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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the period ended: March 31, 2006



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

For the transition period from  to

Commission File Number: 0-28260

EP
MEDSYSTEMS, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|New Jersey                                                     |  | 22-3212190                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|575 Route 73 N. Building D, West Berlin, New Jersey            |  | 08091                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

(856) 753-8533

(Registrants telephone number)

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

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

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

APPLICABLE ONLY TO
CORPORATE ISSUERS

State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date:



|                                |  |                            
|------------------------------- |  | ---------------------------
|Class                           |  | Outstanding at May 13, 2006
|Common Stock, without par value |  | 30,365,236 shares          



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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

FORM 10-Q

CONTENTS



|                               |  |                                                                                                                 |  |   
|------------------------------ |  | --------------------------------------------------------------------------------------------------------------- |  | --
|                               |  | Page                                                                                                           
|PART I  FINANCIAL INFORMATION |  |                                                                                                                
|                               |  |                                                                                                                
|Item 1.                        |  | Financial Statements                                                                                            |  |   
|                               |  |                                                                                                                
|                               |  | Consolidated Balance Sheets at March 31, 2006 (unaudited) and December 31, 2005                                 |  | 3 
|                               |  |                                                                                                                
|                               |  | Consolidated Statements of Operations for the three months ended March 31, 2006 and 2005 (unaudited)            |  | 4 
|                               |  |                                                                                                                
|                               |  | Consolidated Statement of Changes in Shareholders Equity for the three months ended March 31, 2006 (unaudited) |  | 5 
|                               |  |                                                                                                                
|                               |  | Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005 (unaudited)            |  | 6 
|                               |  |                                                                                                                
|                               |  | Notes to Consolidated Financial Statements (unaudited)                                                          |  | 7 
|                               |  |                                                                                                                
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                           |  | 17
|                               |  |                                                                                                                
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                                                      |  | 27
|                               |  |                                                                                                                
|Item 4.                        |  | Controls and Procedures                                                                                         |  | 28
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                                                
|                               |  |                                                                                                                
|Item 1.                        |  | Legal Proceedings                                                                                               |  | 28
|                               |  |                                                                                                                
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                     |  | 30
|                               |  |                                                                                                                
|Item 3.                        |  | Defaults Upon Senior Securities                                                                                 |  | 30
|                               |  |                                                                                                                
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                                             |  | 31
|                               |  |                                                                                                                
|Item 5.                        |  | Other Information                                                                                               |  | 31
|                               |  |                                                                                                                
|Item 6.                        |  | Exhibits                                                                                                        |  | 31
|                               | 
|Signatures                     |  | 32                                                                                                             
|                               | 
|Exhibit Index                  |  | 33                                                                                                             



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PART I. FINANCIAL INFORMATION



|Item 1. | Financial Statements.
|------- | ---------------------

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ----------- | - | ---------------- | - | ----------- | -
|                                                                                                                                                             |  | March 31,2006 |             |   | December 31,2005 |  
|                                                                                                                                                             |  | (Unaudited)   |             |   |                  |  
|ASSETS                                                                                                                                                       |  |               |             |   |                  |   |             |  
|Current assets:                                                                                                                                              |  |               |             |   |                  |   |             |  
|Cash and cash equivalents                                                                                                                                    |  | $             | 12,375,438  |   |                  | $ | 5,180,001   |  
|Accounts receivable, net of allowances for doubtful accounts of $242,000 and $215,000 as of March 31, 2006 and December 31, 2005,
respectively               |  |               | 4,137,596   |   |                  |   | 3,372,426   |  
|Inventories, net of reserves                                                                                                                                 |  |               | 3,110,619   |   |                  |   | 3,223,783   |  
|Prepaid expenses and other current assets                                                                                                                    |  |               | 469,355     |   |                  |   | 408,402     |  
|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|Total current assets                                                                                                                                         |  |               | 20,093,008  |   |                  |   | 12,184,612  |  
|Property, plant and equipment, net                                                                                                                           |  |               | 2,235,055   |   |                  |   | 2,289,495   |  
|Goodwill                                                                                                                                                     |  |               | 341,730     |   |                  |   | 341,730     |  
|Other intangible assets, net                                                                                                                                 |  |               | 165,636     |   |                  |   | 190,164     |  
|Other assets                                                                                                                                                 |  |               | 106,959     |   |                  |   | 125,370     |  
|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|Total assets                                                                                                                                                 |  | $             | 22,942,388  |   |                  | $ | 15,131,371  |  
|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                         |  |               |             |   |                  |   |             |  
|Current liabilities:                                                                                                                                         |  |               |             |   |                  |   |             |  
|Accounts payable                                                                                                                                             |  |               | 1,683,128   |   |                  |   | 2,221,934   |  
|Accrued expenses                                                                                                                                             |  |               | 1,813,968   |   |                  |   | 1,716,770   |  
|Deferred revenue                                                                                                                                             |  |               | 407,385     |   |                  |   | 487,536     |  
|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|Total current liabilities                                                                                                                                    |  |               | 3,904,481   |   |                  |   | 4,426,240   |  
|Deferred warranty revenue, non-current                                                                                                                       |  |               | 339,592     |   |                  |   | 372,309     |  
|Secured convertible note, non-current                                                                                                                        |  |               | 1,982,648   |   |                  |   | 1,980,198   |  
|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|Total liabilities                                                                                                                                            |  | $             | 6,226,721   |   |                  | $ | 6,778,747   |  
|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|Commitments and contingencies                                                                                                                                |  |               |             |   |                  |   |             |  
|Shareholders equity:                                                                                                                                        |  |               |             |   |                  |   |             |  
|Preferred stock, no par value, 5,000,000 shares authorized, no shares issued or outstanding at March 31, 2006 and at December 31,
2005                       |  |               |            |   |                  |   |            |  
|Common stock, $.001 stated value, 40,000,000 shares authorized 30,365,236 and 25,970,176 shares issued at March 31, 2006 and
December 31, 2005, respectively |  |               | 30,366      |   |                  |   | 25,971      |  
|Additional paid-in capital                                                                                                                                   |  |               | 66,692,445  |   |                  |   | 56,829,190  |  
|Accumulated other comprehensive loss                                                                                                                         |  |               | (77,558     | ) |                  |   | (67,148     | )
|Treasury stock, 50,000 shares at cost                                                                                                                        |  |               | (100,000    | ) |                  |   | (100,000    | )
|Accumulated deficit                                                                                                                                          |  |               | (49,829,586 | ) |                  |   | (48,335,389 | )
|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|Total shareholders equity                                                                                                                                   |  |               | 16,715,667  |   |                  |   | 8,352,624   |  
|                                                                                                                                                             |  |               |             |   |                  |   |             |  
|Total liabilities and shareholders equity                                                                                                                   |  | $             | 22,942,388  |   |                  | $ | 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

