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** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 
| **x**                                                                                                                                                                           | **ANNUAL REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                      |
| **For the fiscal year ended December 31, 2008**                                                                                                                            |
| ** **                                                                                                                                                                      |
| **o**                                                                                                                                                                           | **TRANSITION REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                      |
| **For the transition period from                        to** |
| ** **                                                                                                                                                                      |
| **Commission file number: 333-103781**                                                                                                                                          |

 

**ProUroCare Medical Inc.**

(Exact name of registrant as specified in its charter)

 

| **Nevada**                                                     | ** ** | **20-1212923**      |
|----------------------------------------------------------------|------------|---------------------|
| (State or other jurisdiction                                   |       | (IRS Employer       |
| of incorporation)                                              |       | Identification No.) |
|                                                           |       |                |
| **6440 Flying Cloud Drive,  Suite 101, Eden Prairie, MN** | ** ** | **55344**           |
| (Address of principal executive offices)                       |       | (Zip Code)          |

 

Registrant’s telephone number,including area code  **952-476-9093**

 

**5500 Wayzata Blvd.,Suite 310, Golden Valley, MN 55416**

(Former name or former address, if changed since lastreport.)

 

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

 

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

 

**CommonStock $0.00001 par value; Common Stock Warrants**

 

**Units,consisting of one share of Common Stock and one Warrant**

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.

**o**** Yes   ****x**** No**

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or15(d) of the Act.

**o**** Yes   ****x**** No**

 

Indicate by check mark whetherthe issuer (1) filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act during the past 12 months (or forsuch 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   ****o**** No**

 

Indicate by check mark ifdisclosure of delinquent filers in response to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K                                                         **o**

 

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

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined by Rule 12-b of theExchange Act).   **o**** Yes   ****x**** No**

 

State the aggregate marketvalue of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was sold, or theaverage bid and asked price of such common equity, as of the last business dayof the registrant’s most recently completed second fiscal quarter.                                                     **$853,897 as of June 30, 2008**

 

Indicate the number ofshares outstanding of each of the registrant’s classes of common equity, as ofthe latest practicable date.

 

**3,108,767common shares and 6,041,281 Units at March 18, 2009**

 

 

 

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**INTRODUCTORY CAUTIONARY STATEMENT**

 

*This Annual Report on Form 10-Kincludes forward-looking statements within the meaning of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”).  These statements are based on management’s currentbeliefs and assumptions and on information currently available to us.Forward-looking statements include, among others, the information concerningpossible or assumed future results of operations of ProUroCare Medical, Inc.and its subsidiary (the “Company,” “we,” “us,” or “our”) set forth under theheading “Management’s Discussion and Analysis or Plan of Operation” andelsewhere in this Annual Report. Forward-looking statements also include statements where the words “may,”““will,” “should,” “could,” “expect,” “anticipate,” “intend,” “plan,” “believe,”“estimate,” “predict,” “potential,” or similar expressions are used.  Forward-looking statements are not guaranteesof future performance. Our future actual results and shareholder values maylikely differ materially from those expressed in these forward-lookingstatements. We caution you not to put undue reliance on any forward-lookingstatements included in this document. See “Risk Factors Associated with our Business, Operations, andSecurities.”*

 

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**TABLE OF CONTENTS**

 
| ** **        |                                                                                              | **Page** |
|-------------------|---------------------------------------------------------------------------------------------------|----------|
| **PART I**   |                                                                                              |     |
| ITEM 1:           | BUSINESS                                                                                          | 2        |
| ITEM 1A           | RISK FACTORS                                                                                      | 20       |
| ITEM 1B           | UNRESOLVED STAFF  COMMENTS                                                                        | 35       |
| ITEM  2:          | PROPERTIES                                                                                        | 36       |
| ITEM  3:          | LEGAL  PROCEEDINGS                                                                                | 36       |
| ITEM  4:          | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                              | 36       |
|              |                                                                                              |     |
| **PART II**  |                                                                                              |     |
| ITEM  5:          | MARKET  FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY  SECURITIES | 36       |
| ITEM  6:          | SELECTED  FINANCIAL DATA                                                                          | 38       |
| ITEM  7:          | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS       | 38       |
| ITEM  7A:         | QUANTITATIVE  AND QUALITATTIVE DISCLOSURES ABOUT MARKET RISK                                      | 43       |
| ITEM 8:           | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                      | F-1      |
| ITEM  9:          | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES            | 44       |
| ITEM 9A(T):       | CONTROLS AND  PROCEDURES                                                                          | 44       |
| ITEM  9B:         | OTHER  INFORMATION                                                                                | 45       |
|              |                                                                                              |     |
| **PART III** |                                                                                              |     |
| ITEM  10:         | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                           | 45       |
| ITEM 11:          | EXECUTIVE  COMPENSATION                                                                           | 47       |
| ITEM  12:         | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS  | 50       |
| ITEM  13:         | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                        | 53       |
| ITEM  14:         | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                           | 54       |
|              |                                                                                              |     |
| **PART IV**  |                                                                                              |     |
| ITEM  15:         | EXHIBITS,  FINANCIAL STATEMENT SCHEDULES                                                          | 55       |
|              |                                                                                              |     |
| **SIGNATURES**    |                                                                                              | 60       |

 

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**PART I**

 

**ITEM1:  BUSINESS**

 

See Item 1A, “RISK FACTORSASSOCIATED WITH OUR BUSINESS, OPERATIONS AND SECURITIES”, page 19.

