of additional pre-tax compensation expense as a result of the adoption of SFAS
No. 123R.

Results of Operations.

Results of
Operation for the Fiscal Year Ended December 31, 2006 Compared to the Fiscal Year Ended December 31, 2005

We had net sales of
$15,558,000 for the year ended December 31, 2006, as compared to $16,669,000 for the year ended December 31, 2006. This $1,111,000 (or 6.7%) decrease was primarily due to lower sales of our EP-WorkMate system with Boston Scientific
Corporations RPM Navigation system which has become less competitive due to a lack of support from Boston Scientific for this product line. We realized higher sales of our EP-WorkMate system product line, but we are not closing higher priced
combination systems as we did in 2005. Our sales of consumable products were up 9% over the same period last year. Sales of ALERT catheters were flat as we are not actively recruiting new placements. However, sales of ViewFlex ultrasound catheters
increased 23% over the same period in 2005. Sales in the United States were down 13% over the same period in 2005. Sales in Asia were essentially unchanged year over year. Sales in Europe increased 32% due to strong sales in the last 9 months of the
year by our distributors in the region and our representative in France.

Gross profit on sales for the year ended December 31, 2006
was $9,433,000 as compared with $10,249,000 for the same period in 2005. Gross profit as a percentage of sales was relatively flat at 61%. Gross profit for the year ended December 31, 2006 was impacted by certain write-downs of inventory of
approximately $411,000 as the Company assessed the market valuation and obsolescence of certain items in inventory.



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Sales and marketing expenses increased $1,198,000 (or 14%) to $9,683,000 for the year ended
December 31, 2006 as compared to the same period in 2005. Of this increase, our clinical affairs department accounted for approximately $296,000 of the increase in symposia costs, share-based compensation for our senior medical advisor and
clinical fees associated with the Companys ICE CHIP study. We completed phase I of the ICE CHIP study in July of 2006 and after data analysis we will determine whether to begin enrollment in phase II in the middle of 2007, depending on the
results. We are also in the initial phase of a second clinical trial to support additional applications of our ViewMate II cardiac ultrasound catheter system. We incurred an additional $500,000 in compensation costs of which $344,000 was share-based
compensation associated with the adoption of FAS 123R. The balance of the compensation costs was for additional head count. In connection with the increased headcount, we had $50,000 in additional travel costs as well.

General and administrative expenses decreased $1,660,000 (or 31%) to $3,737,000 for the year ended December 31, 2006 as compared to the same period
in 2005. The decrease in general and administrative expenses was due to a number of factors. There was a decrease in our legal costs of $1,696,000 as a result of what we anticipate is the completion of a significant portion of the legal work
associated with our receipt of the Administrative Subpoena and the investigation by the Department of Commerce and other governmental entitles described more fully in Note 16 of the Consolidated Financial Statements included in this Annual Report on
Form 10-K. We incurred approximately $1,430,000 of legal, consulting and accounting expenses in the third and fourth quarters of 2005 associated with our response to these governmental investigations. These expenses were primarily attributable to
our Audit Committee investigation, our negotiations with the government and the termination of Reinhard Schmidt, our former President and Chief Executive Officer. Although we are unable to estimate the amount of additional legal expenses we may be
required to incur to resolve these governmental investigations and inquiries, we have incurred approximately $210,000 of legal and other fees and expenses in connection with these matters for the year ended December 31, 2006. We believe that
additional legal and other costs and expenses through the remainder of 2007 may be significant as we work to resolve these matters and continue to implement control procedures designed to prevent our products or services from being provided to
customers in any foreign countries in violation of applicable law. With respect to this matter, we have signed a settlement agreement with the Department of Commerce and recorded an expense of $244,000 associated with the expected fines and
penalties with no restrictions on commercial or export activities. Notwithstanding the agreement as to settlement terms with the Commerce Department, the investigations by the U.S. Treasury Department and the Securities and Exchange Commission have
not been closed, and could result in findings that we violated applicable law resulting in additional civil, administrative or criminal fines or penalties. In November 2006, the Treasury Department has orally indicated to the Company the maximum
penalty the Department would be seeking is $44,000 with no restrictions on commercial or export activities. We have received a settlement agreement from Treasury, in which the penalty was $33,000. The agreement also had certain other requirements.
The Company has executed the agreement, paid the fine and forwarded it to the Treasury. This issue is deemed to be closed. We cannot assure you that the ongoing investigations by the Commission or the U.S. Treasury Department will not result in
other significant costs, fines or penalties that could, in the aggregate, have a material adverse effect on our business, financial condition, prospects or results of operations. The Company has made no provision for any future costs associated with
these investigations or any costs associated with the Companys defense or negotiations with the various governmental entities to resolve these outstanding issues.

Notwithstanding the penalties accrued, we had a decrease in non-cash expenses of $568,000 as a result of fluctuations in foreign currency and a decrease of consulting fees of $129,000 associated with our planned
compliance with Section 404 of Sarbanes-Oxley. In addition, there were lower deferred financing fees associated with lower conversions of the Laurus Convertible Note. We had higher compensation costs of $588,000 primarily associated with
share-based compensation costs of $460,000. There was a decrease of $143,000 in other costs associated with the above mentioned investigations.

Research and development expenses increased $364,000 (or 15%) to $2,738,000 for the year ended December 31, 2006 as compared to the same period in 2005. The increase was due to an increase of $260,000 in



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salaries, benefits and recruiter fees associated with additional headcount in the research and development and quality departments, including $102,000
related to share-based compensation. There was also an increase in destructive testing costs of $77,000 associated with the ViewFlex catheter product. We believe these testing costs will continue into the second quarter of 2007 as we manage changes to the catheter to improve the
supply. These costs were offset by a reduction in project costs. Costs for research and development can fluctuate on a quarter-by-quarter basis depending on the status of projects and intellectual property strategies.

Interest expense increased $2,000 to $258,000 for the year ended December 31, 2006, as compared to the same period in 2005. This increase in
interest expense is a result of higher interest rates in 2006 offset by a decrease in the beneficial conversion feature and decrease in the accretion of debt discount as a result of the conversion of debt to equity related to the convertible note
issued to Laurus. Interest and other income increased $219,000 to $420,000 primarily due to higher cash balances and higher interest rates.

Results of
Operations for the Fiscal Year Ended December 31, 2005 Compared to the Fiscal Year Ended December 31, 2004

We had net sales
of $16,669,000 for the year ended December 31, 2005 as compared to $16,369,000 for the year ended December 31, 2004. This $300,000 (or 2%) increase was primarily due to a $665,000 increase in sales of our ViewMate® and its ViewFlex catheter as we are building our
installed base of the units and driving utilization of the catheters, a $356,000 increase in sales of EP-WorkMate systems® and upgrades and $339,000 increase in parts and warranty contract revenue. The increase in sales of these products in 2005 was offset primarily by
approximately $900,000 in lower sales of the WorkMate® integrated with RPM and lower sales of our diagnostic catheter products. We had an $829,000 increase in sales in Asia, with the renewed relationship with our Japanese distributor, which was offset by a decrease
in sales in Europe. Sales in Europe may have been impacted by the termination of our European Sales Manager and the termination of certain distributor relationships.

Gross profit on sales for the year ended December 31, 2005 was $10,249,000 as compared with $9,706,000 for the same period in 2004. This increase in gross profit as a percentage of sales from 59% to 61% was
primarily the result of the regional sales mix in 2005. Sales were lower in Europe where overall margins are lower.

Sales and marketing
expenses increased $139,000 (or 2%) to $8,485,000 for the year ended December 31, 2005 as compared to the same period in 2004. This increase was a result of higher compensation and travel costs as a result of additional headcount for the
clinical affairs department, marketing department and field applications department of $499,000. There were also additional consulting costs of $85,000 associated with options to purchase our common stock provided to our Senior Medical Advisor.
These costs were offset by lower convention expenses of $113,000 as we worked with our strategic partners in the management and attendance at certain conventions. In addition, through better management of customer and demo shipments we experienced a
reduction of freight cost of $118,000. We also experienced higher depreciation expense associated with upgrading our demo equipment offset by a reduction of royalty expense associated with lower sales of WorkMate® system integrated with RPM.

General and administrative expenses increased $2,363,000 (78%) to $5,397,000 for the year ended December 31, 2005 as compared to the same period in 2004. This increase was primarily due to an increase in our
legal costs of $1,814,000, which were primarily associated with governmental investigations and inquiries relating to the sale and/or export of our products to Iran and Syria. We incurred approximately $1,430,000 of legal, consulting and accounting
expenses in the third and fourth quarters of 2005 associated with our response to these governmental investigations. These expenses were primarily attributable to our Audit Committee investigation, our negotiations with the government and the
termination of Reinhard Schmidt, our former President and Chief Executive Officer. Although we are unable to estimate the amount of additional legal expenses we may be required to incur to resolve these governmental investigations and inquiries, we
have incurred approximately $114,000 of legal and other fees and expenses in connection with these matters through February 28, 2006. In addition, we may be required to make substantial payments for fines, penalties or



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settlements in connection with the resolution of these matters. Any of such expenses or payments could have a material adverse effect on our results of
operations and financial condition. In addition to increased legal costs, we incurred higher Board of Directors compensation costs in connection with the independent investigation of approximately $100,000. We also had an increase in non-cash
expenses of $393,000 as a result of fluctuations in foreign currency. Expenses in connection with being a public company increased significantly in the first half of 2005 as we incurred an additional $158,000 in consulting costs primarily as a
result of our efforts to comply with Section 404 of Sarbanes-Oxley. We expect to incur additional costs in our efforts to comply with the requirements of Sarbanes-Oxley in the future, which costs may vary depending on changes to compliance
requirements. These cost increases were offset by a decrease in business insurance costs of $92,000.

Research and development expenses
decreased $96,000 (or 4%) to $2,374,000 for the year ended December 31, 2005 as compared to the same period in 2004. The decrease was primarily due to a decrease in project costs and consulting costs of $160,000 as our products have been
approved for sale and a decrease in patent costs of $36,000 as we completed certain intellectual property strategies in 2005. These decreases have been offset by an increase in compensation costs in 2005 associated with an increase in headcount in
our quality assurance department of $105,000 to manage increased production and quality assurance across multiple product lines. Research and development costs can fluctuate quarter to quarter depending on the status of the ongoing development
projects and intellectual property strategies.

Interest expense increased $46,000 to $256,000 for the year ended December 31, 2005 as
compared to the same period in 2004. This was the result of higher interest rates on our secured convertible note (the Laurus Convertible Note) sold to Laurus Master Fund, Ltd. (Laurus) on August 28, 2003, partially
offset by a lower average debt balance and lower amortization of the beneficial conversion feature and lower accretion of debt discount. Interest income increased $134,000 to $201,000 primarily as a result of higher interest rates.

Liquidity and Capital Resources

Since our
incorporation in January 1993, our expenses have exceeded sales, resulting in an accumulated deficit of approximately $54.8 million at December 31, 2006 and approximately $48.3 million at December 31, 2005.

Financing Activities

On August 28, 2003, we
issued the Laurus Convertible Note to Laurus and entered into a related Security Agreement with Laurus, pursuant to which Laurus provided us with a $4,000,000 revolving asset-based credit facility in the form of a three-year Laurus Convertible Note
secured by our accounts receivable, inventory, real property and other assets, other than intellectual property.

At the closing of the
transaction, we issued the Laurus Convertible Note to Laurus having a principal amount of $4,000,000 and received net proceeds of $2,661,600. An additional $1,000,000 of the Laurus Convertible Note was previously restricted. Those restrictions were
released during the third quarter of 2004 and that amount became available to us. The balance of the proceeds was used to pay fees incurred in connection with this transaction. Deferred financing fees are being amortized over the life of the Laurus
Convertible Note using the effective interest method. In addition, we paid a portion of the fees payable to an intermediary, Biscayne Capital Markets, Inc. (Biscayne), in 40,000 shares of our common stock having a market value on the
date of closing of this transaction equal to $100,000. The net proceeds of the Laurus Convertible Note have been, and will be, used for working capital purposes and payment of outstanding debt.

The portion of the Laurus Convertible Note against which Laurus advances funds based on our accounts receivable bears interest at the prime rate, with a
floor of 4%, which is an effective interest rate of approximately 21% (including accretion of discount and amortization of beneficial conversion feature), and the balance (the



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Advance Amounts) bears interest at the prime rate plus 2%. One half of the Advance Amounts outstanding on February 28, 2005 was required to
be repaid on or before that date. However, there were no Advance Amounts outstanding on that date, as the net collateral exceeded the principal amount outstanding on the Laurus Convertible Note. The remaining balance of the Advance Amounts
outstanding on the date of the closing was required to be repaid on or before August 28, 2006. On November 9, 2005, the Convertible Notes maturity date was extended to February 28, 2008. Subject to certain rights of
cancellation, we may extend the Laurus credit facility, on a year-by-year basis, commencing February 28, 2008. We may repay in cash, without penalty, up to $500,000 of the Laurus Convertible Note in any one calendar year, plus all Advance
Amounts.

Subject to certain volume limitations and other conditions, all or a portion of the Laurus Convertible Note was convertible into
our common stock at our option if the market price of our common stock reached a level, for 11 consecutive trading days, which was more than 120% of the fixed conversion price, as defined (the Fixed Conversion Price). Subject to certain
volume limitations and other conditions, Laurus has the option to convert all or a portion of the Laurus Convertible Note into shares of our common stock at the Fixed Conversion Price.

Following the conversion into our common stock by us and/or Laurus of an aggregate of $2,000,000 of the principal amount of the Laurus Convertible Note
(a Conversion Event), the Fixed Conversion Price will be adjusted upward to a price which is 115% of the average of the closing price of our common stock for the three trading days prior to the Conversion Event. On December 15,
2004, the balance of the first $2,000,000 of the principal amount was converted into shares of our common stock at the Fixed Conversion Price, and the Fixed Conversion Price on the remaining $2,000,000 principal balance was adjusted upward from
$2.55 to $4.20. Subject to certain limitations, including the repayment obligations with respect to Advance Amounts described above, the dollar amounts of the Laurus Convertible Note converted may be re-borrowed. The Fixed Conversion Price is
subject to adjustment, with customary exceptions and on a weighted-average basis, in connection with sales of our securities below the Fixed Conversion Price then in effect, and is also subject to adjustment for stock splits, combinations, stock
dividends and similar events.

As part of the Laurus Convertible Note transaction, Laurus and Biscayne also received warrants to purchase
an aggregate of 240,750 shares of our common stock (the Warrants), with exercise prices set as follows: $2.93 per share for the purchase of up to the first 133,750 shares, $3.19 per share for the purchase of up to the next 80,250 shares,
and $3.70 per share for the purchase of up to the final 26,750 shares. The expiration date of the Warrants is August 28, 2010. The exercise price of the Warrants and the number of shares underlying the Warrants are subject to adjustments for
stock splits, combinations, stock dividends and similar events.

In October 2003, we registered, under the Securities Act of 1933, as
amended, 1,500,000 shares of our common stock which may be received by Laurus upon conversion of the Laurus Convertible Note and exercise of the Warrant, and the remaining 293,628 of such shares were registered in November 2004. In accordance with
the provisions of Emerging Issues Task Force (EITF) Issue 00-27, Application of EITF Issue No. 98-5 Accounting for Convertible Securities with Beneficial Conversion Features of Contingently Adjustable Conversion Ratios, to
Certain Convertible Securities, the allocated value of the Laurus Convertible Note contained a beneficial conversion feature calculated based on the difference between the effective conversion price of the proceeds allocated to the Laurus
Convertible Note and the Warrants at the date of issuance. The amount arising from the beneficial conversion feature aggregated approximately $486,000 and is being amortized as interest expense from the date of the issuance of the Laurus Convertible
Note to the mandatory redemption date of August 28, 2006. We valued the Laurus Convertible Note and the Warrants at issuance. The fair value of the Warrants at the time of issue was $407,500. In accordance with EITF 00-19, Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock, we marked the Warrants to market at September 30, 2003 incurring a non-cash charge of $264,000. The registration rights agreement
associated with the Laurus Convertible Note was amended on November 25, 2003 and, as a result, the amount associated with the Warrants was transferred to equity. We marked the Warrants to market at the date of the amendment which reduced the
overall expense to $210,750 for the year ended December 31, 2003. The net carrying value of the Laurus Convertible Note, after allocation of the fair value of the Warrants, is being accreted to interest expense over the life of the agreement
using the effective interest method.