(unaudited)



|                                                                                     |  |                            |            |   |               |   |            |  
|------------------------------------------------------------------------------------ |  | -------------------------- | ---------- | - | ------------- | - | ---------- | -
|                                                                                     |  | For the Three Months Ended |           
|                                                                                     |  | March 31,2006              |            |   | March 31,2005 |  
|Net sales                                                                            |  | $                          | 4,078,111  |   |               | $ | 3,476,052  |  
|Cost of products sold (1)                                                            |  |                            | 1,588,236  |   |               |   | 1,277,706  |  
|                                                                                     |  |                            |            |   |               |   |            |  
|Gross profit                                                                         |  |                            | 2,489,875  |   |               |   | 2,198,346  |  
|Operating costs and expenses:                                                        |  |                            |            |   |               |   |            |  
|Sales and marketing expenses (2)                                                     |  |                            | 2,402,312  |   |               |   | 2,128,598  |  
|General and administrative expenses (3)                                              |  |                            | 863,235    |   |               |   | 870,900    |  
|Research and development expenses (4)                                                |  |                            | 698,093    |   |               |   | 584,314    |  
|                                                                                     |  |                            |            |   |               |   |            |  
|Total operating expenses                                                             |  |                            | 3,963,640  |   |               |   | 3,583,812  |  
|                                                                                     |  |                            |            |   |               |   |            |  
|Loss from operations                                                                 |  |                            | (1,473,765 | ) |               |   | (1,385,466 | )
|Interest income                                                                      |  |                            | 40,274     |   |               |   | 41,017     |  
|Interest expense                                                                     |  |                            | (60,706    | ) |               |   | (63,060    | )
|                                                                                     |  |                            |            |   |               |   |            |  
|Net loss                                                                             |  | $                          | (1,494,197 | ) |               | $ | (1,407,509 | )
|                                                                                     |  |                            |            |   |               |   |            |  
|Basic and diluted loss per share                                                     |  | $                          | (.06       | ) |               | $ | (.05       | )
|                                                                                     |  |                            |            |   |               |   |            |  
|Weighted average shares outstanding used to compute basic and diluted loss per share |  |                            | 26,165,556 |   |               |   | 25,602,761 |  
|                                                                                     |  |                            |            |   |               |   |            |  

---

|(1) | Includes share-based compensation expenses of $4,239 for the three months ended March 31, 2006.
|--- | -----------------------------------------------------------------------------------------------



|(2) | Includes share-based compensation expenses of $87,362 for the three months ended March 31, 2006.
|--- | ------------------------------------------------------------------------------------------------



|(3) | Includes share-based compensation expenses of $74,896 for the three months ended March 31, 2006.
|--- | ------------------------------------------------------------------------------------------------



|(4) | Includes share-based compensation expenses of $25,524 for the three months ended March 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 THREE MONTHS ENDED MARCH 31, 2006