 

***Overview***

 

We are a development stagecompany engaged in the business of developing for market innovative productsfor the detection and characterization of male urological prostate disease. Ourprimary focus is currently the ProUroScanTM prostate imaging system (the “ProUroScanSystem”).

 

The ProUroScan System is animaging system designed for use as an aid to the physician in visualizing anddocumenting tissue abnormalities in the prostate that have been previouslydetected by a digital rectal exam (“DRE”). The ProUroScan System is comprisedof an array of sensors mounted on a probe, a central processing unit,proprietary software and image construction algorithms, and a color monitor. Asan adjunct to DRE, the ProUroScan System will be used following an abnormal DREto generate a real time image and map of the prostate and to store thisinformation electronically.

 

The ProUroScan system is notcurrently marketed or sold and is not cleared for marketing by theU.S. Food and Drug Administration (“FDA”). Our initial goal is to obtain abasic mapping and data maintenance claim from the FDA under a 510(k) applicationfor the first generation system. The remaining regulatory and clinical work onthe ProUroScan System will be performed under our development contract withArtann Laboratories Inc. (“Artann”), a scientific technology company basedin Trenton, New Jersey, that is focused on early-stage technology development.Artann has completed all pre-clinical activities and testing on the ProUroScanSystem, is conducting clinical trials for the basic mapping and datamaintenance claim, and will prepare and submit the 510(k) application forsuch claim.

 

The ProUroScan System willinitially be marketed as an “adjunctive” tool following an abnormal DRE tocreate a map of the prostate and an electronic record of the image.  More specifically, the proposed indicationfor use that Artann intends to seek for the ProUroScan System 510(k) submission,which we refer to as the “basic mapping and data maintenance claim,” is for useas an aid to the physician in visualizing and documenting abnormalities of theprostate detected by a DRE.

 

Once FDA 510(k) clearanceis obtained on our first generation ProUroScan System, we intend to have thesystems manufactured by one or more FDA-regulated contract manufacturers andmarket the system in cooperation with a medical device company that has anestablished presence in the urology market. We are currently exploringpotential marketing relationships with several urology product companiesinterested in marketing the ProUroScan System in the prostate disease market.We expect such a relationship would provide financial resources and access todown stream marketing, engineering, manufacturing and sales support.

 

In the future, subject toreceipt of appropriate FDA approvals or clearances, we plan to develop andintroduce enhanced versions and additional indications for use of theProUroScan System that we expect will be able to monitor changes in prostatetissue over time, guide prostate biopsies and assess changes in prostate sizefollowing drug treatment for Benign Prostatic Hypertrophy (“BPH”).

 

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* *

***Corporate Information***

 

ProUroCare Inc. (“PUC”) was incorporated in 1999 as a Minnesotacorporation.  In January 2002, PUClicensed the rights to certain advanced prostate mechanical imaging technology,and became engaged in the business of developing this technology for assessingcharacteristics of the prostate.  In2004, through a reverse merger transaction with Global Internet Communications(“Global”), a Nevada corporation, PUC became the wholly owned and soleoperating subsidiary of Global, which was then renamed ProUroCare Medical Inc.

*** ***

***Market Focus—Prostate Disease***

 

Prostate cancer is the mostcommon form of cancer and the second leading cause of cancer death in men.According to the National Cancer Institute, more than 186,000 men wereexpected to be diagnosed with prostate cancer and over 28,000 were expected todie from the disease in 2008. Currently, there are approximately42 million men in the U.S. over the age of 50. For men in this agecategory, the standard of care to screen for the presence of prostate cancer isto have a physical exam each year in which two tests are routinely performed:the DRE and the Prostate Specific Antigen (“PSA”) blood test. Although used formany years, the specificity of these tests has been widely questioned. Datafrom community based studies suggest that the positive predictive value of aDRE for prostate cancer is 15% to 30% and varies relatively little withage. For elevated PSA levels between 4 and 10ng/mL, the positivepredictive value is approximately 20%. For studies in which biopsies were donewhen the results of either test were abnormal, 18% to 26% of screenedpatients had suspicious results, cancer was actually detected in approximately4% of screened patients and the positive predictive value of the tests combinedwas 15% to 21%. In another study involving 6,630 volunteers, thecombination of DRE and PSA detected 26% more cancers than PSA alone. AlthoughPSA and DRE provide some positive predictive value, neither of these testscreates a physical or visual record of the abnormality or its position in theprostate.