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In May of 2004, we engaged a physician as a consultant to head our clinical affairs department as senior
medical advisor. In connection with that agreement, we issued 10,000 shares of our common stock to the physician and granted the physician an option to purchase 10,000 shares of the common stock which vests three years from the date of grant. Also
in connection with the agreement, we granted the physician an option to purchase 40,000 shares of our common stock which vests in equal installments over three years. The exercise price of each of the options was the fair market value of our common
stock on the date of the grant. The transactions were accounted for in accordance with 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. The fair value was measured using the Black-Scholes option pricing model under Statement of Financial Accounting Standard No. 123 using the following assumptions for each grant as follows: risk free rate:
3.07%, 10 year life, and a volatility percentage of 83.86%.

During 2005, three additional options to purchase shares of our common stock
were issued to this senior medical advisor in the amounts of 40,000, 40,000 and 100,000 shares of common stock respectively, on which the exercise price of the options was the fair market value of our common stock on the date of the grant. With
respect to the two 40,000 option issuances, they vest in equal installments over three years and we expensed $171,000 representing the fair value of the options measured using the Black-Scholes option pricing model for each grant as follows: risk
free rate of 3.77% and 4.33%; 10 year live, and volatility percentage of 77.98% and 81.1%. The issuance of an option in the amount of 100,000 shares of our common stock did not meet the criteria for expensing in 2005. In the first quarter of 2006,
the consultants performance obligation in connection with these options was fulfilled and we recorded an expense of $196,480, valued using the Black-Scholes option pricing model for each grant as follows: risk free rate of 4.82%, 10 year life,
and volatility percentage of 84.23%.

On March 27, 2006, we completed a $10,000,000 private placement of its common stock to a number
of accredited investors. We issued 3.78 million shares of its common stock at a purchase price of $2.25 per share. In addition, FatBoy Capital, LP purchased approximately 617,000 shares of common stock at a price of $2.43 per share in
accordance with NASDAQ marketplace rules. David Jenkins, the Companys Chairman is a managing member of FatBoy Capitals general partner. In connection with this transaction, certain anti-dilution provisions of the Laurus Convertible Note
resulted in a reduction of the conversion price of that note from $4.20 to $3.96.

Operating and Investing Activities

Net cash used in operating activities for the year ended December 31, 2006 increased by $2,169,000 to $6,623,000 as compared to the same period in
2005. The increase in our net use of cash in operations during 2006 was due to the increase in our net loss and accounts receivables and was partially offset by a $923,000 in share-based compensation associated with the adoption of SFAS 123R.
Capital expenditures were $194,000 for the year ended December 31, 2006 as compared to $201,000 and $308,000 in 2005 and 2004, respectively. We expect to purchase capital equipment in 2007 as we grow. We lease office space and certain office
equipment under operating leases.

Assets increased by $3,180,000 from $15,131,000 at December 31, 2005 to $18,311,000 at
December 31, 2006. The change in assets was due to a number of factors. Cash and cash equivalents increased by $2,563,000 from primarily associated with private placement in March 2006. In addition there was a $1,436,000 increase in accounts
receivable. The increase in assets was offset by lower inventory associated with the write-down certain products, lower fixed assets, and lower other assets as a results of the amortization of costs associated with our convertible debt.

Liabilities decreased approximately $656,000 from $6,779,000 at December 31, 2005 to $6,123,000 at December 31, 2006. The decrease in
liabilities was primarily associated with a $690,000 decrease in accounts payable. The 2005 payables included a significant amount of payables pertaining to internal investigations.

We evaluate the collectability of our receivables quarterly. The allowance for bad debts is based upon specific identification of customer accounts for
which collection is doubtful and our estimate of the likelihood of



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potential loss. To date, we have experienced only modest credit losses with respect to our accounts receivable. To date, we have experienced minor inventory
write-downs, and the reserve is consistent with managements expectations.

We have a history of operating losses and we expect to
continue to incur operating losses in the near future as we continue to expend substantial funds for research and development, increased manufacturing activity, expansion of sales and legal and other costs associated with the various government
investigations. The amount and timing of future losses will depend upon, among other things, volume of sales of our existing products, market acceptance of the ultrasound products, and developmental, regulatory and market success of new products
under development, as well as our ability to establish, preserve and enforce intellectual property rights related to our products and favorable resolution of the various government investigations. There can be no assurance that any of our
development projects will be successful or that if development is successful, the products will generate any sales or that material cost, or in the case of the government investigations, material fines and possible civil or criminal penalties will
not be imposed. Based upon our current plans and projections, we believe that our existing capital resources will be sufficient to meet our anticipated capital needs through the end of the fourth quarter of 2007.

We incurred approximately $1,430,000 of legal, consulting and accounting expenses in the third and fourth quarters of 2005 associated with our response
to governmental investigations and inquiries relating to certain sales of our products into Iran and Syria and certain financial and accounting reporting matters. See Item 3. Legal Matters. Although we are unable to estimate the
amount of additional legal expenses we may be required to incur to resolve these governmental investigations and inquiries, in 2006 we have incurred approximately $210,000 of legal and other fees and expenses in connection with these matters. We
believe that additional legal and other costs and expenses through the remainder of 2007 may be significant as we work to resolve these matters and continue to implement control procedures designed to prevent our products or services from being
provided to customers in any foreign countries in violation of applicable law. In addition, we may be required to make substantial payments for fines, penalties or settlements in connection with the resolution of these matters. Any of such expenses
or payments could have a material adverse effect on our liquidity and capital resources.

Off-Balance Sheet Arrangements

As of December 31, 2006, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

Summary of Contractual Obligations

The following
table summarizes our contractual cash obligations at December 31, 2006, and the effects such obligations are expected to have on liquidity and cash flow in future periods. We do not have any other commercial commitments.



|                                   |  |                        |           |                 |   |           |  |           |           |              |   |   |  |   |  
|---------------------------------- |  | ---------------------- | --------- | --------------- | - | --------- |  | --------- | --------- | ------------ | - | - |  | - | -
|                                   |  | Payments Due by Period
|Contractual Obligations            |  | Total                  |           | Less than1 year |   | 1-3 years |  | 4-5 years |           | After5 years
|Long-Term Debt (1)                 |  | $                      | 2,000,000 |                 | $ | 0         |  | $         | 2,000,000 |              | $ | 0 |  | $ | 0
|Operating Lease Obligations        |  | $                      | 191,000   |                 | $ | 115,000   |  | $         | 76,000    |              | $ | 0 |  | $ | 0
|Other Long Term Obligations (2)    |  | $                      | 0         |                 | $ | 0         |  | $         | 0         |              | $ | 0 |  | $ | 0
|                                   |  |                        |           |                 |   |           |  |           |           |              |   |   |  |   |  
|Total Contractual Cash Obligations |  | $                      | 2,191,000 |                 | $ | 115,000   |  | $         | 2,076,000 |              | $ | 0 |  | $ | 0
|                                   |  |                        |           |                 |   |           |  |           |           |              |   |   |  |   |  

---

|(1) | We are also contractually obligated to pay variable interest on the Long-Term Debt, the principal of which comes due February 2008.
|--- | -----------------------------------------------------------------------------------------------------------------------------------



|(2) | The Company also has contractual obligations for certain licensing contracts. We have signed a license agreement with Biosense Webster that provides for a license
payment on sales of MapMate units. This
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| | license is payable upon sales of the units. We also have other license agreements which the Company may terminate unilaterally in the event that the
technology is no longer deemed relevant.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Item 7A. | Quantitative and Qualitative Disclosures About Market Risk.
|-------- | -----------------------------------------------------------

We are exposed to a variety of risks, including changes in interest rates affecting our outstanding debt balance and fixed rate investments of our cash and cash equivalents and foreign currency fluctuations. The Company does not have any
market risk with respect to such factors as commodity prices or equity prices. We do not invest in, or otherwise use, foreign currency or other derivative financial or derivative commodity instruments, and we do not engage in hedging transactions
for speculative or trading or any other purposes.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio for our non-current debt obligations and our cash and cash equivalents.

At December 31, 2006, we had the Laurus Convertible Note outstanding in the approximate amount of $2,000,000. Interest on the Laurus Convertible
Note is based on the prime rate. This floating rate debt may lead to additional interest expense if interest rates increase. In addition, interest on the note may be higher if our collateral consistency of eligible accounts receivable and the value
of our facility are not in access of the amount of the convertible note. Because management does not believe that our exposure to interest rate market risk is material at this time, we have not developed or implemented a strategy to manage this
market risk through the use of derivative financial instruments or otherwise. We will assess the significance of interest rate market risk from time to time and will develop and implement strategies to manage that market risk as appropriate.

We invest our excess cash in money market funds and government securities, which creates a degree of interest rate risk. Our primary
exposure to market risk relates to changes in interest rates on our cash and cash equivalents. Our primary investment objective with respect to our cash and cash equivalents is to preserve principal, while at the same time maximizing yields without
significantly increasing risk.

Our portfolio includes money markets funds and/or government securities. The diversity of our portfolio
helps us to achieve our investment objective. As of December 31, 2006, 100% of our investment portfolio matures less than 90 days from the date of purchase. Due to the short-term nature of these investments, we believe that we are not subject
to any material market risk exposure, and as a result, the estimated fair value of our cash and cash equivalents approximates their principal amounts. If market interest rates were to increase immediately and uniformly by 10% from levels at
December 31, 2006, we estimate that the fair value of investment portfolio would decline by an immaterial amount.

Foreign Currency Risk

Our international revenues were 28%, 23% and 22% of our total revenues for the year ended December 31, 2006, 2005 and 2004,
respectively. Our international sales are made through international distributors, our direct sales force and sales to alliance partners, with payments to us typically denominated in United States dollars and the Euro. Approximately 5% of our
foreign sales are denominated in the Euro. Management believes that the aggregate impact of foreign currency risk is minimal since a majority of our sales are billed in United States dollars. Our international business is subject to risks typical of
an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future
results could be materially adversely affected by changes in these or other factors. We do not hedge our foreign currency exposure at present.



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##### Table of Contents

|Item 8. | Financial Statements and Supplementary Data.
|------- | --------------------------------------------

The
information in response to this item is set forth in the Consolidated Financial Statements beginning on page F-1 of this Annual Report.



|Item 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
|------- | -------------------------------------------------------------------------------------

Not applicable.



|Item 9A. | Controls and Procedures.
|-------- | ------------------------

As of the end of the
period covered by this report, we conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls
and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission rules
and forms. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under
all potential future conditions, regardless of how remote.

There was no change in our internal control over financial reporting during our
most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.



|Item 9B. | Other Information.
|-------- | ------------------

Not applicable.



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##### Table of Contents

PART III



|Item 10. | Directors, Executive Officers and Corporate Governance.
|-------- | -------------------------------------------------------

All information required by this Item 10 may be found under the sections entitled Item 1: Certain Information Concerning Nominees and Continuing Directors, Certain Information Concerning Board Meetings and
Committees, Executive Compensation and Related Matters in our Proxy Statement, which is expected to be mailed to shareholders on or around May 20, 2007, which is incorporated herein by reference.



|Item 11. | Executive Compensation.
|-------- | -----------------------

All information required
by this Item 11 is may be found under, in the sections entitled Executive Compensation, Board Compensation, Related Matters, Report of the Compensation Committee, and Miscellaneous in
our Proxy Statement for our Annual Meeting of Stockholders which is expected to be mailed to shareholders on or around May 20, 2007, which is incorporated herein by reference.



|Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
|-------- | -----------------------------------------------------------------------------------------------

All information required by this Item 12 may be found under the sections entitled Executive Compensation, Security Ownership of
Management and Certain Beneficial Owners and Miscellaneous in our Proxy Statement for our Annual Meeting of Stockholders which is expected to be mailed to shareholders on or around May 20, 2007, which is incorporated herein by
reference.



|Item 13. | Certain Relationships and Related Transactions, and Director Independence.
|-------- | --------------------------------------------------------------------------

All information required by this Item 13 may be found under the section entitled Certain Relationships and Related Transactions in our Proxy Statement for our Annual Meeting of Stockholders which is
expected to be mailed to shareholders on or around May 20, 2007, which is incorporated herein by reference.



|Item 14. | Principal Accountant Fees and Services.
|-------- | ---------------------------------------

All
information required by this Item 14 may be found under the section entitled Audit and Other Fees Paid to Independent Auditors and Audit Committee Policies and Procedures in our Proxy Statement for our Annual
Meeting of Stockholders which is expected to be mailed to shareholders on or around May 20, 2007, which is incorporated herein by reference.



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##### Table of Contents

PART IV



|Item 15. | Exhibits and Financial Statement Schedules.
|-------- | -------------------------------------------

(a)
Financial Statements, Financial Statements, Financial Statement Schedules, and Exhibits:

(1) Financial Statements

The financial statements filed as part of this report are listed on the index to Consolidated Financial Statements in
Item 8.

(2) Financial Statement Schedules:

None. Any information required in the Financial Statement Schedules is provided in sufficient detail in our Consolidated Financial
Statements and notes thereto.

(3) Exhibits

Exhibits are listed in the Exhibit Index on page E-1 filed here with.

The Exhibits include management contracts, compensatory plans and arrangements required to filed as exhibits to the Form 10-K by item 601
or Regulation S-K.

(b) Exhibits

The Exhibits filed or incorporated by reference herewith are as specified in the exhibit Index.



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SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



EP MEDSYSTEMS, INC.By:

/s/    DAVID I.
BRUCEDavid I. Bruce,President and Chief Executive OfficerDate: March 30, 2007


KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes
and appoints David A. Jenkins and Matthew C. Hill, and each of them individually, his true and lawful attorney-in-fact, proxy and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all
capacities, to act on, sign any and all 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
attorneys-in-fact, proxies and agents, and each of them individually, full power and authority to do and perform each and every act and thing necessary and appropriate to be done in and about the premises, as fully as he might or could do in person,
hereby approving, ratifying and confirming all that said attorneys-in-fact, proxies and agents or any of his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

In accordance with the Securities Exchange Act of 1934, as amended, 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(s)                                   |  | Title(s)                                                             |  | Date          
|                                               |  |                                                                     
|/s/    DAVID I.
BRUCE David I. Bruce           |  | President, Chief Executive Officer, Director                         |  | March 30, 2007
|                                               |  |                                                                     
|/s/    DAVID A.
JENKINS David A. Jenkins       |  | Chairman of the Board of Directors                                   |  | March 30, 2007
|                                               |  |                                                                     
|/s/    MATTHEW C.
HILL Matthew C. Hill         |  | Chief Financial Officer (Principal Financial and Accounting Officer) |  | March 30, 2007
|                                               |  |                                                                     
|/s/    GERARD
MICHEL Gerard Michel             |  | Director                                                             |  | March 30, 2007
|                                               |  |                                                                     
|/s/    RICHARD C.
WILLIAMS Richard C. Williams |  | Director                                                             |  | March 30, 2007
|                                               |  |                                                                     
|/s/    ABHIJEET
LELE Abhijeet Lele             |  | Director                                                             |  | March 30, 2007



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INDEX TO FINANCIAL STATEMENTS

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                                |  |     
|--------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                |  | Page
|FINANCIAL STATEMENTS                                                                                            |  |     
|                                                                                                                | 
|Report of Independent Registered Public Accounting Firm                                                         |  | 51  
|                                                                                                                | 
|Consolidated Balance Sheets as of December 31, 2006 and December 31, 2005                                       |  | 52  
|                                                                                                                | 
|Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004                      |  | 53  
|                                                                                                                | 
|Consolidated Statements of Changes in Shareholders Equity for the years ended December 31, 2006, 2005 and 2004 |  | 54  
|                                                                                                                | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004                      |  | 55  
|                                                                                                                | 
|Notes to Consolidated Financial Statements                                                                      |  | 56  



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##### Table of Contents

Report Of Independent Registered Public Accounting Firm

Board of Directors and

Shareholders of EP MedSystems, Inc.

We have audited the
accompanying consolidated balance sheets of EP MedSystems, Inc. (a New Jersey corporation) as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in shareholders equity, and cash flows for each of
the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based
on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its
internal control over financial reporting. Our audit of the consolidated financial statements included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of EP MedSystems, Inc. as of December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period
ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

As discussed in
Note 2 to the consolidated financial statements, the Company has adopted Financial Accounting Standards Board Statement No. 123(R), Share Based Payments in 2006.

Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Schedule II is presented
for purposes of additional analysis and is not a required part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in
our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.

/s/ Grant Thornton LLP

Philadelphia, PA

March 21, 2007



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##### Table of Contents

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----------- | - | ---- | - | ----------- | -
|                                                                                                                                                                       |  | December 31, |            
|                                                                                                                                                                       |  | 2006         |             |   | 2005 |  
|ASSETS                                                                                                                                                                 |  |              |             |   |      |   |             |  
|Current assets:                                                                                                                                                        |  |              |             |   |      |   |             |  
|Cash and cash equivalents                                                                                                                                              |  | $            | 7,743,239   |   |      | $ | 5,180,001   |  
|Accounts receivable, net of allowance for doubtful accounts of $308,000, and $215,000 as of December 31, 2006 and 2005,
respectively                                   |  |              | 4,808,225   |   |      |   | 3,372,426   |  
|Inventories, net of reserves                                                                                                                                           |  |              | 2,859,677   |   |      |   | 3,223,783   |  
|Prepaid expenses and other current assets                                                                                                                              |  |              | 419,411     |   |      |   | 408,402     |  
|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total current assets                                                                                                                                                   |  |              | 15,830,552  |   |      |   | 12,184,612  |  
|Property, plant and equipment, net                                                                                                                                     |  |              | 1,937,131   |   |      |   | 2,289,495   |  
|Goodwill                                                                                                                                                               |  |              | 341,730     |   |      |   | 341,730     |  
|Other intangible assets, net                                                                                                                                           |  |              | 187,081     |   |      |   | 190,164     |  
|Other assets                                                                                                                                                           |  |              | 14,851      |   |      |   | 125,370     |  
|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total assets                                                                                                                                                           |  | $            | 18,311,345  |   |      | $ | 15,131,371  |  
|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                   |  |              |             |   |      |   |             |  
|Current liabilities:                                                                                                                                                   |  |              |             |   |      |   |             |  
|Accounts payable                                                                                                                                                       |  |              | 1,531,799   |   |      |   | 2,221,934   |  
|Accrued expenses                                                                                                                                                       |  |              | 1,722,944   |   |      |   | 1,716,770   |  
|Deferred revenue                                                                                                                                                       |  |              | 542,351     |   |      |   | 487,536     |  
|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total current liabilities                                                                                                                                              |  |              | 3,797,094   |   |      |   | 4,426,240   |  
|Deferred warranty revenuenon-current                                                                                                                                  |  |              | 335,658     |   |      |   | 372,309     |  
|Secured convertible note, non-current                                                                                                                                  |  |              | 1,989,760   |   |      |   | 1,980,198   |  
|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total liabilities                                                                                                                                                      |  | $            | 6,122,512   |   |      | $ | 6,778,747   |  
|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Commitments and contingencies                                                                                                                                          |  |              |            |   |      |   |            |  
|Shareholders equity:                                                                                                                                                  |  |              |             |   |      |   |             |  
|Preferred stock, no par value, 5,000,000 shares authorized, no shares issued and outstanding                                                                           |  |              |            |   |      |   |            |  
|Common stock, $.001 stated value, 40,000,000 shares authorized, 30,365,236 issued at December 31, 2006 and 25,970,176 shares issued at
December 31, 2005, respectively |  |              | 30,366      |   |      |   | 25,971      |  
|Additional paid-in capital                                                                                                                                             |  |              | 67,423,769  |   |      |   | 56,829,190  |  
|Accumulated other comprehensive loss                                                                                                                                   |  |              | (352,628    | ) |      |   | (67,148     | )
|Treasury stock, 50,000 shares at cost                                                                                                                                  |  |              | (100,000    | ) |      |   | (100,000    | )
|Accumulated deficit                                                                                                                                                    |  |              | (54,812,674 | ) |      |   | (48,335,389 | )
|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total shareholders equity                                                                                                                                             |  |              | 12,188,833  |   |      |   | 8,352,624   |  
|                                                                                                                                                                       |  |              |             |   |      |   |             |  
|Total liabilities and shareholders equity                                                                                                                             |  | $            | 18,311,345  |   |      | $ | 15,131,371  |  
|                                                                                                                                                                       |  |              |             |   |      |   |             |  

The accompanying notes are an integral part of these statements.



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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31,



|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  
|------------------------------------------------------------------------------------ |  | ---- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                                     |  | 2006 |            |   | 2005 |   |            | 2004 | 
|Net sales                                                                            |  | $    | 15,558,085 |   |      | $ | 16,669,107 |      |  | $ | 16,368,609 |  
|Cost of products sold (1)                                                            |  |      | 6,125,088  |   |      |   | 6,420,125  |      |  |   | 6,663,055  |  
|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  
|Gross profit                                                                         |  |      | 9,432,997  |   |      |   | 10,248,982 |      |  |   | 9,705,554  |  
|Operating costs and expenses:                                                        |  |      |            |   |      |   |            |      |  |   |            |  
|Sales and marketing expenses (2)                                                     |  |      | 9,683,576  |   |      |   | 8,485,193  |      |  |   | 8,346,138  |  
|Research and development (3)                                                         |  |      | 2,737,914  |   |      |   | 2,373,914  |      |  |   | 2,470,258  |  
|General and administrative (4)                                                       |  |      | 3,736,871  |   |      |   | 5,397,197  |      |  |   | 3,034,501  |  
|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  
|Total operating expenses                                                             |  |      | 16,158,361 |   |      |   | 16,256,304 |      |  |   | 13,850,897 |  
|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  
|Loss from operations                                                                 |  |      | (6,725,364 | ) |      |   | (6,007,322 | )    |  |   | (4,145,343 | )
|Interest expense                                                                     |  |      | (258,308   | ) |      |   | (256,458   | )    |  |   | (210,068   | )
|Interest expense, debt conversion                                                    |  |      |           |   |      |   |           |      |  |   | (581,698   | )
|Interest and other income                                                            |  |      | 419,514    |   |      |   | 200,578    |      |  |   | 66,368     |  
|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  
|Loss before income tax benefit                                                       |  | $    | (6,564,158 | ) |      | $ | (6,063,202 | )    |  | $ | (4,870,741 | )
|Income tax benefit                                                                   |  |      | 86,873     |   |      |   | 290,128    |      |  |   | 460,478    |  
|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  
|Net loss                                                                             |  | $    | (6,477,285 | ) |      | $ | (5,773,074 | )    |  | $ | (4,410,263 | )
|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  
|Basic and diluted net loss per share                                                 |  | $    | (0.22      | ) |      | $ | (0.22      | )    |  | $ | (0.19      | )
|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  
|Weighted average shares outstanding used to compute basic and diluted loss per share |  |      | 29,330,452 |   |      |   | 25,801,729 |      |  |   | 23,514,846 |  
|                                                                                     |  |      |            |   |      |   |            |      |  |   |            |  

---

|(1) | Includes share-based compensation expense of $17,046 for the year ended December 31, 2006
|--- | -----------------------------------------------------------------------------------------

|(2) | Includes share-based compensation expense of $343,938 for the year ended December 31, 2006
|--- | ------------------------------------------------------------------------------------------

|(3) | Includes share-based compensation expense of $101,878 for the year ended December 31, 2006
|--- | ------------------------------------------------------------------------------------------

|(4) | Includes share-based compensation expense of $460,483 for the year ended December 31, 2006
|--- | ------------------------------------------------------------------------------------------



The accompanying notes are an integral part of these statements.



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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2004, 2005, 2006



|                                                                                                 |  |                     |  |                     |        |                        |   |          |                       |  |   |                            |   |                                               |   |            |                |   |          |                     |  |   |          |   |  |   |             |   |  |   |            |  
|------------------------------------------------------------------------------------------------ |  | ------------------- |  | ------------------- | ------ | ---------------------- | - | -------- | --------------------- |  | - | -------------------------- | - | --------------------------------------------- | - | ---------- | -------------- | - | -------- | ------------------- |  | - | -------- | - |  | - | ----------- | - |  | - | ---------- | -
|                                                                                                 |  | Common Stock Shares |  | Common Stock Amount |        | Preferred Stock Shares |   |          | Preferred StockAmount |  |   | Additional Paid-in Capital |   | Accumulated Other Comprehensive Income (Loss) |   |            | Treasury Stock |   |          | Accumulated Deficit |  |   | Total    |  
|Balance, December 31, 2003                                                                       |  | 23,098,179          |  | $                   | 23,098 |                        | $ | 373,779  |                       |  | $ | 618,161                    |   |                                               | $ | 49,414,829 |                | $ | (177,728 | )                   |  | $ | (100,000 | ) |  | $ | (38,152,052 | ) |  | $ | 11,626,308 |  
|                                                                                                 |  |                     |  |                     |        |                        |   |          |                       |  |   |                            |   |                                               |   |            |                |   |          |                     |  |   |          |   |  |   |             |   |  |   |            |  
|Issuance of stock in connection with joint conversion of secured convertible note                |  | 694,314             |  |                     | 695    |                        |   |         |                       |  |   |                           |   |                                               |   | 1,744,742  |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 1,745,437  |  
|Issuance of stock in connection with exercise of options                                         |  | 85,137              |  |                     | 85     |                        |   |         |                       |  |   |                           |   |                                               |   | 173,641    |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 173,726    |  
|Issuance of stock, options and warrants in connection with clinical affairs consulting contracts |  | 10,000              |  |                     | 10     |                        |   |         |                       |  |   |                           |   |                                               |   | 152,799    |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 152,809    |  
|Issuance of common stock in private placement, net of offering costs.                            |  | 1,500,000           |  |                     | 1,500  |                        |   |         |                       |  |   |                           |   |                                               |   | 4,154,031  |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 4,155,531  |  
|Acceleration of option vesting in connection with separation agreement                           |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   | 10,780     |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 10,780     |  
|Foreign currency translation                                                                     |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   |           |                |   | (102,854 | )                   |  |   |         |   |  |   |            |   |  |   | (102,854   | )
|Net loss                                                                                         |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   |           |                |   |         |                     |  |   |         |   |  |   | (4,410,263  | ) |  |   | (4,410,263 | )
|                                                                                                 |  |                     |  |                     |        |                        |   |          |                       |  |   |                            |   |                                               |   |            |                |   |          |                     |  |   |          |   |  |   |             |   |  |   |            |  
|Balance, December 30, 2004                                                                       |  | 25,387,630          |  | $                   | 25,388 |                        |   | 373,779  |                       |  | $ | 618,161                    |   |                                               | $ | 55,650,822 |                | $ | (280,582 | )                   |  | $ | (100,000 | ) |  | $ | (42,562,315 | ) |  | $ | 13,351,474 |  
|Issuance of common stock in connection with conversion of preferred stock                        |  | 387,946             |  |                     | 388    |                        |   | (373,779 | )                     |  |   | (618,161                   | ) |                                               |   | 617,773    |                |   |         |                     |  |   |         |   |  |   |            |   |  |   |           |  
|Issuance of common stock in connection with exercise of options                                  |  | 194,600             |  |                     | 195    |                        |   |         |                       |  |   |                           |   |                                               |   | 389,595    |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 389,790    |  
|Issuance of options in connection with clinical affairs consulting                               |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   | 171,000    |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 171,000    |  
|Foreign currency translation                                                                     |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   |           |                |   | 213,434  |                     |  |   |         |   |  |   |            |   |  |   | 213,434    |  
|Net Loss                                                                                         |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   |           |                |   |         |                     |  |   |         |   |  |   | (5,773,074  | ) |  |   | (5,773,074 | )
|                                                                                                 |  |                     |  |                     |        |                        |   |          |                       |  |   |                            |   |                                               |   |            |                |   |          |                     |  |   |          |   |  |   |             |   |  |   |            |  
|Balance, December 31, 2005                                                                       |  | 25,970,176          |  | $                   | 25,971 |                        |   |         |                       |  |   |                           |   |                                               | $ | 56,829,190 |                | $ | (67,148  | )                   |  | $ | (100,000 | ) |  | $ | (48,335,389 | ) |  | $ | 8,352,624  |  
|Issuance of common stock in connection with private placement, net of offering costs             |  | 4,395,060           |  |                     | 4,395  |                        |   |         |                       |  |   |                           |   |                                               |   | 9,474,754  |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 9,479,149  |  
|Share-based compensation                                                                         |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   | 923,345    |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 923,345    |  
|Vesting of options in connection with options issued to consultant                               |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   | 196,480    |                |   |         |                     |  |   |         |   |  |   |            |   |  |   | 196,480    |  
|Foreign currency translation                                                                     |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   |           |                |   | (285,480 | )                   |  |   |         |   |  |   |            |   |  |   | (285,480   | )
|Net Loss                                                                                         |  |                    |  |                     |       |                        |   |         |                       |  |   |                           |   |                                               |   |           |                |   |         |                     |  |   |         |   |  |   | (6,477,285  | ) |  |   | (6,477,285 | )
|                                                                                                 |  |                     |  |                     |        |                        |   |          |                       |  |   |                            |   |                                               |   |            |                |   |          |                     |  |   |          |   |  |   |             |   |  |   |            |  
|Balance, December 31, 2006                                                                       |  | 30,365,236          |  | $                   | 30,366 |                        |   |         |                       |  |   |                           |   |                                               | $ | 67,423,769 |                | $ | (352,628 | )                   |  | $ | (100,000 | ) |  | $ | (54,812,674 | ) |  | $ | 12,188,833 |  
|                                                                                                 |  |                     |  |                     |        |                        |   |          |                       |  |   |                            |   |                                               |   |            |                |   |          |                     |  |   |          |   |  |   |             |   |  |   |            |  

The accompanying notes are an integral part of these statements.



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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31,



|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|--------------------------------------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                                                    |  | 2006 |            |   | 2005 |   |            | 2004 | 
|Cash flows from operating activities:                                                               |  |      |            |   |      |   |            |      |  |   |            |  
|Net Loss                                                                                            |  | $    | (6,477,285 | ) |      | $ | (5,773,074 | )    |  | $ | (4,410,263 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                         |  |      |            |   |      |   |            |      |  |   |            |  
|Foreign currency gain                                                                               |  |      | (308,000   | ) |      |   |           |      |  |   |           |  
|Depreciation and amortization                                                                       |  |      | 761,019    |   |      |   | 784,012    |      |  |   | 784,901    |  
|Bad debt expense                                                                                    |  |      | 93,000     |   |      |   | 76,000     |      |  |   | 113,354    |  
|Change in value of warrants and amortization of beneficial conversion feature                       |  |      |           |   |      |   | 45,222     |      |  |   | 299,451    |  
|Accretion of note discount                                                                          |  |      |           |   |      |   | 21,587     |      |  |   | 282,244    |  
|Deferred income taxes                                                                               |  |      | 9,249      |   |      |   |           |      |  |   | 397,720    |  
|Shared-based compensation                                                                           |  |      | 923,345    |   |      |   |           |      |  |   |           |  
|Non cash expenses in connection with issuance of common stock and options for consulting agreements |  |      | 196,480    |   |      |   | 171,000    |      |  |   | 163,589    |  
|Changes in assets and liabilities:                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|(Increase) decrease in accounts receivable                                                          |  |      | (1,522,657 | ) |      |   | 886,649    |      |  |   | (1,413,003 | )
|Decrease (increase) in inventories                                                                  |  |      | 272,934    |   |      |   | (843,866   | )    |  |   | (1,338,868 | )
|Increase in prepaid expenses and other assets                                                       |  |      | 40,207     |   |      |   | 72,706     |      |  |   | 390,511    |  
|(Decrease) increase in accounts payable                                                             |  |      | (665,949   | ) |      |   | 114,471    |      |  |   | 144,907    |  
|Increase (decrease) in accrued expenses, deferred revenue, customer deposits and accrued interest   |  |      | 54,791     |   |      |   | (8,778     | )    |  |   | 160,101    |  
|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash used in operating activities                                                               |  | $    | (6,622,866 | ) |      | $ | (4,454,071 | )    |  | $ | (4,425,356 | )
|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|Cash flows from investing activities:                                                               |  |      |            |   |      |   |            |      |  |   |            |  
|Capital expenditures                                                                                |  |      | (193,795   | ) |      |   | (200,891   | )    |  |   | (308,103   | )
|Cash payments of patent costs                                                                       |  |      | (107,137   | ) |      |   | (113,261   | )    |  |   | (171,863   | )
|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash used in operating activities                                                               |  | $    | (300,932   | ) |      | $ | (314,152   | )    |  | $ | (479,966   | )
|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|Cash flows from financing activities:                                                               |  |      |            |   |      |   |            |      |  |   |            |  
|Payments under term notes payable                                                                   |  |      |           |   |      |   |           |      |  |   | (2,200,000 | )
|Decrease in restricted cash                                                                         |  |      |           |   |      |   |           |      |  |   | 1,000,000  |  
|Proceeds from issuance of common stock, net of offering costs                                       |  |      | 9,479,149  |   |      |   | 389,790    |      |  |   | 4,304,193  |  
|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash provided by financing activities                                                           |  | $    | 9,479,149  |   |      | $ | 389,790    |      |  | $ | 3,104,193  |  
|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|Effect of exchange rate changes                                                                     |  |      | 7,887      |   |      |   | 213,434    |      |  |   | (102,854   | )
|Net increase (decrease) in cash and cash equivalents                                                |  |      | 2,563,238  |   |      |   | (4,164,999 | )    |  |   | (1,903,983 | )
|Cash and cash equivalents, beginning of period                                                      |  |      | 5,180,001  |   |      |   | 9,345,000  |      |  |   | 11,248,983 |  
|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|Cash and cash equivalents, end of period                                                            |  | $    | 7,743,239  |   |      | $ | 5,180,001  |      |  | $ | 9,345,000  |  
|                                                                                                    |  |      |            |   |      |   |            |      |  |   |            |  
|Supplemental cash flow information:                                                                 |  |      |            |   |      |   |            |      |  |   |            |  
|Cash paid for interest                                                                              |  | $    | 232,408    |   |      | $ | 191,579    |      |  | $ | 933,057    |  
|Net non-cash reclassification of assets from inventory to fixed assets                              |  | $    | 22,000     |   |      | $ | 567,936    |      |  | $ | 722,845    |  

The accompanying notes are an integral part of these statements.