|                                                                                     |  |                    |  |                   |        |                      |   |                      |   |                          |   |                                   |  |   |               |   |  |                    |          |   |       |   |             |   |  |   |            |  
|------------------------------------------------------------------------------------ |  | ------------------ |  | ----------------- | ------ | -------------------- | - | -------------------- | - | ------------------------ | - | --------------------------------- |  | - | ------------- | - |  | ------------------ | -------- | - | ----- | - | ----------- | - |  | - | ---------- | -
|                                                                                     |  | CommonStock Shares |  | CommonStockAmount |        | PreferredStockShares |   | PreferredStockAmount |   | AdditionalPaid-inCapital |   | AccumulatedOtherComprehensiveLoss |  |   | TreasuryStock |   |  | AccumulatedDeficit |          |   | Total |  
|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  |  
|Vesting of options in connection with options issued to consultant                   |  |                   |  |                   |       |                      |  |                      |  |                          |   | 196,480                           |  |   |              |   |  |                    |         |   |       |   |            |   |  |   | 196,480    |  
|Share-based compensation                                                             |  |                   |  |                   |       |                      |  |                      |  |                          |   | 192,021                           |  |   |              |   |  |                    |         |   |       |   |            |   |  |   | 192,021    |  
|Foreign currency translation                                                         |  |                   |  |                   |       |                      |  |                      |  |                          |   |                                  |  |   | (10,410       | ) |  |                    |         |   |       |   |            |   |  |   | (10,410    | )
|Net loss                                                                             |  |                   |  |                   |       |                      |  |                      |  |                          |   |                                  |  |   |              |   |  |                    |         |   |       |   | (1,494,197  | ) |  |   | (1,494,197 | )
|                                                                                     |  |                    |  |                   |        |                      |   |                      |   |                          |   |                                   |  |   |               |   |  |                    |          |   |       |   |             |   |  |   |            |  
|Balance, March 31, 2006                                                              |  | 30,365,236         |  | $                 | 30,366 |                      |  |                      |  |                          | $ | 66,692,445                        |  | $ | (77,558       | ) |  | $                  | (100,000 | ) |       | $ | (49,829,586 | ) |  | $ | 16,715,667 |  
|                                                                                     |  |                    |  |                   |        |                      |   |                      |   |                          |   |                                   |  |   |               |   |  |                    |          |   |       |   |             |   |  |   |            |  

The accompanying notes are an integral part of this statement.



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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)



|                                                                            |  |                            |            |   |               |   |            |  
|--------------------------------------------------------------------------- |  | -------------------------- | ---------- | - | ------------- | - | ---------- | -
|                                                                            |  | For the Three Months Ended |           
|                                                                            |  | March 31,2006              |            |   | March 31,2005 |  
|Cash flows from operating activities:                                       |  |                            |            |   |               |   |            |  
|Net loss                                                                    |  | $                          | (1,494,197 | ) |               | $ | (1,407,509 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                            |            |   |               |   |            |  
|Depreciation and amortization                                               |  |                            | 264,667    |   |               |   | 241,428    |  
|Accretion of note discount                                                  |  |                            | 2,450      |   |               |   | 6,407      |  
|Amortization of beneficial conversion feature                               |  |                            | 5,132      |   |               |   | 13,474     |  
|Noncash expenses in connection with issuance of options to consultant       |  |                            | 196,480    |   |               |   |           |  
|Share-based compensation                                                    |  |                            | 192,021    |   |               |   |           |  
|Bad debt expense                                                            |  |                            | 27,000     |   |               |   |           |  
|Changes in assets and liabilities:                                          |  |                            |            |   |               |   |            |  
|(Increase) decrease in accounts receivable                                  |  |                            | (792,170   | ) |               |   | 694,379    |  
|Increase in inventories                                                     |  |                            | (48,696    | ) |               |   | (411,530   | )
|(Increase) decrease in prepaid expenses and other assets                    |  |                            | (47,674    | ) |               |   | 74,813     |  
|Decrease in accounts payable                                                |  |                            | (538,806   | ) |               |   | (516,730   | )
|Decrease in accrued expenses and deferred revenue                           |  |                            | (15,670    | ) |               |   | (194,850   | )
|                                                                            |  |                            |            |   |               |   |            |  
|Net cash used in operating activities                                       |  | $                          | (2,249,463 | ) |               | $ | (1,500,118 | )
|                                                                            |  |                            |            |   |               |   |            |  
|Cash flows from investing activities:                                       |  |                            |            |   |               |   |            |  
|Capital expenditures                                                        |  |                            | (23,839    | ) |               |   | (14,882    | )
|Patent costs                                                                |  |                            |           |   |               |   | (93,471    | )
|                                                                            |  |                            |            |   |               |   |            |  
|Net cash used in investing activities                                       |  | $                          | (23,839    | ) |               | $ | (108,353   | )
|                                                                            |  |                            |            |   |               |   |            |  
|Cash flows from financing activities:                                       |  |                            |            |   |               |   |            |  
|Net proceeds from issuance of common stock, net of offering expenses        |  |                            | 9,479,149  |   |               |   | 77,790     |  
|                                                                            |  |                            |            |   |               |   |            |  
|Net cash provided by financing activities                                   |  | $                          | 9,479,149  |   |               | $ | 77,790     |  
|                                                                            |  |                            |            |   |               |   |            |  
|Effect of exchange rate changes                                             |  |                            | (10,410    | ) |               |   | 40,855     |  
|Net increase (decrease) in cash and cash equivalents                        |  |                            | 7,195,437  |   |               |   | (1,489,826 | )
|Cash and cash equivalents, beginning of period                              |  |                            | 5,180,001  |   |               |   | 9,345,000  |  
|                                                                            |  |                            |            |   |               |   |            |  
|Cash and cash equivalents, end of period                                    |  | $                          | 12,375,438 |   |               | $ | 7,855,174  |  
|                                                                            |  |                            |            |   |               |   |            |  
|Supplemental cash flow information                                          |  |                            |            |   |               |   |            |  
|Cash paid for interest                                                      |  | $                          | 44,972     |   |               | $ | 36,328     |  

The accompanying notes are an integral part of these statements.