 

If a patient is suspected ofhaving an abnormal tissue formation in the prostate as a result of a positiveDRE or a high PSA value, he is generally referred to a urologist. A urologistwill usually perform their own DRE and may decide to perform a prostate biopsyto obtain tissue samples for microscopic analysis. The prostate is biopsied bya needle that is guided by ultrasound into the prostate through the rectalwall. Since the existence and exact location of possible cancerous tissue isnot known, the urologist will usually take 10 to 14 samples in a scatteredpattern throughout the prostate in an attempt to find the suspect tissue. Ofthe approximately 1 million prostate biopsy procedures done each year inthe United States, only approximately 25 percent actually detect thepresence of cancer. The low predictive ability of the DRE and PSA tests togauge the presence of cancer tends to over-inflate the number of referrals forinvasive biopsy that are necessary to confirm that a patient has cancer.

 

We believe there is a marketneed to be able to visualize and create an electronic record (map) that canshow the relative size and position of abnormal tissue in the prostate gland.We believe that the ProUroScan System offers a solution that meets these needsand one that will (assuming we apply for and obtain FDA approval or clearancefor this indication) enable physicians to monitor and compare images of theprostate over time. With additional development and further FDA approvals, webelieve the ProUroScan System may eventually be used to guide prostate biopsyand assess the effect of medical treatments of BPH.

* *

***Prostate Cancer Screening andDiagnosis***

 

The two most commonscreening tests for identifying prostate cancer are the DRE and the PSA. Thesetests have been used for years, but have often been criticized for their lackof specificity and selectivity.

 

In a DRE exam, a physicianwearing a latex glove inserts a lubricated finger into the rectum to palpatethe prostate gland to detect abnormalities. The clinician must rely on his orher experience and sensitivity of touch to estimate the size of the prostateand detect irregularities in shape or hardness. There is significantsubjectivity inherent in the DRE exam which can be negatively affected by poorexaminer training, lack of experience or poor ability to

 

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interpret the results, as well as other patient related limitationsincluding excessive obesity, patient discomfort and unusual anatomicalpositioning of the prostate.

 

Data from community-basedstudies indicate that the positive predictive value of a DRE in detectingcancer is 15% to 30% and varies relatively little with age. In aScandinavian study, the positive predictive value of DRE was found to be only22% to 29%. According to the Eighth Edition of Campbell’s Urology, a DREhas only fair reproducibility even with experienced examiners and the testmisses a substantial proportion of cancers before they become advanced and lessamenable to treatment.

 

The other primary screeningtest for detecting prostate cancer is the measurement of PSA in serum. Theadvantages offered by PSA testing are its simplicity, objectivity,reproducibility and low level of invasiveness. Although PSA is specific toprostate tissue, it is not specific to prostate cancer. Older men that havebenign enlargement of the prostate and acute prostatitis often have elevatedPSA levels. Serum levels of PSA can also be elevated for a period of timeafter transrectal needle biopsy, acute urinary retention and prostate surgery.Because of the prevalence of these conditions in men over the age of 50,the positive predictive value of PSA measurements decreases with age.

 

In clinical practice, a PSAlevel greater than 4ng/mL is generally considered an abnormal result. Recentcommunity-based studies show that PSA levels greater than 4ng/mL are seenin about 15% of men who are older than 50 years of age. Theprobability, or positive predictive value, that a man who is older than 50having prostate cancer if his PSA level is elevated is approximately20% to 30%. However, the likelihood of cancer depends on the degree ofelevation in the PSA levels. For levels between 4 and 10ng/mL, the positivepredictive value is about 20 percent. This value increases to between42 percent and 64 percent if the PSA level is greater than10ng/nL. Despite these variances, PSA testing has increased the detectionrate of early-stage prostate cancers, which are more curable than late-stagecancers.

 

Most clinicians have adoptedthe strategy of performing both tests in combination, which has been shown toincrease the combined predictive value. In fact, in a large study ofvolunteers, the combination of DRE and PSA detected 26% more cancers than PSAalone. However, because of the significant risk of prostate cancer, prostatebiopsy is recommended for all men who have DRE abnormalities, regardless ofPSA level, because 25% of men with cancer have PSA levels less than4mg/nL.