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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



|1. | Basis of Presentation
|-- | ---------------------

EP MedSystems, Inc. (the
Company) operates in a single segment. EP MedSystems develops, manufactures and markets a broad-based line of products for the cardiac electrophysiology market for the purpose of diagnosing, monitoring, visualizing and treating irregular
heartbeats known as arrhythmias.

The Company faces a number of risks, including developing and sustaining a profitable, cash positive
business, which is largely dependent upon market acceptance of recently developed products.

The Company believes that its existing cash
will enable the Company to meet its liquidity needs through at least December 31, 2007. We will continue to rely on outside sources of financing to meet our long-term capital needs. The outcome of these matters cannot be predicted at this time.
Further, there can be no assurance, assuming we successfully raise additional funds, that we will achieve positive cash flow. If we are not able to secure additional funding, we will be required to scale back our sales and marketing efforts,
research and development programs, preclinical studies and clinical trials, and general and administrative activities.



|2. | Summary of Significant Accounting Policies
|-- | ------------------------------------------

Principles of
Consolidation

The consolidated financial statements include the accounts of EP MedSystems, Inc. and its wholly owned subsidiaries, EP
MedSystems UK Ltd., EP MedSystems France SAS, and ProCath Corporation. All material intercompany accounts and transactions have been eliminated in consolidation.

Cash and Cash Equivalents

EP MedSystems considers all short-term highly liquid investments with an original maturity of
three months or less to be cash equivalents. The carrying amount of cash and cash equivalents approximates fair value.

Concentrations of Credit Risk

EP MedSystems is potentially subject to concentrations of credit risk with respect to its cash investments and trade accounts
receivable. EP MedSystems invests its excess cash in institutional money market accounts.

EP MedSystems customer base for its
products is primarily comprised of medical institutions and distributors throughout the United States and abroad. For certain transactions, EP MedSystems may require payment in advance or issuance of an irrevocable letter of credit.

The Company has subsidiaries in the United Kingdom, France and the Netherlands and thus is exposed to risks that arise from foreign currency exchange
rate fluctuations. Such exposures arise from transactions denominated in foreign currencies, primarily from translation of results of operations outside the United States, inter-company advances and inter-company purchases of inventory. The Company
does not engage in hedging of foreign currencies through the purchase of option contracts or forward exchange contracts.

Credit is
extended based on evaluation of the customers financial condition. Accounts receivable payment terms vary and are stated in the financial statements at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding
longer than the payment terms are considered past due. The allowance is determined by considering a number of factors, including the length of time trade accounts receivable are past due, previous loss history, customers current ability to pay
their obligations, and the condition of the general economy and the industry as a whole. The Company writes off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance
for doubtful accounts.



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Inventories

Inventories are valued at the lower of cost or market with cost being determined on a first-in, first-out basis. The Company recorded a write-down of approximately $411,000 for the year ended December 31, 2006 associated with the
evaluation of the value of certain items in its inventory

Property and Equipment

Property and equipment are recorded at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets as follows:



|                           |  |            
|-------------------------- |  | -----------
|Buildings and improvements |  | 10-25 years
|Machinery and equipment    |  | 3-10 years 
|Furniture and fixtures     |  | 3-7 years  

Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated
useful lives or the term of the lease. Expenditures for repairs and maintenance are expensed as incurred.

Goodwill and Intangible Assets

Registration and legal fees associated with patent filings are capitalized and amortized over three years. Management reviews these
assets for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets might not be recoverable. EP MedSystems has determined that, as of December 31, 2006 and 2005, no such assets have been impaired.

Goodwill represents the excess of the cost over the fair value of net assets acquired in business combinations. Currently, the Company
operates as a single reporting unit. Goodwill and other indefinite-lived assets are not amortized and are subject to the impairment rules of Statement of Financial Accounting Standards No. 142. Goodwill is tested for impairment on
an annual basis or upon the occurrence of certain circumstances or events. The Company determines the fair market value of its reporting unit using quoted market rates and cash flow techniques. The fair market value of the reporting unit is compared
to the carrying value of the reporting unit to determine if an impairment loss should be calculated. If the book value of the reporting unit exceeds the fair value of the reporting unit, an impairment loss is indicated. The loss is calculated by
comparing the fair value of the goodwill to the book value of the goodwill. If the book value of the goodwill exceeds the fair value of goodwill, an impairment loss is recorded. Fair value of goodwill is determined by subtracting the fair value of
the identifiable assets of a reporting unit from the fair value of the reporting unit. There were no impairment losses recorded in 2006 or 2005.

Revenue Recognition

EP MedSystems ships products to customers based on FOB shipping point and recognizes revenue from
product sales on the date of shipment. Installation services are minimal and considered perfunctory. Payments received in advance of shipment of product are deferred until such products are shipped. EP MedSystems does not have royalty agreements
that result in revenue to EP MedSystems. Royalties paid to third parties on product sales are included in the sales and marketing expense. EP MedSystems does not generally provide distributors or end-users with a general right to return products
purchased.

EP MedSystems provides a one-year warranty on all of its electronic products and, in accordance with Statement of Financial
Accounting Standard No. 5 Accounting for Contingencies, accrues for the estimated cost of providing this warranty at the time of sale. Further, the Company incurs discretionary costs to service its products in connection with
product performance issues. The estimates of the future warranty costs are based on historical experience. A summary of warranty reserve activity follows:



|                  |  |      |          |   |      |   |          |      |  |   |          |  
|----------------- |  | ---- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                  |  | 2006 |          |   | 2005 |   |          | 2004 | 
|Beginning balance |  | $    | 313,000  |   |      | $ | 331,000  |      |  | $ | 126,000  |  
|Warranties        |  |      | 284,000  |   |      |   | 570,000  |      |  |   | 649,000  |  
|Warranty payments |  |      | (325,000 | ) |      |   | (588,000 | )    |  |   | (444,000 | )
|                  |  |      |          |   |      |   |          |      |  |   |          |  
|Ending balance    |  | $    | 272,000  |   |      | $ | 313,000  |      |  | $ | 331,000  |  
|                  |  |      |          |   |      |   |          |      |  |   |          |  



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In addition to the standard one-year warranty provided on all products, EP MedSystems offers separately
priced extended warranties. EP MedSystems recognizes revenue from these warranty contracts on a straight-line basis over the contract period in accordance with FASB Technical Bulletin 90-1 Accounting for Separately Priced Product Warranties
and Product Maintenance Contracts.

Shipping and Handling Costs

In accordance with EITF 00-10: Accounting for Shipping and Handling Fees and Costs, the Company reflects freight costs associated with shipping its products to customers as a component of sales and marketing expenses.
Total direct shipping costs incurred in 2006, 2005 and 2004 were approximately $293,000, $299,000 and $416,000 respectively. The Company records freight billed to customers in net sales on the Statement of Operations.

Research and Development

Research and development
costs are expensed as incurred. Research and development costs consist of labor and direct and indirect material costs related to specific projects, as well as regulatory costs.

Stock Based Compensation

Effective January 1, 2006, the Company follows Financial Accounting
Standards Board (FASB) Statement No. 123R, Share-Based Payment. Statement 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost is measured
based on the fair value of the equity or liability instruments issued. Statement 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights,
and employee share purchase plans. In addition to the accounting standard that sets forth the financial reporting objectives and related accounting principles, Statement 123R includes an appendix that provides expanded guidance on measuring the fair
value of share-based payment awards. Statement 123R replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123, as originally issued
in 1995, established a fair-value-based method of accounting for share-based payment transactions with employees. However, Statement 123 permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to
financial statements disclosed what net income would have been had the preferable fair-value-based method been used. The impact of Statement 123R, if it had been in effect, on the net loss and related per share amounts for years ended
December 31, 2005 and 2004 was disclosed in Note 9 Stock Option Plans included in the Companys Form 10-K for the year ended December 31, 2005.

Since the Company adopted Statement 123R using the modified-prospective-transition-method, prior periods have not been restated. Under this method, we are required to record compensation expense for all awards granted
after the date of adoption and for the unvested portion of previously granted awards that remain outstanding as of the beginning of the period of adoption. The Company measured share-based compensation cost using the Black-Scholes option pricing
model.



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The Company currently has five share-based employee compensation plans. Share-based compensation of net
of a fully reserved tax benefit, or $(0.03) per share, was recognized for the year ended December 31, 2006. At this time the Company anticipates that share-based compensation for its employees will not exceed $1,000,000, net of tax benefits for
the year ended December 31, 2007. Reported net income, adjusting for share-based compensation that would have been recognized in last years financial statements if Statement 123R had been followed is as follows:



|                                                                                             |  |                  |            |   |                  |   |            |                  |  |   |            |  
|-------------------------------------------------------------------------------------------- |  | ---------------- | ---------- | - | ---------------- | - | ---------- | ---------------- |  | - | ---------- | -
|                                                                                             |  | December 31,2006 |            |   | December 31,2005 |   |            | December 31,2004 | 
|Net loss, as reported                                                                        |  | $                | (6,477,285 | ) |                  | $ | (5,773,074 | )                |  | $ | (4,410,263 | )
|Less: stock-based compensation costs determined under fair value based method for all awards |  |                  |           |   |                  |   | (754,129   | )                |  |   | (559,575   | )
|                                                                                             |  |                  |            |   |                  |   |            |                  |  |   |            |  
|Adjusted net loss                                                                            |  | $                | (6,477,285 | ) |                  | $ | (6,572,200 | )                |  | $ | (4,969,838 | )
|                                                                                             |  |                  |            |   |                  |   |            |                  |  |   |            |  
|Loss per share of common stock:                                                              |  |                  |            |   |                  |   |            |                  |  |   |            |  
|As reported                                                                                  |  | $                | (.22       | ) |                  | $ | (.22       | )                |  | $ | (.19       | )
|                                                                                             |  |                  |            |   |                  |   |            |                  |  |   |            |  
|Share-based compensation costs                                                               |  |                  |           |   |                  |   | (.03       | )                |  |   | (.02       | )
|                                                                                             |  |                  |            |   |                  |   |            |                  |  |   |            |  
|Adjusted net earnings                                                                        |  | $                | (.22       | ) |                  | $ | (.25       | )                |  | $ | (.21       | )
|                                                                                             |  |                  |            |   |                  |   |            |                  |  |   |            |  

Expected volatility is based on the historical volatility of the price of shares of our common
stock over the past approximately 10 years. Management uses historical information to estimate expected forfeitures and uses the simplified method to estimate the expected term of options within the valuation model. The expected term of awards
represents the period of time that options granted are expected to be outstanding. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Compensation
cost is recognized using a straight-line method over the vesting or service period and is net of estimated forfeitures.

EP MedSystems
records the fair value of stock issuances to non-employees based on the market price on the date issued. The amount is expensed, capitalized or recorded as a reduction of paid-in capital, depending on the purpose for which the stock is issued. It is
EP MedSystems policy to account for stock options granted to non-employees in accordance with 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, and the fair value is measured using the Black-Scholes option pricing model under SFAS No. 123.

The fair value of these options is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for grants in fiscal 2006, 2005, 2004, respectively;
expected volatility of 83%, 80%, 82%, weighted average risk-free interest rates of 4.69%, 4.22% and 3.56%, with expected life of 7 years and no anticipated dividends.

Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of shares
of common stock outstanding. Diluted net loss per share does not differ from basic net loss per share since potential shares of common stock from the exercise of stock options and warrants are anti-dilutive for all periods presented. Accordingly,
potential common shares of approximately 4,229,000, 4,024,000 and 4,386,000 for the years ended December 31, 2006, 2005 and 2004, respectively, have been excluded from the diluted per share calculation.

Income Taxes

Income taxes are accounted for under
the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit



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carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are
expected to be recovered or settled. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets, unless it is more likely than not that such assets will be realized.

Comprehensive Income / Loss

For the years ended
December 31, 2006, 2005 and 2004, components of comprehensive loss consisted of net loss and foreign currency translation adjustments. Comprehensive loss for the years ended December 31, 2006, 2005 and 2004 was $6,763,000, $5,560,000 and
$4,513,000, respectively.

Foreign Currency Translation

In accordance with Statement of Financial Accounting Standard No. 52, Foreign Currency Translation, (SFAS No. 52), foreign denominated assets and liabilities are translated from Euros
and British Pounds Sterling into U.S. dollars using the spot rate at the balance sheet date. Revenue and expenses are translated into U.S. dollars using the weighted average exchange rate for the respective year. Translation adjustments are recorded
in Shareholders Equity as adjustments to accumulated other comprehensive loss.

Also in accordance with SFAS No. 52, transaction
gains and/or losses are incurred as a result of the changes between functional currency and the transaction denominated currency. These gains and/or losses are marked to the current exchange rate on a quarterly basis and included in expenses in the
Statement of Operations. For the year ended December 31, 2006 the transaction gain recorded was $308,000. For the year ended December 31, 2005, the transaction losses were approximately $261,000. For 2004, the transaction gain recorded was
approximately $132,000.

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 amounts reported in the financial
statements and accompanying notes. The primary estimates used by management are in the determination of the allowance for doubtful accounts, inventory obsolescence reserve and warranty reserve. Although these estimates are based on managements
knowledge of current events and actions it may undertake in the future, the estimates may ultimately differ from actual results.