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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Note 1. Basis of Presentation

The accompanying
unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q.
Accordingly, they do not include all of the financial information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (including normal recurring
adjustments) considered necessary for a fair presentation have been included.

The preparation of financial statements in conformity with
generally accepted accounting principles 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. Actual results could differ from
those estimates.

The results of operations for the respective interim periods are not necessarily indicative of the results to be expected
for the full year. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in EP MedSystems, Inc.s (the Company or
EP MedSystems) Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission (SEC or Commission).

Note 2. Inventories

Inventories are valued at the
lower of cost or market with cost being determined on a first-in, first-out basis. Inventories consist of the following at March 31, 2006 and December 31, 2005:



|                         |  |               |           |   |                  |   |           |  
|------------------------ |  | ------------- | --------- | - | ---------------- | - | --------- | -
|                         |  | March 31,2006 |           |   | December 31,2005 |  
|                         |  | (unaudited)   |           |   |                  |  
|Raw materials            |  | $             | 1,351,500 |   |                  | $ | 1,531,746 |  
|Work in process          |  |               | 270,118   |   |                  |   | 538,567   |  
|Finished goods           |  |               | 1,731,001 |   |                  |   | 1,367,470 |  
|Reserve for obsolescence |  |               | (242,000  | ) |                  |   | (214,000  | )
|                         |  |               |           |   |                  |   |           |  
|                         |  | $             | 3,110,619 |   |                  | $ | 3,223,783 |  
|                         |  |               |           |   |                  |   |           |  

Note 3. 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.



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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 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. In connection with the private placement consummated in March of 2006, 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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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.

Note 4. 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.

During the year ended December 31, 2001, EP MedSystems consummated the private sale and issuance of Series A convertible preferred stock to Medtronic, Inc. (Medtronic). In



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2002, Medtronic converted a portion of its preferred stock into shares of common stock of the Company. At December 31, 2004, Medtronic held 373,779 of
the Companys Series A Preferred Shares which were convertible into 387,946 shares of common stock of the Company at the option of Medtronic or the Company in accordance with the terms of the agreement with Medtronic. The Series A Preferred
Shares had a liquidation preference of $2.048 per share. During the first quarter of 2005, Medtronic converted all their 373,779 shares of preferred stock into 387,946 shares of common stock of the Company.

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 March 31, 2006 and December 31, 2005.

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, 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 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 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 the Companys common stock were issued to a physician consultant, engaged as the Companys 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 equal to 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
the Company 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, 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 President, Chief Executive Officer, Chief Operating Officer and 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.



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Note 5. Stock Based Compensation

Effective January 1, 2006, the Company follows FASB Statement No. 123R, Shared-Based Payment. Statement 123R requires that the compensation cost relating to share-based payment transaction 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 Employee. Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting
for share-based payment transactions with employees. However, that Statement 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, 2004, and 2003 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-base compensation cost using the Black-Scholes option pricing model.



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The Company, currently, has five stock-based employee compensation plans. Share-based compensation of
$192,000 net of a fully reserved tax benefit or $0.01 per share, was recognized for the three months ended March 31, 2006. 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, 2006. Reported net income, adjusting for share-based compensation that would have been recognized in last years comparative three month periods if Statement 123R had been followed is as follows:



|                                                                                             |  |                    |            |   |               |   |            |  
|-------------------------------------------------------------------------------------------- |  | ------------------ | ---------- | - | ------------- | - | ---------- | -
|                                                                                             |  | Three Months Ended |           
|                                                                                             |  | March 31,2006      |            |   | March 31,2005 |  
|Net loss, as reported                                                                        |  | $                  | (1,494,197 | ) |               | $ | (1,407,509 | )
|Less: stock-based compensation costs determined under fair value based method for all awards |  |                    |           |   |               |   | (176,730   | )
|                                                                                             |  |                    |            |   |               |   |            |  
|Adjusted net loss                                                                            |  | $                  | (1,494,197 | ) |               | $ | (1,584,239 | )
|                                                                                             |  |                    |            |   |               |   |            |  
|Loss per share of common stock  :                                                           |  |                    |            |   |               |   |            |  
|As reported                                                                                  |  | $                  | (0.06      | ) |               | $ | (0.05      | )
|                                                                                             |  |                    |            |   |               |   |            |  
|Shared-based compensation costs                                                              |  |                    |           |   |               | $ | (0.01      | )
|                                                                                             |  |                    |            |   |               |   |            |  
|Adjusted net earnings                                                                        |  | $                  | (0.06      | ) |               | $ | (0.06      | )
|                                                                                             |  |                    |            |   |               |   |            |  

The fair value of each option grant is estimated on the date of grant using the Black-Scholes
options-pricing model with the following weighted average assumptions used for grants in 2006: expected volatility of 84%; risk-free interest rate of 4.82% and an expected life of a range of 7.5 to 10 years.

Expected volatility is based on the historical volatility of the price of our common shares over the past approximately 10 years. Management has used
historical information to estimate expected forfeitures and used the simplified method to estimate the expected lives 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 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.