 

A patient with a positiveDRE or an elevated PSA is typically referred to a urologist for furtherdiagnosis. The urologist will usually perform a prostate biopsy to obtaintissue samples for microscopic analysis. The prostate is biopsied by a needlethat is guided by ultrasound into the prostate through the rectal wall. Sincethe existence and exact location of possible cancerous tissue is not known, theurologist will usually take 10 to 14 samples in a scattered pattern throughoutthe prostate in an attempt to find the suspect tissue. The tissue samples arethen sent to a laboratory for analysis and interpretation, and the results arereported several days later. If the results are negative or indeterminate, theurologist may suggest a second biopsy procedure, or that the patient increasethe frequency of future screening examinations. According to Oregon Health andScience University, approximately 1 million patients are biopsied eachyear in the United States, but only approximately 25% of biopsy proceduresperformed detects the presence of cancer.

 

The treatment path forpatients who test positive for prostate cancer depends on many variables,including age, location and pathology of the cancerous tissue and generalhealth of the patient. Generally, a younger, otherwise healthy patient willelect to have the prostate removed to eliminate the possibility that it mightspread beyond the prostate. Older, less healthy patients may elect not toundergo surgery, and instead monitor the disease closely by semi-annual PSA andDRE exams, and annual biopsies. This monitoring regimen is commonly referred toas “active surveillance.” Some patients may elect radiation or drug treatments,in addition to necessary ongoing active surveillance. The National CancerInstitute estimates that there are approximately 2 million men alive whohave a

 

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history of cancer of the prostate. On this basis, we estimate that thenumber of men over the last decade that have elected against prostate removaland thus are undergoing ongoing active surveillance exceeds one million.

 

***The ProUroScanTM Prostate ImagingSystem***

 

The ProUroScan System is animaging system designed to provide a map of the prostate and to store a digitalimage for review. As an adjunctive tool to DRE, it will be used after aphysician identifies abnormal tissue during a DRE examination. The firstgeneration system will provide a map or record of the pressures that aregenerated from palpation of the posterior surface of the prostate using asensor probe. The system’s operation is based on measurement of the stresspattern on the rectal wall when the probe is pressed against the prostate.Temporal and spatial changes in the stress pattern provide information on theelastic structure of the gland and allow two-dimensional reconstruction ofprostate anatomy and visualization of prostate mechanical properties. The dataacquired allow the calculation of prostate features such as size and shape. Theprostate image is displayed on a screen that allows physicians to visualizetissue abnormalities in the prostate gland. In addition to the real time visualimage, the results are stored electronically as a digital record.

 

The ProUroScan Systemconsists of arrays of pressure sensors mounted on a probe, a central processingunit, proprietary software and image construction algorithms, and a colormonitor. The probe is specially designed for the rectal anatomy to minimizepatient discomfort. It is ergonomic for the clinician and similar to atraditional DRE for the patient. The probe utilizes highly sensitive pressuresensors located on the face of the probe head to palpate the prostate. Theprobe’s positioning system ensures that the person administering the scanexamines the entire surface of the prostate, and assists prostate imageconstruction.

 

To perform a scan, theclinician inserts the tip of the probe into the patient’s rectum and palpates theprostate. As the prostate is palpated, a color image of the prostate isproduced and displayed on the computer monitor, along with indicators of theamount of pressure being applied to help guide the clinician. Differences intissue stiffness and elasticity will be depicted in real time on a colormonitor. Total testing time for a healthy prostate is under one minute.

 

***ProUroScan System Status***

 

The first generationProUroScan System has been tested in laboratory experiments on prostate modelsand in a pre-clinical study. In addition, the system was used for over twoyears and on approximately 168 patients at the Robert Wood Johnson MedicalCenter in New Brunswick, New Jersey.  In March 2008,an article authored by Artann scientists and published in the peer- reviewed *Urology* reported that in 84% of the cases in thispre-clinical study, the ProUroScan System was able to construct a real-timecolor image and map of the prostate.

 

Based on discussions betweenArtann and representatives from the FDA, we believe that the ProUroScan Systemwith a basic mapping and data maintenance claim will be regulated by the FDA asa class II device. Class II devices typically are cleared formarketing by the FDA through a 510(k) application.

 

Under the terms of itscontract with us, Artann is responsible for submitting and obtaining theinitial 510(k) clearance for the ProUroScan System for the basic mappingand data maintenance claim. In April 2008, representatives from Artann metwith the FDA to solicit feedback from the agency regarding the proposedclinical testing that the FDA will require to support a 510(k). Artanncommenced the clinical study in the fourth quarter of 2008. In order to meetthe requirements established by the FDA for the 510(k) clinical study,three centers were identified to participate in the study and to serve asfuture training and referral sites for the eventual market rollout of theProUroScan System. The sites include the Mayo Clinic in Rochester, Minnesota,the Robert Wood Johnson Medical Center in New Brunswick, New Jersey and the VAMedical Center in Minneapolis, Minnesota. Institutional Review Board (“IRB”)approvals have been obtained, and ProUroScan Systems have been installed, atall three sites. Physician training has also been completed at all three sitesand formal clinical studies have commenced at the Robert Wood Johnson MedicalCenter and the VA Medical Center. It is expected that clinical studieswill commence at the