Fair Value of
Financial Instruments

The carrying value of EP MedSystems financial instruments, including accounts receivable, accounts payable
and accrued liabilities approximate their fair values due to their short maturities. Based on borrowing rates currently available to EP MedSystems for loans with similar terms, the carrying value of the long-term debt also approximates fair value.
The Company had not entered into any derivative financial instruments for hedging or other purposes.



|3. | Inventories
|-- | -----------

Inventories consist of the following:



|                                             |  |              |           |   |      |   |           |  
|-------------------------------------------- |  | ------------ | --------- | - | ---- | - | --------- | -
|                                             |  | December 31, |          
|                                             |  | 2006         |           |   | 2005 |  
|Raw
materials.         |  | $            | 1,487,745 |   |      | $ | 1,531,746 |  
|Work in
progress                             |  |              | 165,903   |   |      |   | 538,567   |  
|Finished
goods                               |  |              | 1,492,029 |   |      |   | 1,367,470 |  
|Reserve for
obsolescence... |  |              | (286,000  | ) |      |   | (214,000  | )
|                                             |  |              |           |   |      |   |           |  
|                                             |  | $            | 2,859,677 |   |      | $ | 3,223,783 |  
|                                             |  |              |           |   |      |   |           |  



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|4. | Property and Equipment
|-- | ----------------------

Property and equipment
consist of the following:



|                               |  |              |            |   |      |   |            |  
|------------------------------ |  | ------------ | ---------- | - | ---- | - | ---------- | -
|                               |  | December 31, |           
|                               |  | 2006         |            |   | 2005 |  
|Land                           |  | $            | 69,738     |   |      | $ | 69,738     |  
|Buildings and improvements     |  |              | 1,042,664  |   |      |   | 1,042,664  |  
|Leasehold improvements         |  |              | 143,815    |   |      |   | 143,815    |  
|Machinery and equipment        |  |              | 5,440,214  |   |      |   | 5,188,405  |  
|Furniture and fixtures         |  |              | 318,215    |   |      |   | 317,624    |  
|                               |  |              |            |   |      |   |            |  
|                               |  | $            | 7,014,646  |   |      | $ | 6,762,246  |  
|Less: accumulated depreciation |  |              | (5,077,515 | ) |      |   | (4,472,751 | )
|                               |  |              |            |   |      |   |            |  
|                               |  | $            | 1,937,131  |   |      | $ | 2,289,495  |  
|                               |  |              |            |   |      |   |            |  



|5. | Intangible Assets
|-- | -----------------

Intangible assets, excluding
goodwill, consist of the following:



|                               |  |              |          |   |      |   |          |  
|------------------------------ |  | ------------ | -------- | - | ---- | - | -------- | -
|                               |  | December 31, |         
|                               |  | 2006         |          |   | 2005 |  
|Other intangible assets        |  | $            | 589,048  |   |      | $ | 481,910  |  
|Less: accumulated amortization |  |              | (401,967 | ) |      |   | (291,746 | )
|                               |  |              |          |   |      |   |          |  
|                               |  | $            | 187,081  |   |      | $ | 190,164  |  
|                               |  |              |          |   |      |   |          |  

At December 31, 2006 other intangible assets consist of patent costs, which are expected to
be amortized as follows:



|     |  |   |        
|---- |  | - | -------
|2007 |  | $ | 116,000
|2008 |  |   | 48,000 
|2009 |  |   | 23,000 



|6. | Commitments
|-- | -----------

Operating Leases

EP MedSystems leases office space in the United Kingdom, France and the Netherlands to support European and Asian sales and service. The Company owns its
executive offices and its manufacturing facility in West Berlin, New Jersey, and leases additional office and warehouse space nearby. The rent expense associated with office and warehouse leases was approximately $147,000, $104,000 and $67,000 in
2006, 2005, and 2004, respectively. Additionally, EP MedSystems also leases certain office equipment for periods extending through 2009.

The aggregate future commitment for minimum rentals as of December 31, 2006 is as follows:



|     |  |   |        
|---- |  | - | -------
|2007 |  | $ | 115,000
|2008 |  |   | 72,000 
|2009 |  |   | 4,000  

Employee Life Insurance

EP MedSystems has a key man life insurance policy for $500,000 covering the Vice President of Engineering, for which it is the beneficiary.



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Suppliers

The Company outsources the manufacture of some components of its products. Some of these arrangements are sourced from one supplier.



|7. | Notes payable
|-- | -------------

On August 28, 2003, the Company
issued a Secured Convertible Note (the Convertible Note) to Laurus Master Fund, Ltd. (Laurus) and entered into a related Security Agreement with Laurus, pursuant to which Laurus provided the Company with a $4,000,000
revolving asset-based credit facility in the form of a three-year Convertible Note secured by the accounts receivable, inventory, real property and other assets of the Company, other than intellectual property.

At the closing of the transaction, the Company issued the Convertible Note to Laurus having a principal amount of $4,000,000 and received net proceeds of
$2,661,600. An additional $1,000,000 of the Convertible Note was previously restricted and those restrictions were released during the third quarter of 2004. The balance of the proceeds was used to pay fees incurred in connection with this
transaction. Deferred financing fees are being amortized over the life of the Convertible Note using the effective interest method. In addition, the Company paid a portion of the fees payable to an intermediary, Biscayne Capital Markets, Inc.
(Biscayne), in 40,000 shares of the Companys Common Stock having a market value on the date of closing of this transaction equal to $100,000. The net proceeds of the Convertible Note was used by the Company for working capital
purposes and payment of outstanding debt.

The portion of the Convertible Note against which Laurus advances funds based on the
Companys accounts receivable bears interest at the prime rate, with a floor of 4%, and the balance (the Advance Amounts) bears interest at the prime rate plus 2%, effective interest rate of 21% for the year ended December 31,
2005, including accretion of debt discount and amortization of the beneficial conversion feature. One half of Advance Amounts outstanding on February 28, 2005 was required to be repaid on or before that date. However, there were no Advance
Amounts on that date, as the net collateral exceeded the principal amount outstanding on the Convertible Note. The remaining balance of the Advance Amounts outstanding on the date of the closing was required to be repaid on or before August 28,
2006. On November 9, 2005, the Convertible Notes maturity date was extended to February 28, 2008. The Company evaluated the impact of the change in the maturity date on the present value of the cash flows of the Convertible Note in
conjunction with EITF 96-19, Debtors Accounting for a Modification or Exchange of Debt Instruments. This EITF provides guidance when a modification of a debt instrument should be considered an extinguishment. The change in the
present value of the modification did not meet the criteria to be treated as an extinguishment. The Company, subject to certain rights of cancellation, may extend the credit facility by Laurus, on a year-by-year basis, commencing February 28,
2008. The Company may repay in cash, without penalty, up to $500,000 of the Convertible Note in any one calendar year, plus all Advance Amounts.

Subject to certain volume limitations and other conditions, all or a portion of the Convertible Note was convertible into the Common Stock of the Company at the Companys option if the market price of the Companys Common Stock
reached a level, for 11 consecutive trading days, which is above 120% of $2.55 (the Fixed Conversion Price), which through December 14, 2004 was $2.55 and which was a price in excess of the market price of the Companys Common
Stock on the date of closing. Subject to certain volume limitations and other conditions, Laurus has the option to convert all or a portion of the Convertible Note into shares of the Companys Common Stock at the Fixed Conversion Price.

Following the conversion into the Companys Common Stock by the Company and/or Laurus of an aggregate of $2,000,000 of the principal
amount of the Convertible Note (a Conversion Event), the Fixed Conversion Price will be adjusted upward to a price which is 115% of the average of the closing price of the Companys Common Stock for the three trading days prior to
the Conversion Event. On December 15, 2004, the



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balance of the first $2,000,000 of the principal amount was converted into shares of the Companys common stock. The fixed conversion price was adjusted
upwards from $2.55 to $4.20, on the remaining $2,000,000 principal balance. Subject to certain limitations, including the repayment obligations with respect to Advance Amounts described above, the dollar amounts of the Convertible Note converted may
be re-borrowed.

The Fixed Conversion Price is subject to adjustment, with customary exceptions and on a weighted-average basis, in
connection with sales of the Companys securities below the Fixed Conversion Price then in effect, and is also subject to adjustment for stock splits, combinations, stock dividends and similar events. As part of the credit facility transaction,
Laurus and the intermediary also received warrants to purchase an aggregate of 240,750 shares of the Companys Common Stock (the Warrants), with exercise prices set as follows: $2.93 per share for the purchase of up to the first
133,750 shares, $3.19 per share for the purchase of up to the next 80,250 shares, and $3.70 per share for the purchase of up to the final 26,750 shares. The expiration date of the warrant is August 28, 2010. The exercise price of the warrants
and the number of shares underlying the warrants are subject to adjustments for stock splits, combinations, stock dividends and similar events.

In October 2003, the Company registered, under the Securities Act of 1933, as amended, 1,500,000 shares of its Common Stock which may be received by Laurus upon conversion of the Convertible Note and exercise of the Warrant and the
remaining 293,628 of such shares were registered in November of 2004.

In accordance with the provisions of Emerging Issues Task Force
(EITF) Issue 00-27, Application of EITF Issue No. 98-5 Accounting for Convertible Securities with Beneficial Conversion Features of Contingently Adjustable Conversion Ratios, to Certain Convertible Securities, the
allocated value of the Convertible Note contained a beneficial conversion feature calculated based on the difference between the effective conversion price of the proceeds allocated to the Convertible Notes and the Warrants at the date of issuance.
The amount arising from the beneficial conversion feature aggregated approximately $486,000 and is being amortized as interest expense from the date of the issuance of the Convertible Note to the mandatory redemption date of February 28, 2008.
The Company valued the Convertible Note and the Warrants at issuance. The fair value of the Warrants at the time of issue was $407,500. In accordance with EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Companys Own Stock, the Company marked the Warrants to market at September 30, 2003 incurring a non-cash charge of $264,000. The registration rights agreement associated with the Convertible Note was amended on
November 25, 2003 and, as a result, the amount associated with the Warrants was transferred to equity. The Company marked the Warrants to market at the date of the amendment which reduced the overall expense to $210,750 for the year ended
December 31, 2003. The net carrying value of the Convertible Note, after allocation of the fair value of the Warrants is being accreted to interest expense over the term of the Convertible Note using the effective interest method.

The maturities on long-term debt consists of the following at December 31, 2006:



|     |  |   |          
|---- |  | - | ---------
|2007 |  | $ |         
|2008 |  | $ | 1,989,760
|     |  | $ | 1,989,760

The maturities above are net of $10,240 in discount of the Convertible Note at December 31,
2006.



|8. | Shareholders Equity
|-- | --------------------

Preferred Stock

EP MedSystems is authorized to issue 5,000,000 shares of undesignated preferred stock, no par value per share. The Board of Directors has the authority to
issue preferred stock in one or more classes, to fix the number of shares constituting a class and the stated value thereof, and to fix the terms of any such class, including dividend rights, dividend rates, conversion or exchange rights, voting
rights, rights and terms of redemption, the redemption price and the liquidation preference of such shares or class.



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Common Stock

EP MedSystems is authorized to issue 40,000,000 shares of common stock, no par value, $.001 stated value per share, of which a total of 30,365,236 and 25,970,176 shares were issued and 50,000 shares were held in Treasury Stock at
December 31, 2006 and 2005, respectively.

In May of 2004, the Company engaged a physician as a consultant to head its clinical
affairs department. In connection with that agreement, the Company issued 10,000 shares of the Companys common stock to the physician and granted the physician an option to purchase 10,000 shares of the Companys common stock which vests
three years from the date of grant. Also in connection with the agreement, the Company granted the physician an option to purchase 40,000 shares of the Companys common stock which vests in equal installments over three years. The exercise
price of each of the options was the fair market value of the Companys common stock on the date of the grant. The transactions were accounted for in accordance with 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. The fair value was measured using the Black-Scholes option pricing model under Statement of Financial Accounting Standard
No. 123 using the following assumptions for the grant as follows: risk free rate: 3.07%, 10 year life, and a volatility percentage of 83.86%.

In October 2004, the Company engaged a physician as a consultant to manage a clinical study. In connection with that agreement, the Company granted the physician a warrant to purchase 10,000 shares of the Companys common stock which
vested immediately. The exercise price of the warrants was the fair market value of the Companys common stock on the date of the grant. The transaction was accounted for in accordance with 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. The fair value was measured using the Black-Scholes option pricing model under Statement of
Financial Accounting Standard No. 123 using the following assumptions: risk free rate of 3.36%, 10 year life, and a volatility percentage of 77.25%.

During 2005, three additional options to purchase shares of the Companys common stock were issued to this senior physician consultant in the amounts of 40,000, 40,000 and 100,000 shares of common stock
respectively, on which the exercise price of the options was the fair market value of the Companys common stock on the date of the grant. With respect to the two 40,000 option issuances, they vest in equal installments over three years and the
Company expensed $171,000 representing the fair value of the options measured using the Black-Scholes option pricing model for each grant as follows: risk free rate of 3.77% and 4.33%; 10 year life, and volatility percentage of 77.98% and 81.1%. The
issuance of an option in the amount of 100,000 shares of the Companys common stock did not meet the criteria for expensing in 2005. In the first quarter of 2006, the consultants performance obligation in connection with these options was
fulfilled and we recorded an expense of $196,480, valued using the Black-Scholes option pricing model for each grant as follows: risk free rate of 4.82%, 10 year life, and volatility percentage of 84.23%.

On December 15, 2004, the Company completed a $4,500,000 private placement of its common stock to two accredited investors. The Company issued
1,500,000 shares of its common stock at a purchase price of $3.00 per share.

On March 27, 2006, the Company completed a $10,000,000
private placement of its common stock to a number of accredited investors. The Company issued 3.78 million shares of its common stock at a purchase price of $2.25 per share. In addition, FatBoy Capital, LP purchased approximately 617,000 shares
of common stock at a price of $2.43 per share in accordance with NASDAQ marketplace rules. David Jenkins, the Companys Chairman is a managing member of FatBoy Capitals general partner. The company received net proceeds from the private
placement of approximately $9,475,000 after offering costs. In connection with this transaction, certain anti-dilution provisions of the Laurus Convertible Note resulted in a reduction of the conversion price of that note from $4.20 to $3.96



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|9. | Stock Option Plans
|-- | ------------------

Effective January 1, 2006,
the company adopted SFAS No. 123R using the modified prospective transition method. SFAS No. 123(R) requires entities to recognize the cost of employee services in exchange for awards of equity instruments based on the grant-date fair
value of those awards (with limited exceptions). That cost, base on the estimated number of awards that are expected to vest, will be recognized over the period during which the employee is required to provide the service in exchange for the award.
No compensation cost is recognized for awards for which employees do not render the requisite service. Upon adoption, the grant-date fair value of employee share options and similar instruments was estimated using the Black-Scholes valuation model.

Compensation cost for the unvested portions of equity-classified awards granted prior to January 1, 2006, will be recognized in the
results of operations over the remaining vesting periods. Changes in fair vale of unvested liability instruments during the requisite service period will be recognized as compensation cost over that service period. Changes in the fair value of
vested liability instruments during the contractual term will be recognized as an adjustment to compensation cost in the period of the change in fair value. The Company expensed $923,000 in share-based compensation cost for the year ended
December 31, 2006. Due to the modified prospective adoption of SFAS No. 123(R), results for prior periods have not been restated. EP MedSystems has stock-based compensation plans under which directors, officers and other eligible employees
receive stock options.

1995 Long Term Incentive Plan

EP MedSystems 1995 Long Term Incentive Plan (the 1995 Incentive Plan) was adopted by the Board of Directors and shareholders in November 1995. On November 5, 1999, the Shareholders approved an
amendment increasing the number of shares available under the Plan from 700,000 to 1,000,000. The 1995 Incentive Plan provides for grants of incentive and non-qualified stock options to employees of EP MedSystems. The 1995
Incentive Plan is administered by the Compensation Committee, which determines the optionees and the terms of the options granted, including the exercise price, number of shares subject to the options and the exercisability thereof. The 1995
Incentive Plan terminated on November 30, 2005. No further options may be issued under the plan.

1995 Director Option Plan

EP MedSystems 1995 Director Option Plan (the 1995 Director Plan) was adopted by the Board of Directors and the shareholders in November
1995. A total of 180,000 shares of common stock of EP MedSystems are available for issuance under the 1995 Director Plan. The 1995 Director Plan provides for grants of director options to eligible directors of EP MedSystems and for grants of advisor
options to eligible members of the Scientific Advisory Board of EP MedSystems. Each of the director options and the advisor options are exercisable at the rate of 1,000 shares per month, commencing with the first month following the date of
grant. The terms of these options are five years. The 1995 Director Plan terminated on November 30, 2005. No further options may be issued under the plan.

2002 Option Plan

EP MedSystems 2002 Stock Option Plan (the 2002 Plan) was approved by the Shareholders in
August 2002 and amended in December 2004. A total of 1,000,000 shares of the common stock of the Company are reserved for issuance under this Plan. The 2002 Plan provides for grants of incentive stock options to employees of EP MedSystems. The
2002 Plan is administered by the Compensation Committee. The 2002 Plan will terminate on August 29, 2012, unless terminated earlier by the Board of Directors.

During the second quarter of 2004, in connection with a separation agreement with one of the Companys employees, there was an acceleration of the vesting of certain options. In connection with the accelerated
vesting, the Company recorded an expense in accordance with FIN44, Accounting for Certain Transactions Involving Stock Compensation.