Note 6. Industry Segment and Geographic Information

EP MedSystems manages its business based on 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.



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The following table sets forth product sales by geographic segment for the three months ended
March 31, 2006 and 2005.



|                     |  |                                     |           |      |   |          
|-------------------- |  | ----------------------------------- | --------- | ---- | - | ---------
|                     |  | For The Three Months EndedMarch 31,
|                     |  | 2006                                |           | 2005
|United States        |  | $                                   | 2,665,000 |      | $ | 2,759,000
|Europe/Middle East   |  |                                     | 362,000   |      |   | 205,000  
|Asia and Pacific Rim |  |                                     | 1,051,000 |      |   | 512,000  
|                     |  |                                     |           |      |   |          
|                     |  | $                                   | 4,078,000 |      | $ | 3,476,000
|                     |  |                                     |           |      |   |          

Sales of EP MedSystems cardiac electrophysiology equipment and related catheters aggregated
approximately $3,705,000 and $373,000 respectively, for the three months ended March 31, 2006, and $3,041,000 and $435,000, respectively, for the comparable period in 2005. EP MedSystems long-lived assets are primarily located in the U.S.
One customer accounted for 24% and another customer accounted for 16% of the Companys sales for the three months ended March 31, 2006.

Net sales for the three months ended March 31, 2006 were billed in two currencies: $3,927,000 in U.S. dollars and the equivalent of $151,000 in Euros. Management has determined the impact of foreign currency risk on sales to be 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. Cumulative translation losses amounted to approximately $80,000 as of March 31, 2006.
In addition, EP MedSystems had not entered into any derivative financial instruments for hedging or other purposes.

Note 7. Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of shares of common stock outstanding. Due to the losses
incurred for the quarter, diluted net loss per share does not differ from basic net loss per share for each period presented, since potential shares of common stock issuable upon the exercise of stock options, warrants, and convertible debt are
anti-dilutive for all periods presented. Accordingly, potential common shares of 3,246,809 and 3,724,585 for the three months ended March 31, 2006 and 2005, respectively, have been excluded from the diluted per share calculation.

Note 8. Comprehensive Income/Loss

For the three
months ended March 31, 2006 and 2005, EP MedSystems comprehensive loss consisted of net loss and foreign currency translation adjustments. The comprehensive losses for the three months ended March 31, 2006 and 2005, were
approximately $1,505,000 and $1,367,000, respectively.

Note 9. Recently Issued Accounting Standards

In November 2004, the FASB issued SFAS No.151, Inventory Costsan amendment of ARB No. 43, Chapter 4. This Statement amends the guidance in ARB
No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that 
.. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require



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treatment as current period charges. This Statement requires that those items be recognized as current-period charges regardless of whether they
meet the criterion of so abnormal. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective
for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this Statement had no material impact on the Companys results of operations, financial position or cash flow.

In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary Assets. This Statement addresses the measurement of exchanges of nonmonetary
assets. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that
Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary
assets that do not have commercial substance. A nonmonetrary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This Statement is effective for financial
statements for fiscal years beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges incurred during fiscal years beginning after the date of this statement is issued. The adoption of this Statement had no
material impact on the Companys results of operations, financial position or cash flow.

In December 2004, the FASB issued two
FASB Staff Positions (FSP) regarding the accounting implications of the American Jobs Creation Act of 2004. The adoption of FAS No. 109-1, Application of FASB Statement No. 109 Accounting for Income Taxes to the Tax
Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 and FSP No. 109-2 Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation
Act of 2004 did not materially affect the Companys effective tax rate in 2005.

At its September 29-30, 2004, meeting, the
FASB reached a conclusion on Emerging Issues Task Force (EITF) Issue No. 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings Per Share, that contingently convertible debt instruments will be subject to the
if-converted method under FASB Statement No. 128 (SFAS No. 128), Earnings Per Share, regardless of the contingent features included in the instrument. Under current practice, issuers of contingently convertible debt instruments exclude
potential common shares underlying the debt instruments from the calculation of diluted earnings per share until the market price or other contingency is met. Due to the losses incurred for the year, the Companys diluted net loss per share
does not differ from basic net loss per share, since potential shares of common stock issuable upon the conversion of the convertible debt are anti-dilutive for all periods presented and the adoption of Issue 04-8 had no impact on our results of
operations. EITF 04-8 could have a future impact on the Companys results of operations in the event that the potential shares of common stock issuable upon conversion of the convertible debt were included in the diluted earnings per share
calculation.

Note 10. Commitments and 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



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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.

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 has conducted an independent investigation into these matters and has 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, the Company incurred approximately
$474,000 in legal consulting and accounting expenses associated with the governmental and Audit Committee investigations and approximately $45,000 associated with the Companys defense and negotiations with the government. In the first quarter
of 2006, the Company incurred approximately $131,000 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
penalties and fines are not 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



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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.

In the fourth quarter of 2005, we terminated our agreements with our Armenian and German distributors.
The German distributor is contesting the termination, and while we believe its claim is without merit, we cannot, at this time, estimate the costs we may incur in enforcing this termination or the impact on our revenue.