 

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Mayo Clinic in late March or early April 2009. We expect tocomplete this study in May 2009, and submit the 510(k) application tothe FDA shortly thereafter.  Oncesubmitted, the FDA will have 90 days to review and grant clearance, askquestions or turn the 510(k) down. However, the 510(k) applicationprocess may be significantly longer if the FDA has questions upon its review ormakes a request for additional information from Artann. Once cleared and uponProUroCare’s first commercial sale of a ProUroScan System, Artann will transferthe 510(k) to ProUroCare. No assurances can be given in regard to thetiming of any of these events.

 

***Planned Development of theProUroScan System***

 

We believe that theProUroScan System’s existing technology provides a platform on which to developmultiple future generation systems. Once 510(k) clearance is obtained fora basic mapping and data maintenance claim and is transferred to us fromArtann, we intend to work with Artann to develop more enhanced productfeatures. Future generation systems will require us to obtain regulatoryapproval or clearance for use of the ProUroScan System for additional prostaterelated indications and file additional submissions with the FDA to obtainexpanded labeling claims. Such regulatory clearances or approvals may requireus to perform additional clinical studies. Future generations of the ProUroScanSystem may also require us to secure rights to additional intellectualproperty.

* *

*Active Surveillance*

 

We believe that one of themore valuable future applications for the ProUroScan System, assuming we obtainany necessary FDA clearance or approval, will be to allow physicians to monitorchanges in the prostate over time. The ProUroScan System is designed to producea digital image of the prostate showing the size and symmetry of the prostateand the location of tissue abnormalities within the prostate. The ProUroScanSystem creates a digital record of the exam that can be stored and used forcomparison to subsequent exams. We believe its ability to digitally store notonly the scan results but all of the individual pressure readings taken duringthe course of the procedure should facilitate a quantitative analysis of the progressionof the disease over time. By comparing the data taken in a baseline examinationto subsequent examinations during the course of active surveillance, we believethe urologist will gain valuable information about changes in the patient’scondition that can influence their decision to pursue additional treatment orcontinue surveillance. We believe that this expanded use of the ProUroScanSystem will provide consistent mapping over time as compared to variationsresulting from differences in technique and experience of clinicians performingDREs. We believe this will enable physicians to compare and contrast thepatient’s results from exam to exam, and to get second opinions on the patient’sstatus in regards to the diagnosis without an additional office visit. Webelieve that comparisons of multiple scans over time will also enable thephysician to make longitudinal assessments of the patient’s disease.

* *

*Three Dimensional Imaging*

 

We believe that anotherfuture enhancement of the current generation system may be the capability toidentify the specific three-dimensional location of lesions found in theprostate. This enhanced system may also be able to create a three-dimensionalimage of the position of the lesions and allow the physician to rotate the imageto assist in identifying the actual position of the lesion in the prostategland. We believe that having this capability may prove helpful in providing adiagnosis of the patient’s condition in conjunction with other commerciallyavailable diagnostic tools.

* *

*Guiding Biopsy*

 

We believe that futureexpansion to three dimensional imaging may facilitate guiding biopsy needles tothe point where suspicious lesions exist so that a tissue sample can beobtained from the prostate gland. Having the three-dimensional coordinates of alesion will enable the physician to precisely guide the biopsy needle to thepoint where he can be assured that tissue samples are being taken from thatarea. Having this capability increases the likelihood of finding cancerous tissuewhile also potentially minimizing the number of biopsies that are taken on anindividual

 

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patient. According to Oregon Health and Science University,approximately 1 million patients are biopsied each year in the UnitedStates, but only 25 percent of biopsy procedures performed detects thepresence of cancer.

* *

*Evaluating Drug Treatment for BPH Patients*

 

For patients who havesymptoms of BPH, we believe that future generations of the ProUroScan Systemmay also be used to monitor changes in prostate size before and during thecourse of drug treatments, allowing physicians to more quickly assess theeffectiveness of alternative therapeutic approaches. Assuming future FDAapproval or clearance is granted, use of the ProUroScan System in patientsdiagnosed with BPH will allow physicians to monitor changes in the size andvolume of the prostate following treatment with drugs or other tissue reducingtechnologies. Timely, accurate assessment of prostate volume changes and theeffectiveness of treatment should enable physicians to recommend alternativetreatments sooner than current assessment methods, and thus provide moreimmediate relief to patients.

*** ***

***Marketing and Distribution***

 

Our business plan is builton the premise that the map and physical record created by the ProUroScanSystem will become a valuable tool in assisting physicians and patients inunderstanding the scope of the abnormalities that are identified with a DRE.Physicians performing the scan will need to acquire a ProUroCare System, whichwill be placed under a direct purchase, lease or user utilization agreement.