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2006 Stock Option Plan

EP MedSystems 2006 Stock Option Plan (the 2006 Plan) was approved by the Shareholders in December 2005. A total of 1,000,000 shares of the common stock of the Company are reserved for issuance
under this Plan. The 2006 Plan provides for grants of incentive stock options to employees of EP MedSystems. The 2006 Plan is administered by the Compensation Committee. The 2006 Plan will terminate on October 21, 2015, unless terminated
earlier by the Board of Directors.

2006 Director Option Plan

EP MedSystems 2006 Director Option Plan (the 2006 Director Plan) was adopted by the Board of Directors in October 2005 and the shareholders in December 2005. A total of 1,000,000 shares of
common stock of EP MedSystems are available for issuance under the 2006 Director Plan. The 2006 Director Plan provides for grants of director options to eligible directors of EP MedSystems and for grants of advisor options to eligible members of the
Scientific Advisory Board of EP MedSystems. Each of the director options and the advisor options are exercisable at the rate of 1,000 shares per month, commencing with the first month following the date of grant. The terms of these options are five
years. The 2006 Director Plan will terminate on October 21, 2015, unless terminated earlier by the Board of Directors.

For the year
ended December 31, 2005 two non-employee holders of stock options exercised their options.

Stock Options

Stock options are granted with an exercise price equal to the closing market price of a share of common stock on the date of grant. Except for grants to
non-employee directors, which vest monthly over 5 years, awards generally vest in five years of continuous service and have ten-year contractual terms from the date of grant.

The fair value of each stock option award is estimated on the date of grant using the Black-Scholes valuation model. The Company uses historical data
regarding stock option exercise behaviors to estimate the expected term of options granted (based on the period of time that options granted are expected to be outstanding). Expected volatility is base on the historical volatility of the
Companys stock for the length of time corresponding to the expected term of the option. The expected dividend yield is based on the Companys historical dividend payments. The risk-free interest rate is based on the U.S. treasury yield
curve on the grant date for the expected term of the option.

At December 31, 2006, 2005, and 2004, EP MedSystems had 4,823,000,
4,055,000, and 2,577,000 shares, respectively, of common stock reserved for stock options under all plans. All stock options granted by EP MedSystems, were granted at exercise prices not less than the current fair market value of EP MedSystems
common stock on the date of grant, as determined by the Board of Directors or the fair market value on the date of grant. The Board of Directors of the Company has approved immediate vesting in the event of a change in control.



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Information relating to stock options is as follows:



|                                 |  |                  |   |  |                     |              |                                 |   |     
|-------------------------------- |  | ---------------- | - |  | ------------------- | ------------ | ------------------------------- | - | ----
|                                 |  | Number of Option |   |  | Options Price Range |              | Weighted Average Exercise Price
|Outstanding at December 31, 2003 |  | 1,587,410        |   |  | $                   | 1.32  $4.13 |                                 | $ | 2.35
|Granted                          |  | 576,500          |   |  | $                   | 2.48  $3.56 |                                 | $ | 2.61
|Exercised                        |  | (85,137          | ) |  | $                   | 1.32  $2.88 |                                 | $ | 2.09
|Forfeited/expired                |  | (160,315         | ) |  | $                   | 1.32  $3.75 |                                 | $ | 2.44
|                                 |  |                  |   |  |                     |              |                                 |   |     
|Outstanding at December 31, 2004 |  | 1,918,458        |   |  | $                   | 1.32  $4.13 |                                 | $ | 2.60
|                                 |  |                  |   |  |                     |              |                                 |   |     
|Granted                          |  | 940,000          |   |  | $                   | 2.49  $3.73 |                                 | $ | 2.96
|Exercised                        |  | (194,750         | ) |  | $                   | 1.90  $2.60 |                                 | $ | 2.00
|Forfeited/Expired                |  | (367,000         | ) |  | $                   | 1.91  $4.13 |                                 | $ | 2.37
|                                 |  |                  |   |  |                     |              |                                 |   |     
|Outstanding at December 31, 2005 |  | 2,296,708        |   |  | $                   | 1.32  $4.25 |                                 | $ | 2.83
|Granted                          |  | 1,438,500        |   |  | $                   | 1.19  $2.86 |                                 | $ | 1.47
|Exercised                        |  |                 |   |  |                     |             |                                 |   |    
|Forfeited/Expired                |  | (349,000         | ) |  | $                   | 1.96  $4.13 |                                 | $ | 2.93
|                                 |  |                  |   |  |                     |              |                                 |   |     
|Outstanding at December 31, 2006 |  | 3,386,208        |   |  | $                   | 1.19  $4.25 |                                 | $ | 2.25
|                                 |  |                  |   |  |                     |              |                                 |   |     
|Exercisable at December 31, 2006 |  | 30,000           |   |  | $                   | 1.32         |                                 | $ | 1.32
|                                 |  |                  |   |  |                     |              |                                 |   |     

Under SFAS No. 123, the fair value of each stock option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following weighted average assumptions in 2006, 2005 and 2004, respectively:



|                                                               |  |      |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                               |  | 2006 |         |   | 2005 |   |         | 2004 | 
|Risk free interest rate                                        |  |      | 4.69    | % |      |   | 4.22    | %    |  |   | 3.56    | %
|Expected life                                                  |  |      | 7 years |   |      |   | 5 years |      |  |   | 5 years |  
|Volatility                                                     |  |      | 83      | % |      |   | 81.15   | %    |  |   | 80.07   | %
|Weighted average fair value of options granted during the year |  | $    | 1.13    |   |      | $ | 2.01    |      |  | $ | 3.15    |  
|Expected dividends                                             |  |      |        |   |      |   |        |      |  |   |        |  



|10. | Industry Segment and Geographic Information
|--- | -------------------------------------------

EP
MedSystems manages its business on the basis of one reportable segmentthe manufacture and sale of cardiac electrophysiology products. EP MedSystems chief operating decision makers use consolidated results to make operating and strategic
decisions.

The following table sets forth product sales by geographic segment as of December 31,



|                     |  |      |            |      |   |            |  |   |           
|-------------------- |  | ---- | ---------- | ---- | - | ---------- |  | - | ----------
|                     |  | 2006 |            | 2005 |   | 2004      
|United States        |  | $    | 11,204,000 |      | $ | 12,917,000 |  | $ | 12,751,000
|Europe/Middle East   |  |      | 1,821,000  |      |   | 1,912,000  |  |   | 2,607,000 
|Asia and Pacific Rim |  |      | 2,533,000  |      |   | 1,840,000  |  |   | 1,011,000 
|                     |  |      |            |      |   |            |  |   |           
|                     |  | $    | 15,558,000 |      | $ | 16,669,000 |  | $ | 16,369,000
|                     |  |      |            |      |   |            |  |   |           

Sales of EP MedSystems cardiac electrophysiology devices and related catheters aggregated
$13,596,000 and $1,962,000 in 2006; $14,861,000 and $1,808,000 in 2005; $14,962,000 and $1,407,000 in 2004, respectively. EP MedSystems long-lived assets are primarily located in the U.S. No one foreign country was material to the
Companys sales in 2006. One customer accounted for 10% of the Companys sales for the year ended December 31, 2006.



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Net sales for the year ended December 31, 2006 were billed in two currencies: $14,710,000 in U.S.
dollars and $848,000 in Euros. Management has determined that the impact of foreign currency risk on sales is minimal since a majority of sales are billed in U.S. dollars. EP MedSystems does incur translation gains and losses, which are recorded in
Shareholders Equity.



|11. | Employee Benefit Plan
|--- | ---------------------

During 1997, EP MedSystems
established an employee 401(k)-salary deferral plan that allows contributions by all eligible full time employees. Eligible employees may contribute up to 15% of their respective compensation, subject to statutory limitations, and EP MedSystems may
match a percentage of employee contributions at the discretion of the Board of Directors. During the years ended December 31, 2006, 2005 and 2004, no matching contributions were made to the plan.



|12. | Income Taxes
|--- | ------------

EP MedSystems accounts for income
taxes in accordance with the provisions of Statement of Financial Account Standards No. 109, Accounting for Income Taxes (SFAS No. 109). SFAS No. 109 requires EP MedSystems to recognize income tax benefits for
the loss carryforwards, which have not previously been recorded. At December 31, 2006, 2005 and 2004, a valuation allowance has been recognized to offset all deferred tax assets related to these carryforwards. The tax effects of temporary
differences and carryforwards that give rise to significant portions of deferred tax assets and liabilities consist of the following:



|                                  |  |              |             |   |      |   |             |      |  |   |             |  
|--------------------------------- |  | ------------ | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                  |  | December 31, |            
|                                  |  | 2006         |             |   | 2005 |   |             | 2004 | 
|Allowance for doubtful accounts   |  | $            | 121,600     |   |      | $ | 84,400      |      |  | $ | 55,716      |  
|Inventory reserves                |  |              | 109,616     |   |      |   | 84,545      |      |  |   | 68,392      |  
|Intangible asset amortization     |  |              | (234,808    | ) |      |   | (235,025    | )    |  |   | (216,554    | )
|Depreciation                      |  |              | 108,778     |   |      |   | 166,124     |      |  |   | 53,905      |  
|Accrued liabilities               |  |              | 162,262     |   |      |   | 350,795     |      |  |   | 224,849     |  
|Net operating loss carryforwards  |  |              | 17,499,479  |   |      |   | 14,983,125  |      |  |   | 13,435,067  |  
|Research and development credit   |  |              | 548,183     |   |      |   | 548,183     |      |  |   | 548,183     |  
|Write-down of EchoCath investment |  |              | 560,000     |   |      |   | 560,000     |      |  |   | 560,000     |  
|Write-off of note receivable      |  |              | 43,800      |   |      |   | 43,000      |      |  |   | 43,000      |  
|Deferred warranty income          |  |              | 306,308     |   |      |   | 318,354     |      |  |   | 338,592     |  
|Other                             |  |              | 201,820     |   |      |   | 111,851     |      |  |   | 103,265     |  
|                                  |  |              |             |   |      |   |             |      |  |   |             |  
|                                  |  |              | 19,427,038  |   |      |   | 17,015,352  |      |  |   | 15,214,415  |  
|Less: Valuation allowance         |  |              | (19,427,038 | ) |      |   | (17,015,352 | )    |  |   | (15,214,415 | )
|                                  |  |              |             |   |      |   |             |      |  |   |             |  
|                                  |  | $            |            |   |      | $ |            |      |  | $ |            |  
|                                  |  |              |             |   |      |   |             |      |  |   |             |  

Income Tax Benefit consists of the following:



|         |  |                         |         |   |      |   |          |      |  |   |          |  
|-------- |  | ----------------------- | ------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|         |  | Year Ended December 31, |        
|         |  | 2006                    |         |   | 2005 |   |          | 2004 | 
|Current  |  | $                       | (86,873 | ) |      | $ | (290,128 | )    |  | $ | (858,198 | )
|Deferred |  |                         |        |   |      |   |         |      |  |   | 397,720  |  
|         |  |                         |         |   |      |   |          |      |  |   |          |  
|Total    |  | $                       | (86,873 | ) |      | $ | (290,128 | )    |  | $ | (460,478 | )
|         |  |                         |         |   |      |   |          |      |  |   |          |  

At December 31, 2006, 2005, and 2004, EP MedSystems had approximately $49,254,000,
$42,397,000 and $37,794,000, respectively, of federal net operating loss carryforwards available to offset future income. The federal carryforwards expire between 2009 and 2026. Due to ownership changes that occurred, as defined by Section 382
of the Internal Revenue Code, EP MedSystems may be limited in the use of net operating losses



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generated prior to the changes in ownership in each year following the change in ownership. Additionally, EP MedSystems may have experienced subsequent
changes in ownership, as defined by Section 382, resulting in additional limitations in EP MedSystems ability to utilize certain net operating losses.

During the years ended December 31, 2006, 2005, and 2004, the Company received approval to sell a portion of its unused cumulative New Jersey Net Operating Loss (NOLs) carryforwards under the State of
New Jerseys Technology Business Tax Certificate Transfer Program (the Program). The Program allows qualified technology and biotechnology businesses in New Jersey to sell unused amounts of NOL carryforwards and defined research and
development credits for cash. The Company received approval to sell NOLs of EP MedSystems and ProCath statutory entities in November 2006, 2005, and 2004, respectively. The Company entered into contracts to sell those NOLs for approximately
$87,000, $290,000 and $460,000 in December 2006, 2005, and 2004, respectively.

A reconciliation of EP MedSystems effective tax
rate is as follows:



|                                                     |  |                         |    |  |       |    |  |       |   
|---------------------------------------------------- |  | ----------------------- | -- |  | ----- | -- |  | ----- | --
|                                                     |  | Year Ended December 31, |   
|                                                     |  | 2006                    |    |  | 2005  |    |  | 2004  |   
|Federal statutory rate                               |  | (34.0                   | )% |  | (34.0 | )% |  | (34.0 | )%
|Increase (reduction) in income taxes resulting from: |  |                         |    |  |       |    |  |       |   
|Benefit from sale of state net operating loss        |  | (1.3                    | )% |  | (4.8  | )% |  | (9.5  | )%
|Change in valuation allowance                        |  | 36.6                    | %  |  | 29.7  | %  |  | 30.0  | % 
|Other                                                |  | (2.6                    | )% |  | 4.3   | %  |  | 4.0   | % 
|                                                     |  |                         |    |  |       |    |  |       |   
|Effective Tax Rate                                   |  | (1.3                    | )% |  | (4.8  | )% |  | (9.5  | )%
|                                                     |  |                         |    |  |       |    |  |       |   



|13. | Recently Issued Accounting Standards
|--- | ------------------------------------

Effective
January 1, 2006, the company adopted SFAS No. 123R using the modified prospective transition method. See Note 2 for information regarding stock-based compensation.

The Financial Accounting Standards Board (FASB) released SFAS No. 156, Accounting for Servicing of Financial Assets,
to simplify accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. SFAS No. 156 permits an entity to choose either the amortization method or the fair value measurement method for measuring each class of separately recognized servicing assets and servicing liabilities after they
have been initially measured at fair value. SFAS No. 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entitys fiscal year that begins after September 15,
2006. SFAS No. 156 will be effective for the Company as of December 31, 2007. The Company does not believe the adoption of SFAS No. 156 will have a material impact on its consolidated financial position or results of operations.

On July 13, 2006, the FASB issued Interpretation No. 48 (FIN No. 48) Accounting for Uncertainty in
Income Taxes: an Interpretation of FASB Statement No. 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entitys financial statements in accordance with SFAS No. 109,
Accounting for Income Taxes. FIN No. 48 prescribes a recognition threshold and measurement principles for financial statement disclosure of tax positions taken or expected to be taken on a tax return. This
interpretation is effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN No. 48 in the first quarter of fiscal 2007, effective as of January 1, 2007, the beginning of the Companys 2007
fiscal year. The Company is assessing the impact the adoption of FIN No. 48 will have on its consolidated financial position and results of operations.

The FASB released SFAS No. 157, Fair Value Measurements, to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and
expand disclosures



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about fair value measurements. SFAS No. 157 will be effective for the Company as of December 31, 2007. The company is assessing the
impact the adoption of SFAS No. 157 will have on its consolidated financial position and results of operations.

In September 2006,
the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Postretirement Plans: an amendment of FASB Statements No. 87, 88, 106, and 132(R), which requires an employer to recognize the
over-funded or under-funded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in comprehensive income in the year in which
the changes occur. SFAS No. 158 requires an employer to initially apply the requirement to recognize the funded status of a benefit plan as of the end of the employers fiscal year ending after December 16, 2006. In
addition, SFAS No. 158 also requires an employer to measure plan assets and benefit obligations as of the date of the employers fiscal year-end statement of financial position for fiscal years ending after December 15,
2008. Retrospective application of the recognition and fiscal year-end measurement date provisions of SFAS No. 158 is not permitted. The Company does not believe the adoption of SFAS No. 158 will have a material impact on its
consolidated financial position or results of operations.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 108, Considering the Effect of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB108). SAB108 addresses inconsistencies in the way companies evaluate and
quantify the impact of financial statement misstatements. Historically, companies have evaluated financial statement misstatements using one of two different methods, based on either the effect of the misstatement on the income statement or the
balance sheet. SAB108 requires companies to utilize a dual-approach to assessing the quantitative effect of financial statement misstatements. This method requires quantification of misstatements based on the effect on both of the
companys financial statements and the related financial statement disclosures. This guidance must be applied to annual financial statements for fiscal years ending after November 15, 2006. The Company adopted SAB108 as of
December 31, 2006. The application of SAB108 did not have a material impact on the Companys financial position or results of operations.