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 and while we have been cooperating fully, we cannot predict when we will have a resolution to these outstanding issues. We cannot assure you that the ongoing investigations by the
Department of Commerce and the Commission will not result in significant costs, fines or penalties that could have a material effect on our business, financial conditions prospects or results of operations.

Product Field Action

The Company has
initiated a field action recall for one of its products. This field action will consist 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 $250,000 in costs associated with this field action consisting of shipping of the product and the associated modifications. 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. The Company has responded to this report. However, it is possible that we could receive a warning letter. If a warning
letter is issued, it may impact, among other things our ability to ship products to certain customers.



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|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations.
|------- | --------------------------------------------------------------------------------------

Overview

EP MedSystems was incorporated in January 1993 and operates 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® computerized electrophysiology workstation, the RPM RealTime Position Management navigation technology, our EP 3 Stimulator,
our EP-4 Computerized Cardiac Stimulator, diagnostic electrophysiology catheters (including our unique one-piece catheter) and our ALERT®System (including the ALERT®Companion II and ALERT®family of internal cardioversion catheters), ViewMate® intracardiac ultrasound catheter system and related disposable supplies.

Our core diagnostic product is the EP-WorkMate® which consists of the EP- WorkMate®, the EP-WorkMate integrated with RPM RealTime Position Management System and the EP-4 Computerized Cardiac Stimulator. The EP-WorkMate®is a computerized electrophysiology workstation that monitors displays and stores cardiac electrical activity and arrhythmia data. It
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 the systems of other market
leaders and with other technologies and systems. We received FDA market clearance to sell the EP-WorkMate® integrated the RPM RealTime Position Management System in the third quarter of 2003. This approval was the culmination of a strategic joint development project between Boston
Scientific Corporation and EP Med. It is the only EP recording system on the market to integrate advanced recording and stimulation with anatomic modeling, advanced mapping and 3-D navigation features, allowing electrophysiology studies to be more
efficient and user friendly. The EP-4 Stimulator is a computerized signal generator and processor which, when integrated with the EP-WorkMate®, is used to stimulate the heart with electrical impulses in order to locate arrhythmia. For the three months ended March 31,
2006 and 2005, the EP-WorkMate®platform accounted for approximately 88% and 85%,
respectively, 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% and 3% of our total sales
revenues for the three months ended March 31, 2006 and 2005, respectively.

We have also developed the ViewMate® intracardiac ultrasound catheter system, including the
ViewMate® ultrasound imaging console and
ViewFlexTMintracardiac 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. In April of 2003, we
received CE approval to market the ViewMate® in
Europe. In October 2003, we received FDA market clearance to sell the ViewMate® System in the United States. Sales of the ViewMate® system and related ViewFlex catheters accounted for approximately 6% of our total sales revenues in the three months ended March 31, 2006 and 2005, respectively.



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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. In September 2003, we received pre-market approval to sell the ALERT® Companion II in the United States. Sales of the ALERT®System and related catheters accounted for approximately 4% of our total sales revenues for the three
months ended March 31, 2006 and 2005, respectively.

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. 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 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®does require a set up. For sales to distributors, the distributor is responsible for all set-up of all electronic hardware products. For direct sales, the customer can perform the set-up on its own;
however, EP Med personnel generally will assist customers in this



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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.

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 the 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.



|                  |  |                                     |         |   |      |   |         |  
|----------------- |  | ----------------------------------- | ------- | - | ---- | - | ------- | -
|                  |  | For the Three MonthsEnded March 31, |        
|                  |  | 2006                                |         |   | 2005 |  
|Beginning balance |  | $                                   | 313,000 |   |      | $ | 331,000 |  
|Warranties        |  |                                     | 98,000  |   |      |   | 65,000  |  
|Warranty payments |  |                                     | (93,000 | ) |      |   | (97,000 | )
|                  |  |                                     |         |   |      |   |         |  
|Ending balance    |  | $                                   | 318,000 |   |      | $ | 299,000 |  
|                  |  |                                     |         |   |      |   |         |  

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 and any specific customer collection issues that we have identified. 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. 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.



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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.

Accounting for
Stock-Based Compensation.

Prior to January 1, 2006, we 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 recorded no compensation expense when we granted stock options to employees if the exercise price for a fixed stock option award to an employee was
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
for the year ended December 31, 2005.

On December 16, 2004 the Financial Accounting Standards Board (FASB) issued
SFAS No. 123R, 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



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accounted for using a fair-value-based method and the resulting cost recognized in our financial statements. This new standard is effective beginning in the
first fiscal year beginning after June 15, 2005. We adopted this new standard effective for the first quarter of 2006.

The Company
used the modified prospective method upon adoption 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. The Company has 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 $3,094,000 as of December 31, 2005, which will be
amortized over an average period of approximately 5 years. The Companys 2006 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. In the
first quarter of 2006, the Company recorded share-based compensation of approximately $192,000.

Results of Operations.

Three Months Ended March 31, 2006 versus March 31, 2005

Net sales were $4,078,000 for the three months ended March 31, 2006, as compared to $3,476,000 for the comparable period in 2005. This $602,000 (or 17.3%) increase is a result of an increase in sales of the
EP-Workmate® and upgrades to our Japanese
distributor who is in the process of upgrading its installed base in Japan. While we have an expectation of a level of minimum sales from this distributor over the next 12 months, prospectively we do not believe we will have this level of sales in
any one quarter.