 

Current ProceduralTerminology (“CPT”) codes are used by physicians and other providers to submitclaims. We anticipate that the ProUroScan System may be covered by Medicare asa diagnostic test for patients who have clinical signs or symptoms of disease.At the outset, however, there will not be a unique CPT code for the ProUroScanprocedure. Consequently, obtaining coverage and reimbursement may bechallenging during the initial stages of the ProUroScan System rollout. Duringthis period of time, physicians will have the option of submitting claims undera “miscellaneous” CPT code with proper documentation. We also expect to use a “patientpay” model in which the patient would pay directly for the cost of the scan.During the first few years of use, we will collect the clinical and economicdata necessary in order to apply for a unique CPT code from the AmericanMedical Association (“AMA”).

 

Our initial commercialrollout will focus on urologists in the United States. By focusing onurologists, we expect to establish the clinical and economic value of the scanfor patients, and to demonstrate to both private and government payors therationale and parameters for establishing a CPT code and that the scanshould be covered and adequately reimbursed.

 

We believe that the cost ofestablishing our own direct sales force of sufficient size and capability toeffectively rollout the ProUroScan System in the U.S. would be cost prohibitiveand that our product can be more effectively launched by establishing adistribution relationship with one or more large urology product companies thathave well-established relationships with physicians. We believe thatestablishing such a relationship will not only allow us to quickly andeffectively penetrate the urology market, but may also afford us an opportunityfor additional financial support in the form of licensing fees, equityinvestment and “in kind” support from other key functional departments of theurology product company. We are currently exploring potential marketingrelationships with several urology product companies interested in marketingproducts in the prostate disease market.

 

We anticipate that themajority of our revenue will be generated from the sale and lease of theProUroScan System, as well as from the sale of proprietary disposable suppliesconsumed in the scanning process. ProUroScan Systems likely will be placed inclinics under a variety of programs, including outright sales, operatingleases, financing leases or arrangements where payments are based upon theusage of the system.

 

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***Manufacturing***

 

The ProUroScan System hastwo major proprietary hardware components: a central processor and a rectalprobe. There are also certain off-the-shelf components that presently arewidely available. Artann has provided five clinical prostate imaging systemsthat are being used in performing FDA-controlled clinical trials and forcontract manufacturing assessment. Artann will transfer ownership of these unitsto us upon the date of first commercial sale of the ProUroScan System.

 

We are currently seeking tocontract with one or more third-party manufacturers that are Quality SystemsRegulation (“QSR”) compliant to produce the ProUroScan System. The QSR requiresmanufacturers, including certain third-party manufacturers, to follow stringentdesign, testing, control, documentation and other quality assurance proceduresduring all aspects of the manufacturing process. Because of the unique natureof the two major proprietary components of the ProUroScan System, it is highlylikely that different third party manufacturers will be chosen to assemble thefinal versions of each component. Our goal in both cases is to reduce the costof manufacturing over the first two years, taking advantage of manufacturingscale and purchasing discounts, as well as engineering changes designed toeliminate components and reduce component costs.

 

***ProUroScan System DevelopmentPartner***

 

The ProUroScan System isbased on work originally performed in the late 1990’s by Artann and itsaffiliate, ArMed LLC. In 2002, we licensed the rights to this technologydeveloped by Artann from its owner, Profile L.L.C., a Delaware limitedliability company (“Profile”), a technology holding company, and since thenhave worked with Artann and our other technology partners on its development.In April 2008, we acquired the patents, patent applications and other knowhow associated with this technology previously licensed from Profile. In July 2008,we entered into two new agreements with Artann relating to this technology,namely, a license agreement (the “Artann License Agreement”) and a developmentand commercialization agreement (the “Artann Development Agreement”).

 

Under the Artann LicenseAgreement, Artann has granted us an exclusive, worldwide, sub-licensablelicense to certain patent applications and other know how needed to make, useand market certain mechanical imaging products for the diagnosis or treatmentof urologic disorders of the prostate, kidney or liver. Artann also agreed totransfer to us possession of five clinical prostate imaging systems and grantus full access to all relevant documentation thereto. As an upfront license feepursuant to the Artann License Agreement, on January 14, 2009 we paidArtann $600,000 in cash and $500,000 in shares of our common stock.  In addition, we have agreed to pay Artann:

 

·                  aroyalty fee equal to 4% of the first $30,000,000 of net cumulative sales oflicensed products, 3% of the next $70,000,000 of net cumulative sales and 2% ofnet cumulative sales over $100,000,000; and

 

·                  atechnology royalty fee of 1% of net sales of the prostate imaging systemproducts through the earlier of December 31, 2016 or the date of lastcommercial sale of such products.