On February 15, 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, (FAS159). The Fair value option established by Statement 159 permits,
but does not require, all entities to choose to measure eligible items at fair value at specified election dates. An entity would report unrealized gains and losses on items for which the fair value option has been elected in earnings at each
subsequent reporting date. Statement 159 is effective as of the beginning of an entitys fiscal year that begins after November 15, 2007. The Company is currently assessing what the impact of the adoption of this Statement would be on the
Companys financial position and/or results of operations.



|14. | Related Party Transactions
|--- | --------------------------

On May 12, 2005,
the Board of Directors approved Senior Management Incentive Agreements with each of six senior officers. Those senior officers are Matthew C. Hill, Chief Financial Officer and Secretary, C. Bryan Byrd, Vice President, Engineering and Manufacturing,
John Huley, Vice President, Sales, Thomas Maguire, Vice President, Regulatory and Quality Assurance, Richard Gibbons, Director of Operations, and Kristine Fuimaono, Director of Marketing. The agreements provide that if the senior officer is employed
with EP MedSystems immediately prior to a change of control (as defined in the agreements) of EP MedSystems, EP MedSystems will pay to each of the senior officers an amount equal to two times the senior officers annual base salary
(which excludes any incentive pay, premium pay, commissions, overtime, bonuses and other forms of variable compensation). The agreements also confirm our policy previously approved by our Board of Directors that all options to purchase common stock
of EP MedSystems granted to our employees (including all senior officers) will vest immediately prior to a change of control. The incentive agreements also provide that if a senior officers benefits under the incentive agreement would result
in an Internal Revenue Code Section 280C(b)(1) parachute payment, such senior officer will receive an additional amount not to exceed 20% of the amount of the



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payments and benefits otherwise payable to the senior officer upon the occurrence of a change in control. All senior officers are employed by EP MedSystems
on an at-will basis and none of the senior officers has an employment agreement with EP MedSystems.

In March of 2006, the
Company completed a $10,000,000 private placement. As more fully described in Footnote 8, David Jenkins, the Companys Chairman participated in the private placement.



|15. | Quarterly Financial Data (Unaudited)
|--- | ------------------------------------



|            |  |                                              |        |              |   |          |  |   |                                          |   |  |   |      |  
|----------- |  | -------------------------------------------- | ------ | ------------ | - | -------- |  | - | ---------------------------------------- | - |  | - | ---- | -
|            |  | Fiscal Year Ended December 31, 2006          |       
|            |  | Net Sales                                    |        | Gross Profit |   | Net Loss |  |   | Net Earnings Per Basic Diluted Share (1) |  
|            |  | (in thousands, except per share information) |       
|1stQuarter  |  | $                                            | 4,078  |              | $ | 2,490    |  | $ | (1,494                                   | ) |  | $ | (.06 | )
|2nd Quarter |  |                                              | 3,311  |              |   | 2,068    |  |   | (2,213                                   | ) |  |   | (.07 | )
|3rd Quarter |  |                                              | 3,799  |              |   | 2,247    |  |   | (1,692                                   | ) |  |   | (.06 | )
|4thQuarter  |  |                                              | 4,370  |              |   | 2,628    |  |   | (1,078                                   | ) |  |   | (.04 | )
|            |  |                                              |        |              |   |          |  |   |                                          |   |  |   |      |  
|Total       |  | $                                            | 15,558 |              | $ | 9,433    |  | $ | (6,477                                   | ) |  | $ | (.22 | )
|            |  |                                              |        |              |   |          |  |   |                                          |   |  |   |      |  
|            | 
|            |  | Fiscal Year Ended December 31, 2005          |       
|            |  | Net Sales                                    |        | Gross Profit |   | Net Loss |  |   | Net Earnings Per Basic Diluted Share (1) |  
|            |  | (in thousands, except per share information) |       
|1stQuarter  |  | $                                            | 3,476  |              | $ | 2,198    |  | $ | (1,408                                   | ) |  | $ | (.05 | )
|2nd Quarter |  |                                              | 4,754  |              |   | 3,005    |  |   | (1,165                                   | ) |  |   | (.05 | )
|3rd Quarter |  |                                              | 4,270  |              |   | 2,678    |  |   | (1,849                                   | ) |  |   | (.07 | )
|4thQuarter  |  |                                              | 4,169  |              |   | 2,368    |  |   | (1,351                                   | ) |  |   | (.05 | )
|            |  |                                              |        |              |   |          |  |   |                                          |   |  |   |      |  
|Total       |  | $                                            | 16,669 |              | $ | 10,249   |  | $ | (5,773                                   | ) |  | $ | (.22 | )
|            |  |                                              |        |              |   |          |  |   |                                          |   |  |   |      |  

---

|(1) | Total of quarterly amounts do not necessarily agree to the annual report amounts due to separate quarterly calculations of weighted average shares outstanding.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



|16. | Contingencies
|--- | -------------

Export Compliance

During the second quarter of 2005, the Company received an Administrative Subpoena from the Bureau of Industry and Security of the United States
Department of Commerce (the Department of Commerce) seeking production of records and documents relating to the sale and/or export of the Companys products to Iran and to Syria. In the third quarter of 2005, the Company was
informed that the United States Attorneys Office for the District of New Jersey had commenced a criminal investigation into the same matter. In March 2006, the United States Attorneys Office informed the Company that it will not
prosecute the Company in connection with this matter.

In a letter dated August 16, 2005, the Company was informed by the Philadelphia
District Office of the Securities and Exchange Commission (the SEC District Office) that the Securities and Exchange Commission (the Commission) is conducting a confidential, informal inquiry to determine whether there have
been violations of certain provisions of the federal securities laws in connection with the Companys financial and accounting reporting, including relating to disclosures the Company made in its Form 8-K filed with the Commission on
August 12, 2005 regarding ongoing government investigations of sales by the Company of its products to Iran.



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The Company is cooperating fully with the federal government in connection with these matters.

Based on the Companys investigation of these matters to date, management believes that a limited number of the Companys heart
monitor systems were distributed to medical facilities in Iran in prior periods without United States governmental authorization. We believe the aggregate revenues generated by these transactions were not material to the Companys cumulative
financial results during the period in which such transactions occurred, and the Company has taken steps to implement certain control procedures designed to prevent the Companys products or services from being provided to any foreign countries
in violation of applicable law.

The fact that certain of the Companys heart monitor systems were distributed to medical facilities
in Iran without United States government authorization was voluntarily disclosed by the Company in 2003 to the Department of Commerce and to the Office of Foreign Assets Control of the United States Treasury Department. The federal government is
also investigating the accuracy and completeness of those voluntary disclosures.

Separately, the Audit Committee of the Companys
Board of Directors conducted an independent investigation into these matters and retained outside counsel to assist it. In the third quarter of 2005, the Company incurred approximately $911,000 in legal, consulting and accounting expenses associated
with the governmental and Audit Committee investigations. Additional amounts in the third quarter over previously estimated costs were associated with the additional resource requirement for the SECs inquiry, additional document review,
additional interviews and the termination of Reinhard Schmidt, our former President, Chief Executive Officer and Chief Operating Officer. In the fourth quarter of 2005, the Company incurred $474,000 in legal consulting and accounting expenses
associated with the governmental and Audit Committee investigations and $45,000 associated with the Companys defense and negotiations with the government. This estimate does not include any costs associated with the defense of the Company or
negotiation with the various governmental entities to resolve these outstanding issues as these costs are not estimable but may have a material impact on the Companys results of operations and financial condition.

For the year ended December 31, 2006, the Company incurred approximately $210,000 in connection with negotiations with various governmental
entities. Management cannot predict whether such fees and other expenses will be significantly higher as these costs as well as additional penalties and fines, as more fully described below, are not completely estimable at this time.

Violations of applicable law may result in civil, administrative or criminal fines or penalties, but due primarily to the ongoing nature of the
investigations referred to above, it is not possible at this time to predict the outcome of these investigations or the impact of costs of ultimately resolving this matter on our results of operations or financial condition However, any fees or
expenses or any fines or penalties which might be incurred by the Company in connection with these matters may have a material impact on the Companys results of operations and financial condition. The Company has made no provision for any
future costs associated with the investigations or any costs associated with the Companys defense or negotiations with the various governmental entities to resolve these outstanding issues.

On October 9, 2005, the Board of Directors of the Company terminated Reinhard Schmidts employment as its President, Chief Executive Officer
and Chief Operating Officer for cause. Mr. Schmidts termination resulted from his certification and authorization of statements to the Department of Commerce, some of which the Audit Committee has determined in its independent
investigation to have been inaccurate or incomplete. Mr. Schmidts termination was not a result of the discovery of any financial or accounting irregularity by the investigation. Pursuant to Mr. Schmidts employment agreement,
his position as a director of the Company ceased upon the termination of his employment.

At this time, Mr. Schmidt has not contested
this termination, but it is possible he could contest it at a later time. The likelihood of such a contest, if any, or results of any arbitration or adjudication, cannot be estimated at this time.



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In the fourth quarter of 2005, we terminated our agreements with our Armenian and German distributors.
The German distributor contested the termination, which was settled with no cash payment to the ex-distributor.

On July 20, 2006, the
Company received a proposed charging letter stating that the Department of Commerce has reason to believe that the Company violated export control regulations arising out of sales between October 1999 and January 2004 of cardiac equipment to
end-users in Iran without the required U.S. Government authorization, and that the disclosures made by the Company and certified by Reinhard Schmidt, then the Companys Chief Executive Officer, regarding these transactions in October and
November 2003 were false and misleading. The proposed charging letter set forth possible administrative sanctions which may be imposed, which include civil penalties of up to $407,000, denial of export privileges and/or exclusion from practice
before the Department of Commerce. The Company has signed a settlement agreement to settle this matter prior to issuance of a formal charging letter with the payment of $244,000 in civil penalties, which was accrued at September 30, 2006, with
no restrictions on commercial or export activities. The Company had accrued $345,000 as of June 30, 2006 based on the proposed charging letter at that time. This was paid in the fourth quarter.

In the fourth quarter of 2006, the Company made a settlement offer to Treasury, which orally indicated the maximum penalty would be $44,000 with no
restrictions on commercial or export activities. We have received a settlement agreement from Treasury in which the penalty is $33,000. The agreement included certain other requirements. The Company has executed the agreement, forwarded it to
Treasury, and paid the fine. This issue is deemed to be closed. However, we cannot assure that the ongoing informal inquiry by the Commission will not result in other significant costs, fines or penalties that could, in the aggregate, have a
material adverse effect on our business, financial condition, prospects or results of operations. The Company has made no provision for any future costs associated with these investigations or any costs associated with the Companys defense or
negotiations with the Commission entities to resolve this final outstanding issue.

Product Field Action

The Company initiated a field action recall for its stimulator product in March 2006. This field action consists of an upgrade of the installed base in a
phased process and will consist of bringing the units in-house and making certain modifications. The Company has accrued approximately $256,000 in costs associated with this field action consisting of shipping of the product and the associated
modifications. Through December 31, 2006, the Company has incurred approximately $184,000 in costs associated with this process. Management derived this estimate by evaluating all associated costs including, but not limited to, shipping of the
units, parts to upgrade the units, outside labor to implement the modifications and associated costs to upgrade software at customers sites. This is managements best estimates of the associated costs based on information available at
this time. There are factors that could increase these costs, such as additional rework, the impact of decisions of regulatory bodies as well as additional unforeseen costs, among others and therefore there can be no assurance that additional
expenses arising from this field action may not be incurred in the future. Besides costs, other factors that could impact the Company, include an impact on revenue based on the availability of units for sale and possible damage to our reputation.

In addition, the FDA performed an audit of the subject facility and issued the Company a report containing several observations and the
Company responded to this report. As a result of this audit, the FDA sent a Warning Letter to the Company that identified certain issues with respect to the Companys conformity with the FDAs quality system regulations and certain
reporting requirements. The FDA has requested a written plan outlining the steps to address the issues identified in the letter. The Company has already undertaken steps toward addressing the observations from the FDAs audit of the
Companys facility and has responded to the FDAs request for a written plan. Failure to promptly address these issues may result in regulatory action including but not limited to seizure, injunction and/or civil monetary penalties. The
Company believes it can fully address the concerns of the FDA without a material impact to its business.



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SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS



|     |  |                                 |  |                 |         |                    |   |            |  |   |             |   |  |                 |         |   |  |   |        
|---- |  | ------------------------------- |  | --------------- | ------- | ------------------ | - | ---------- |  | - | ----------- | - |  | --------------- | ------- | - |  | - | -------
|Year |  | Description                     |  | Opening Balance |         | Charged to expense |   | Deductions |  |   | Adjustments |   |  | Closing Balance
|2006 |  | Allowance for doubtful accounts |  | $               | 215,000 |                    | $ | 248,000    |  | $ | (195,000    | ) |  | $               | 40,000  |   |  | $ | 308,000
|2005 |  | Allowance for doubtful accounts |  |                 | 139,000 |                    |   | 51,000     |  |   | (80,000     | ) |  |                 | 105,000 |   |  |   | 215,000
|2004 |  | Allowance for doubtful accounts |  |                 | 99,000  |                    |   | 159,000    |  |   | (95,000     | ) |  |                 | (24,000 | ) |  |   | 139,000
|2006 |  | Inventory Reserve               |  |                 | 214,000 |                    |   | 163,000    |  |   | (235,000    | ) |  |                 |        |   |  |   | 286,000
|2005 |  | Inventory Reserve               |  |                 | 170,000 |                    |   | 143,000    |  |   | (99,000     | ) |  |                 |        |   |  |   | 214,000
|2004 |  | Inventory Reserve               |  | $               | 158,000 |                    | $ | 139,000    |  | $ | (127,000    | ) |  | $               |        |   |  | $ | 170,000



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Index to Exhibits



|              |  |                                                                                                                                                                                                                                                                                                                                                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                                                                      
|              | 
|3.1           |  | Amended and Restated Certificate of Incorporation of EP MedSystems, Inc. filed with the Secretary of the State of New Jersey on April 8, 1996Incorporated by reference to the Companys
Registration Statement on Form SB-2 and Pre-Effective Amendments No. 1 and 2 thereto filed April 18, 1996, May 28, 1996 and June 13, 1996, respectively.
|              | 
|3.2           |  | Certificate of Amendment to the Amended and Restated Certificate of Incorporation of EP MedSystems, Inc. filed with the State of New Jersey on November 6, 1998Incorporated by reference to
the Companys Quarterly Report on Form 10-QSB filed August 19, 2003.                                                                                
|              | 
|3.3           |  | Certificate of Amendment to the Amended and Restated Certificate of Incorporation of EP MedSystems, Inc., filed with the Secretary of the State of New Jersey on October 21,
2001Incorporated by reference to the Companys Quarterly Report on Form 10-QSB filed November 14, 2001.                                                            
|              | 
|3.4           |  | Certificate of Amendment to the Amended and Restated Certificate of Incorporation of EP MedSystems, Inc., filed with the Secretary of the State of New Jersey on December 22, 2003
Incorporated by reference to the Companys Registration Statement on Form S-3 filed January 22, 2004.                                                        
|              | 
|3.5           |  | Certificate of Amendment to the Amended and Restated Certificate of Incorporation of EP MedSystems, Inc., filed with the Secretary of the State of New Jersey on January 12,
2005Incorporated by reference to the Companys Registration Statement on Form S-3 filed January 14, 2005.                                                          
|              | 
|3.6           |  | Bylaws, as amendedIncorporated by reference to the Companys Registration Statement on Form SB-2 and Pre-Effective Amendments No. 1 and 2 thereto filed with the April 18, 1996, May
28, 1996 and June 13, 1996, respectively.                                                                                                                  
|              | 
|4.1           |  | Form of Common Stock and Warrant Purchase Agreement, dated as of August 31, 1999, between EP Med and the Purchasers named therein (including Exhibit A: Form of Registration Rights Agreement and
Exhibit B: Form of Warrant)Incorporated by reference to the Companys Current Report on Form 8-K filed September 7, 1999.                     
|              | 
|4.2           |  | Form of Replacement Warrant, dated as of February 15, 2000, between EP Med and the Purchasers named therein (including Amendment to Registration Rights Agreement and Form of Replacement
Warrant)Incorporated by reference to the Companys Quarterly Report on Form 10-QSB filed May 14, 1999.                                                
|              | 
|4.3           |  | Amended and Restated Common Stock and Warrant Purchase Agreement, dated as of February 16, 2001, between EP Med and the Purchasers (including Exhibit A: Form of Registration Rights Agreement and
Exhibit B: Form of Warrant)Incorporated by reference to the Companys Definitive Proxy Statement on Form 14A filed March 5, 2001.            
|              | 
|4.4           |  | Registration Rights Agreement, dated March 28, 2001, between EP Med and the Purchasers identified thereinIncorporated by reference to the Companys Annual Report on Form 10-KSB filed
April 2, 2001.                                                                                                                                           
|              | 
|4.5           |  | Warrant, dated March 28, 2001, issued by EP Med to Cardiac Capital, LLCIncorporated by reference to the Companys Annual Report on Form 10-KSB filed April 2, 2001.                                                                                                                                                                             
|              | 
|4.6           |  | Warrant, dated March 28, 2001, issued by EP Med to Texada TrustIncorporated by reference to the Companys Annual Report on Form 10-KSB filed April 2, 2001.                                                                                                                                                                                     