Gross profit on sales for the three months ended March 31, 2006 was $2,490,000, as compared to $2,198,000 for
the same period in 2005. The gross profit decreased as a percentage of sales from 63% to 61%. The decrease in gross profit is primarily a result of additional costs of $50,000 associated with our field action recall around one of our products.

Sales and marketing expenses increased $274,000 (or 12.8%) to $2,402,000 for the three months ended March 31, 2006 as compared to the
same period in 2005. The increase in sales and marketing expenses is primarily a result of an additional $292,000 in cost in our clinical affairs department in 2006 over the comparable period in 2005. Of these costs, approximately $196,000 was in
connection with options issued to our Senior Medical Advisor for the delivery of certain patents. There were an additional $54,000 in costs for the Companys clinical study. These costs were partially offset by lower commissions of $27,000 and
lower royalties. There were also approximately $87,000 in share-based compensation costs associated with the adoption of FAS 123R.

General
and administrative expenses decreased $8,000 (or 0.1%) to $863,000 for the three months ended March 31, 2006, as compared to the same period in 2005. This was primarily due to a decrease in compensation costs of approximately $98,000
related to a reduction in head count and salary, approximately $73,000 due to fluctuations in foreign



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currency, and approximately $30,000 associated with lower amortization of deferred financing fees with the extension of the due date of our Secured
Convertible Note. The decrease in costs was offset by an increase of $111,000 in legal costs associated with our ongoing investigations with various governmental entities in connection with sales 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 the Companys Audit
Committee investigation, the Companys 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 $131,000 of legal and other fees and expenses in connection with these matters through March 31, 2006. We believe that additional
legal and other costs and expenses through the remainder of 2006 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 results of operations and financial condition. There was also approximately $75,000 in share-based compensation in connection with the adoption of FAS 123R.

Research and Development costs increased $114,000 (or 19.5%) to $698,000 for the three months ended March 31, 2006 as compared to the same period in
2005. This was primarily due to an increase of $93,000 in compensation costs and benefits associated with additional head counts in the regulatory and research and development departments and $26,500 in share-based compensation in connection with
the adoption of FAS 123R.

Interest expense decreased $2,000 for the three months ended March 31, 2006, as compared to the same
period in 2005. The decrease in interest expense is a result of a lower accretion of debt discount and amortization of beneficial conversion feature offset by 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 $49.8 million at March 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



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financing fees are being amortized over the life of the 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% for the year ended December 31, 2005 (including accretion of
discount and amortization of beneficial conversion feature), and the balance (the 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. 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 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 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 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



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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 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 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 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 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.

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, 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 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 each grant as follows: risk free rate: 3.07%, 10 year life, and a volatility percentage of 83.86%.



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During 2005, three additional options to purchase shares of the Companys 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 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 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 NASAQ marketplace rules. David Jenkins, the Companys President, Chief Executive Officer, Chief Operating Officer and 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 Activities

Net cash used in operating
activities for the three months ended March 31, 2006 increased by $749,000 to $2,249,000 as compared to the same period in 2005. The increase in our net use of cash in operations during 2005 was primarily due to the increase in our receivables
of $765,000, and decrease of our payable of $539,000, and was offset by non-cash share-based compensation of $192,000 and non-cash expenses in connection with the issuance of options to a consultant of $196,000. Capital expenditures were $24,000 for
the three months ended March 31, 2006 as compared to $15,000 for the same period in 2005. We expect to purchase capital equipment in 2006 as we grow. We lease office space and certain office equipment under operating leases.

Assets increased by $7,811,000 from $15,131,000 at December 31, 2005 to 22,942,000 at March 31, 2006 primarily associated with our influx of
cash from the private placement in March 2006. Accounts receivable increased by $765,000 from December 31, 2005.

Liabilities
decreased $552,000 from $6,779,000 at December 31, 2005 to $6,227,000 at March 31, 2006 primarily due to a $539,000 reduction in accounts payable.

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 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



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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 first 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, we have incurred approximately
$131,000 of legal and other fees and expenses in connection with these matters through March 31, 2006. We believe that additional legal and other costs and expenses through the remainder of 2006 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, 2005, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

Cautionary
Statement Regarding Forward-Looking Statements

In addition to historical information, this Quarterly Report on Form 10-Q contains
forward-looking statements relating to such matters as anticipated financial and operational performance, business prospects, technological developments, results of clinical trials, new products, research and development activities and similar
matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. We emphasize to you that a variety of factors could cause our actual results and experience to differ materially from the
anticipated results or other expectations expressed in our forward-looking statements. When we use the words or phrases believe, anticipate, expect, intend, will likely result,
estimate, project or similar expressions in this Quarterly Report on Form 10-Q, we intend to identify such forward-looking statements, but they are not the exclusive means by which such statements are made. The
forward-looking statements are only expectations and/or predictions which are subject to risks and uncertainties, including the significant factors discussed under Risk Factors in our most recent Form 10-K, and general economic, market
or business conditions, opportunities or lack of opportunities that may be presented to us, competitive actions, changes in laws and regulations and other matters discussed herein in the



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section entitled Item 2 - Managements Discussion and Analysis of Financial Condition and Results of Operations and in other sections
herein.