 

The combined royalties aresubject to a minimum annual royalty equal to $50,000 per year for each of thefirst two years after FDA clearance for commercial sale and $100,000 per yearfor each year thereafter until termination or expiration of the Artann LicenseAgreement. We also agreed to grant Artann a non-exclusive, fully paid up,sub-licensable, worldwide license to our patents, patent applications and knowhow relating to the manufacture, use or sale of any mechanical imaging systemfor the diagnosis or treatment of disorders of the female human breast.

 

Under the Artann DevelopmentAgreement, we will collaborate with Artann to develop, commercialize and marketprostate imaging systems. Artann will conduct and complete all pre-clinicalactivities and testing on the prostate imaging system, conduct clinical trials,prepare and submit FDA regulatory submissions and provide hardware and softwaredevelopment, refinement and debugging services to ready the prostate imagingsystem for 

 

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commercial sale. For these development services, we paid Artann$250,000 in cash upon initiation of the clinical study to support the basicmapping and data maintenance claim, and we have agreed to pay Artann:

 

·                  $250,000in cash and $1,000,000 in shares of our common stock upon completion of thatstudy and submission of the 510(k) application to support the basicmapping and data maintenance claim;

 

·                  $750,000in cash and $1,000,000 in shares of our common stock upon FDA clearance thatallows the ProUroScan System to be commercially sold in the United States(subject to reduction of the number of shares by 10% for each month that FDA clearanceis delayed beyond March 23, 2010); and

 

·                  amonthly retainer fee for technical advice and training by Artann personnel of$30,000 per month for each of the first six months and $15,000 per month foreach of the following twelve months.

 

Under the Artann DevelopmentAgreement, Artann will also supply us with such quantities of the ProUroScanSystem as are reasonably required for pre-commercial testing, evaluation,marketing and clinical study and to facilitate the transfer of commercialproduction to a third party manufacturer. Artann also agrees to use its bestreasonable efforts to provide us with a limited number of commercial systems.The pre-commercial and commercial systems will be sold to us at prices yet tobe determined.

 

The Artann License Agreementand the Artann Development Agreement each became effective on December 23,2008. Under the Artann License Agreement, we have a 30-day cure period from thedate of receipt of written notice from Artann of a breach of our paymentobligations under either the Artann License Agreement or Artann DevelopmentAgreement. If we have not cured such payment breach within five days of receiptof the Artann notice, the exclusive licenses convert to non-exclusive licenses,however, neither party may sub-license or grant additional licenses for aperiod of 60 days after receipt of such notice. Under the ArtannDevelopment Agreement, we have a 60-day cure period from the date of receipt ofwritten notice from Artann of a breach of our payment obligations under eitherthe Artann License Agreement or the Artann Development Agreement. If we do notcure a breach of our payment obligations by the end of the 30-day cure period,the licenses granted under the Artann License Agreement will terminate.  Subject to earlier termination due to breach,bankruptcy and certain other events, the Artann License Agreement willterminate upon expiration of all royalty obligations, and the ArtannDevelopment Agreement will terminate on its third anniversary, subject torenewal for additional one year terms upon mutual agreement of us and Artann.

 

In the future, we expect toengage third parties to assist us and Artann in transitioning the technologyfrom research and development to clinical study status, to perform verificationand validation testing including certification of safety related testingstandards, and to develop quality control processes for the transition tomanufacturing of the ProUroScan System.

 

During the years ended December 31,2008 and 2007, we recorded research and development expense of $597,755 and$143,628, respectively.  The 2008research and development expense amount included the $250,000 first projectmilestone payment under the Artann Development Agreement upon the initiation ofclinical trials, additional research and development expenses totaling $50,000related to work performed by Artann under the same agreement, and the expensingof our $300,000 acquisition of certain intellectual property and know-how fromProfile. Fiscal 2007 expenses included a $35,000 payment and the issuance ofwarrants valued at $72,000 to Artann pursuant to a cooperation agreement signedin April 2007 and $24,407 of research costs related to a prostatevisioning system project.

 

***Intellectual Property***

 

Our objective as a medicaldevice company is to effectively and aggressively obtain, maintain and enforcepatent protection for our products, formulations, processes, methods and otherproprietary technologies, preserve our trade secrets and licenses, and operatewithout infringing the proprietary rights of other parties both in the UnitedStates and in all other countries where we may do business. We seek to obtain,where appropriate and financially 

 

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feasible, the broadest intellectual property protection possible forour products, proprietary information and proprietary technology through acombination of contractual arrangements, licenses, and patents, both in theUnited States and throughout the rest of the world.