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|              |  |                                                                                                                                                                                                                                                                                                                                                          
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                                                                              
|4.7           |  | Warrant, dated as of July 20, 2001, issued by EP Med to Reinhard SchmidtIncorporated by reference to the Companys Registration Statement on Form SB-2 and Pre-Effective
Amendments No.1 through 4 filed June 26, 2001, August 24, 2001, September 28, 2001 and October 12, 2001, respectively.                                                         
|              | 
|4.8           |  | Preferred Stock Purchase Agreement, dated as of October 23, 2001, between EP MedSystems and Medtronic, Inc.Incorporated by reference to the Companys Quarterly Report on Form 10-QSB
filed November 14, 2001.                                                                                                                                          
|              | 
|4.9           |  | Registration Rights Agreement, dated as of October 23, 2001, between EP MedSystems and Medtronic, Inc.Incorporated by reference to the Companys Quarterly Report on Form 10-QSB filed
November 14, 2001.                                                                                                                                               
|              | 
|4.10          |  | Common Stock and Warrant Purchase Agreement, dated as of January 31, 2003, by and between EP MedSystems, Inc. and each of the several purchasers named in Exhibit A thereto.Incorporated by
referenced to the Companys Current Report on Form 10-KSB filed March 31, 2003.                                                                             
|              | 
|4.11          |  | Registration Rights Agreement, dated as of January 31, 2003, by and between EP MedSystems, Inc. and the Initial Investors referred to therein.Incorporated by referenced to the
Companys Current Report on Form 10-KSB filed March 31, 2003.                                                                                                           
|              | 
|4.12          |  | Warrant, dated January 31, 2003, issued by EP MedSystems, Inc. to Michael R. Hamblett.Incorporated by referenced to the Companys Current Report on Form 10-KSB filed March 31,
2003.                                                                                                                                                                   
|              | 
|4.13          |  | Warrant, dated January 31, 2003, issued by EP MedSystems, Inc. to Heimdall Investments Ltd.Incorporated by referenced to the Companys Current Report on Form 10-KSB filed March 31,
2003.                                                                                                                                                              
|              | 
|4.14          |  | Warrant, dated January 31, 2003, issued by EP MedSystems, Inc. to EGS Private Healthcare Partnership, L.P.Incorporated by referenced to the Companys Current Report on Form 10-KSB
filed March 31, 2003.                                                                                                                                               
|              | 
|4.15          |  | Warrant, dated January 31, 2003, issued by EP MedSystems, Inc. to EGS Private Healthcare Counterpart, L.P.Incorporated by referenced to the Companys Current Report on Form 10-KSB
filed March 31, 2003.                                                                                                                                               
|              | 
|4.16          |  | Amended and Restated Secured Promissory Note issued to Medtronic International Limited on March 13, 2003, together with First Amendment to Note Purchase Agreement, dated March 13, 2003, between
Medtronic International Limited and EP MedSystems, Inc.Incorporated by referenced to the Companys Current Report on Form 10-KSB filed March 31, 2003.
|              | 
|4.17          |  | Stock Purchase Agreement, dated as of September 5, 2002, between EP MedSystems, Inc. and Boston Scientific Corporation.Incorporated by reference to the Companys Quarterly Report on
Form 10-QSB filed November 14, 2002.                                                                                                                              
|              | 
|4.18          |  | Registration Rights Agreement, dated as of September 5, 2002, between EP MedSystems, Inc. and Boston Scientific CorporationIncorporated by reference to the Companys Quarterly Report
on Form 10-QSB filed November 14, 2002.                                                                                                                          
|              | 
|4.19          |  | Mortgage Note, dated November 21, 2002, issued to William Winstrom, in the principal amount of $375,000, together with related Mortgage and Security AgreementIncorporated by referenced to
the Companys Current Report on Form 10-KSB filed March 31, 2003.                                                                                           
|              | 
|4.20          |  | Mortgage Note, dated November 21, 2002, issued to Anthony Varrichio, in the principal amount of $375,000, together with related Mortgage and Security AgreementIncorporated by
referenced to the Companys Current Report on Form 10-KSB filed March 31, 2003.                                                                                          



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##### Table of Contents

|              |  |                                                                                                                                                                                                                                                                                                            
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                                
|4.21          |  | Agreement between Anthony Varrichio and EP MedSystems, Inc., dated April 2, 2003,Incorporated by reference to the Companys Registration Statement on Form S-3 filed April 18,
2003.                                                                                                                      
|              | 
|4.22          |  | Agreement between William Winstrom and EP MedSystems, Inc., dated April 2, 2003Incorporated by reference to the Companys Registration Statement on Form S-3 filed April 18,
2003.                                                                                                                        
|              | 
|4.23          |  | Common Stock Purchase Agreement between EP MedSystems, Inc. and the several purchasers named therein, dated as of April 11, 2003Incorporated by reference to the Companys Registration
Statement on Form S-3 filed April 18, 2003.                                                                       
|              | 
|4.24          |  | Amendment No. 1, dated April 11, 2003, to Registration Rights Agreement, dated as of January 31, 2003, by and between EP MedSystems, Inc. and the Initial Investors referred to therein
Incorporated by reference to the Companys Registration Statement on Form S-3 filed April 18, 2003.               
|              | 
|4.25          |  | Agreement made as of June 27, 2003, by and between EP MedSystems, Inc. and Anthony VarrichioIncorporated by reference to the Companys Quarterly Report on Form 10-QSB filed August 19,
2003.                                                                                                             
|              | 
|4.26          |  | Agreement made as of June 27, 2003, by and between EP MedSystems, Inc. and William WinstromIncorporated by reference to the Companys Quarterly Report on Form 10-QSB filed August 19,
2003.                                                                                                              
|              | 
|4.27          |  | Notice of EP MedSystems Right to Repurchase Warrants, dated July 23, 2003Incorporated by reference to the Companys Quarterly Report on Form 10-QSB filed August 19,
2003.                                                                                                                               
|              | 
|4.28          |  | Secured Convertible Note, dated August 28, 2003, with Laurus Master Fund, Ltd. in the principal amount of $4,000,000, together with related Registration Rights Agreement, Guaranty, and Security
AgreementIncorporated by reference to the Companys Current Report on Form 8-K filed September 12, 2003.
|              | 
|4.29          |  | Amendment, dated November 25, 2003 to Registration Rights Agreement dated August 28, 2003 with Laurus Master Fund, Ltd.Incorporated by reference to the Companys Annual Report on
Form 10-KSB filed March 30, 2004.                                                                                      
|              | 
|4.30          |  | Warrant, dated August 28, 2003, issued by EP MedSystems, Inc. to Laurus Masterfund, Ltd.Incorporated by reference to the Companys Current Report on Form 8-K filed September 12,
2003.                                                                                                                   
|              | 
|4.31          |  | Warrant, dated August 28, 2003, issued by EP MedSystems, Inc. to Biscayne Capital Markets, Inc.Incorporated by reference to the Companys Registration Statement on Form S-3 filed
October 28, 2003.                                                                                                      
|              | 
|4.32          |  | Form of Common Stock Purchase Agreement dated December 26, 2003 (identical agreements, except for number of shares of Common Stock acquired, were executed by each of the selling
shareholders)Incorporated by reference to the Companys Registration Statement on Form S-3 filed January 22, 2004.      
|              | 
|4.33          |  | Form of Registration Rights Agreement dated December 26, 2003 (identified agreements were executed by each of the selling shareholders)Incorporated by reference to the Companys
Registration Statement on Form S-3 filed January 22, 2004.                                                              
|              | 
|4.34          |  | Common Stock Purchase Agreement, dated as of December 14, 2004, by and between EP MedSystems, Inc. and the Purchasers listed on Exhibit A theretoIncorporated by reference to the
Companys Current Report on Form 8-K filed December 21, 2004.                                                           



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##### Table of Contents

|              |  |                                                                                                                                                                                                                                                                                              
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                  
|4.35          |  | Registration Rights Agreement, dated as of December 14, 2004, by and between EP MedSystems, Inc. and the Investors listed on Exhibit A theretoIncorporated by reference to the
Companys Current Report on Form 8-K filed December 21, 2004.                                                
|              | 
|4.36          |  | Security Agreement, dated August 28, 2003, by and between Laurus Master Fund, Ltd. and EP MedSystems, Inc.Incorporated by reference to the Companys Current Report on Form 8-K filed
September 12, 2003.                                                                                   
|              | 
|4.37          |  | Security Agreement, dated August 28, 2003, by and between Laurus Master Fund, Ltd. and Procath CorporationIncorporated by reference to the Companys Current Report on Form 8-K filed
September 12, 2003.                                                                                   
|              | 
|4.38          |  | Guaranty dated August 28, 2003, by Procath CorporationIncorporated by reference to the Companys Current Report on Form 8-K filed September 12, 2003.                                                                                                                                       
|              | 
|10.1          |  | License Agreement, dated as of November 1, 1995, between EP Med and Dr. Eckhard Alt, as amendedIncorporated by reference to the Companys Registration Statement on Form SB-2 and
Pre-Effective Amendments No. 1 and 2 filed April 18, 1996, May 28, 1996 and June 13, 1996, respectively.  
|              | 
|10.2          |  | License Agreement, dated as of November 1, 1995, between EP Med and Sanjeev SaksenaIncorporated by reference to the Companys Registration Statement on Form SB-2 and Pre-Effective
Amendments No. 1 and 2 filed April 18, 1996, May 28, 1996 and June 13, 1996, respectively.              
|              | 
|10.3          |  | License Agreement, dated February 27, 1997 between EP MedSystems and EchoCath, Inc. together with settlement agreement, dated November 6, 2001 between EP MedSystems and EchoCath,
Inc.Incorporated by reference to the Companys Annual Report on Form 10-KSB filed March 31, 1997.        
|              | 
|10.4          |  | Master Manufacturing Agreement, dated April 16, 1996, between EP Med and Hi Tronics Designs, Inc.Incorporated by reference to the Companys Registration Statement on Form SB-2 and
Pre-Effective Amendments No. 1 and 2 filed April 18, 1996, May 28, 1996 and June 13, 1996, respectively.
|              | 
|10.5          |  | Amended and Restated 1995 Long-Term Incentive PlanIncorporated by reference to the Companys Definitive Proxy Statement on Form 14A filed June 26, 2000.                                                                                                                                    
|              | 
|10.6          |  | Amended and Restated 1995 Director Option PlanIncorporated by reference to the Companys Definitive Proxy Statement on Form 14A filed June 26, 2000.                                                                                                                                        
|              | 
|10.7          |  | Amendment to EP MedSystems, Inc. 1995 Director Option PlanIncorporated by reference to the Companys Definitive Proxy Statement on Form 14A filed July 30, 2002.                                                                                                                            
|              | 
|10.8          |  | EP MedSystems, Inc. 2002 Stock Option Plan as Amended by First AmendmentIncorporated by reference to the Companys Definitive Proxy Statement on Form 14A filed November 24,
2004.                                                                                                          
|              | 
|10.9          |  | Agreement of Lease, dated August 25, 1997, between EP Med and Provident Mutual Life Insurance Company, as landlordIncorporated by reference to the Companys Annual Report on Form
10-KSB filed March 31, 1998.                                                                             
|              | 
|10.10         |  | Note Purchase Agreement, dated as of November 15, 2000, between EP Med and Medtronic Asset Management, Inc.Incorporated by reference to the Companys Quarterly Report on Form
10-QSB filed November 20, 2000.                                                                              
|              | 
|10.11         |  | Secured Promissory Note, dated November 15, 2000, issued by EP Med to Medtronic Asset Management, Inc.Incorporated by reference to the Companys Quarterly Report on Form 10-QSB filed
November 20, 2000.                                                                                   



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##### Table of Contents

|              |  |                                                                                                                                                                                                                                                                                                             
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                                 
|10.12         |  | Stock Pledge Agreement, dated as of November 15, 2000, between Medtronic Asset Management, Inc. and David A. JenkinsIncorporated by reference to the Companys Quarterly Report on Form
10-QSB filed November 20, 2000.                                                                                    
|              | 
|10.13         |  | Subordination Agreement, dated as of November 15, 2000, between Medtronic Asset Management, Inc. and Fleet National BankIncorporated by reference to the Companys Quarterly Report on
Form 10-QSB filed November 20, 2000.                                                                                
|              | 
|10.14         |  | Agreement, dated as of March 9, 1998, between ProCath Corporation and Allan Willis Incorporated by reference to the Companys Annual Report on Form 10-KSB filed May 1,
2001.                                                                                                                              
|              | 
|10.15         |  | License Agreement, dated as of January 21, 1998, between EP Med and Incontrol, Inc. Incorporated by reference to the Companys Registration Statement on Form SB-2 and Pre-Effective
Amendments No.1 through 4 filed June 26, 2001, August 24, 2001, September 28, 2001 and October 12, 2001, respectively.
|              | 
|10.16         |  | Promissory Note dated December 30, 2002 between EP MedSystems, Inc. and EGS Healthcare Limited PartnershipIncorporated by reference to the Companys Annual Report on Form 10-KSB
filed March 31, 2003.                                                                                                    
|              | 
|10.17         |  | Form of Senior Management Incentive AgreementsIncorporated by reference to the Companys Quarterly Report on Form 10-Q filed May 16, 2005.                                                                                                                                                                 
|              | 
|10.18         |  | Software Development, License and Distribution Agreement, dated as of December 19, 2005, by and between EP MedSystems, Inc. and Biosense Webster Inc.                                                                                                                                                       
|              | 
|10.19         |  | 2006 Stock Option PlanIncorporated by reference to the Companys Definitive Proxy Statement on Form 14A filed December 1, 2005.                                                                                                                                                                            
|              | 
|10.20         |  | 2006 Director Option PlanIncorporated by reference to the Companys Definitive Proxy Statement on Form 14A filed December 1, 2005.                                                                                                                                                                         
|              | 
|10.21         |  | Common Stock Purchase Agreement dated March 24, 2006Incorporated by reference to the Companys Current Report on Form 8-K filed March 29, 2006                                                                                                                                                             
|              | 
|10.22         |  | Common Stock Purchase Agreement dated March 24, 2006Incorporated by reference to the Companys Current Report on Form 8-K filed March 29, 2006                                                                                                                                                             
|              | 
|10.23         |  | Registration Rights Agreement dated March 24, 2006Incorporated by reference to the Companys Current Report on Form 8-K filed March 29, 2006                                                                                                                                                               
|              | 
|21.1          |  | Subsidiaries of the RegistrantIncorporated by reference to the Companys Annual Report on Form 10-KSB filed March 30, 2004.                                                                                                                                                                                
|              | 
|23.1*         |  | Consent of Grant Thornton LLP                                                                                                                                                                                                                                                                               
|              | 
|24.1*         |  | Powers of Attorney (included on signature page).                                                                                                                                                                                                                                                            
|              | 
|31.1*         |  | Certification Pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended.                                                                                                                                                                                               
|              | 
|31.2*         |  | Certification Pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended.                                                                                                                                                                                               
|              | 
|32.1*         |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                     
|              | 
|32.2*         |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                     

---

|* | Filed herewith.
|- | ---------------



79