We caution readers to review the cautionary statements set forth in this Quarterly Report on Form 10-Q and in our other reports
filed with the Securities and Exchange Commission and caution that other factors may prove to be important in affecting our business and results of operations. We caution you not to place undue reliance on these forward-looking statements, which
speak only as of the date of this Quarterly Report. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this report.



|Item 3. | 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 March 31, 2006, we had a Convertible Note outstanding in the approximate amount of $2,000,000. Interest on
the Convertible Note is based on the prime rate. This floating rate debt may lead to additional interest expense if interest rates increase. 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 March 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 March 31, 2006, we estimate that the fair value of investment portfolio would decline by an immaterial amount.



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Foreign Currency Risk

Our international revenues were 35% and 21% of our total revenues in the quarters ended March 31, 2006 and 2005, respectively. Our international
sales are made through international distributors, our direct sales force and sales to alliance partners, with payments to the Company typically denominated in United States dollars and the Euro. Approximately 9% of our foreign sales are denominated
in the Euro. Management has determined that the 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 no hedge our foreign currency exposure at present.



|Item 4. | Controls and Procedures
|------- | -----------------------

As of the end of the
period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the Companys disclosure controls
and procedures (as defined in Rule 13a-15 and 15d-15 of 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 the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange 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 the Companys internal control over financial reporting
during the Companys most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially effect, the Companys internal controls over financial reporting.

PART II. OTHER INFORMATION



|Item 1. | 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 accountings reporting, including relating to disclosures the
Company made in its



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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
governmental 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 is conducting an
independent investigation into these matters and has 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 resources requirement for the Commission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, 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. In the first quarter of 2006, the Company incurred approximately $131,000 in connection with negotiations with various
governmental entities. Management currently estimates that additional legal fees and other expenses to be incurred by the Company in connection with the investigation by the Audit Committee may be in excess of $75,000 but cannot predict whether such
fees and other expenses will be significantly higher. 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.

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 provisions 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



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meetings with various governmental agencies with which we have been cooperating fully, but we cannot predict when we will have a resolution to these
outstanding issues.



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

Sales of our products into Iran are under
investigations by the United States Department of Commerce, 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 Commerce has requested certain information relating
to, and is conducting 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 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 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. In addition, the United States Department of Justice, through the United States Attorneys Office for the District of
New Jersey, had also requested certain information and initiated an investigation into the sales of our products into Iran. In March 2006, the United States Attorneys Office for the District of New Jersey informed the Company that it will not
prosecute the Company in connection with this matter.

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 Sates 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 Justice, 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 the first quarter of 2006, the Company incurred approximately $131,000 in connection with negotiations with various governmental entities. We cannot assure you that the ongoing
investigations by the Department of Commerce and 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.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds.
|------- | ------------------------------------------------------------

(a) Reference is made to the Companys Current Report on Form 8-K filed March 28, 2006 for information concerning the issuance by the Company on March 27, 2006 of Company Common Stock, which securities were not
registered under the Securities Act of 1933.

(b) Not applicable.

(c) Not applicable.



|Item 3. | Defaults Upon Senior Securities.
|------- | --------------------------------

None.



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

None.



|Item 5. | Other Information.
|------- | ------------------

(b) None.



|Item 6. | Exhibits.
|------- | ---------

The exhibits are listed in the Exhibit
Index appearing at page 33 herein.



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SIGNATURES

In accordance with the requirements of the Exchange Act, the Registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.



|                   |  |  |  |                                  |  |                     |  |                                                                              
|------------------ |  |  |  | -------------------------------- |  | ------------------- |  | -----------------------------------------------------------------------------
|                   |  |  |  | EP MEDSYSTEMS, INC. (Registrant)
|                   |  |  | 
|Date: May 15, 2006 |  |  |  | By:                              |  | /s/ David Jenkins  
|                   |  |  |  |                                  |  |                     |  | David Jenkins                                                                
|                   |  |  |  |                                  |  |                     |  | Chairman, President and Chief Executive Officer (Principal Executive Officer)
|                   |  |  | 
|Date: May 15, 2006 |  |  |  | By:                              |  | /s/ Matthew C. Hill
|                   |  |  |  |                                  |  |                     |  | Matthew C. Hill                                                              
|                   |  |  |  |                                  |  |                     |  | Chief Financial Officer (Principal Financial and Accounting Officer)         



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Index to Exhibits



|              |  |                                                                                                                                                                           
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                               
|              | 
|10.1          |  | Common Stock Purchase Agreement, dated March 24, 2006 (incorporated by reference to exhibit 10.1 to the Current Report on Form 8-K filed by the Company on March 28, 2006)
|              | 
|10.2          |  | Common Stock Purchase Agreement, dated March 24, 2006 (incorporated by reference to exhibit 10.2 to the Current Report on Form 8-K filed by the Company on March 28, 2006)
|              | 
|10.3          |  | Registration Rights Agreement, dated March 24, 2006 (incorporated by reference to exhibit 10.3 to the Current Report on Form 8-K filed by the Company on March 28, 2006)  
|              | 
|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.
|- | ---------------



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