 

We also depend upon theskills, knowledge and experience of scientific and technical personnel that wehire or outside organizations with whom we contract, as well as our advisors andconsultants. To help protect our proprietary know-how that is not patentable,and for inventions for which patents may be difficult to enforce, we rely ontrade-secret protection and confidentiality agreements. To this end, it is ourpractice to require employees, consultants, advisors and other contractors, asappropriate, to enter into confidentiality agreements that prohibit thedisclosure of confidential information and, where applicable, requiredisclosure and assignment to us of the ideas, developments, discoveries andinventions important to our business.

 

We own patents, patentapplications and know-how associated with mechanical prostate-imaging systems.These patents and patent applications relate to real-time mechanical imaging ofthe prostate (patent expires in 2021), a method and device for mechanicalimaging of the prostate (patent expires in 2012), an intracavity ultrasonicdevice for elasticity imaging (patent expires in 2012), a method and device forelasticity imaging (patent expires in 2013), an apparatus for measuringmechanical parameters of the prostate and for imaging the prostate (patentexpires in 2012), a device for palpation and mechanical imaging of the prostate(patent expires in 2012), and a method for using a transrectal probe tomechanically image the prostate gland (patent expires in 2012). Together, ourmechanical imaging technology is protected by seven U.S. patents, sevenforeign patents (foreign patents expire in 2017), five foreign patentapplications and, along with the Artann patent applications discussed below, isthe basis for the imaging technology used in our ProUroScan System. We ownsimilar patents, patent applications and know-how associated with breastimaging. However, we do not intend to pursue any such applications within ournear-term business plan. Under the Artann License Agreement, we agreed to grantArtann a non-exclusive, fully paid up license to make, use or sell any imagingsystem for the diagnosis or treatment of disorders of the human breast.

 

Artann has filed fouradditional U.S. patent applications (filed in May and June of2005 and June of 2008) that are licensed to us under the Artann LicenseAgreement. These patent applications relate to a method and device foranalyzing overlaps between sensed mechanical images to generate a compositeimage (map) and sensors arranged to locate the prostate.

 

***Third-Party Reimbursement***

 

In the U.S., health careproviders that use the ProUroScan System will generally rely on third-partypayors, including private payors and governmental payors such as Medicare andMedicaid, to cover and reimburse all or part of the cost of using theProUroScan System. Consequently, sales of the ProUroScan System depend in parton the availability of coverage and reimbursement from third-party payors. Themanner in which reimbursement is sought and obtained varies based upon the typeof payor involved and the setting in which the procedure is furnished. Ingeneral, third-party payors will provide coverage and reimbursement for medicallyreasonable and necessary procedures and tests. Most payors, however, will notpay separately for capital equipment, such as the ProUroScan System. Instead,payment for the cost of using the capital equipment is considered to be coveredas part of payments received for performing the procedure. In determiningpayment rates, third-party payors increasingly are scrutinizing the amountcharged for medical procedures.

 

*Medicare and Medicaid*

 

Procedures using theProUroScan System may be considered by Medicare as either a screening test or adiagnostic test depending on whether it is conducted routinely on healthyindividuals or whether the patient presents with a sign or symptom of therelevant disease. In order for Medicare to cover procedures using the ProUroScanSystem as screening, the Secretary of Health and Human Services (the “Secretary”)would need to add the scan to the list of appropriate procedures for prostatecancer screening or the procedure would need to be appropriately 

 

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recommended by the United States Preventative Services Task Force (“USPSTF”)and added through the national coverage determination (“NCD”) process.

 

Recently, Congress expandedthe ability for Medicare to cover additional preventive services under certaincircumstances. In order to be covered by Medicare, Congress required thefollowing three conditions to be satisfied: (1) the service must bereasonable and necessary for the prevention or early detection of an illness ordisability; (2) the service must be recommended with a grade of “A” or “B”by the USPSTF; and (3) the service must be appropriate for Medicarebeneficiaries. Congress also required that the Centers for Medicare andMedicaid (“CMS”) use the NCD process to add covered preventative services.

 

The USPSTF has evaluated thebenefits of prostate screening and concluded that the current evidence isinsufficient to make an “A” or “B” recommendation, regardless of age. Shouldthe USPSTF change its recommendation, CMS still would need to use the NCDprocess to make prostate screening with the ProUroScan System a coveredservice. The NCD process is at least nine months long and in most cases lastsone year. There is no guarantee that this process will result in a positiveoutcome. In fact, CMS could decide not to cover prostate screening proceduresusing the ProUroScan System nationally. It is very difficult to overturn anegative NCD without the further development of substantial clinical evidence.

 

Medicare coverage as ascreening test could be a significant hurdle to overcome. We anticipate,however, that the ProUroScan System may be covered by Medicare as a diagnostictest for patients who have clinical signs or symptoms of disease. We anticipatethat the first generation of the ProUroScan System will be used to map theprostate and to maintain historical records for future tracking for men whohave an abnormal DRE or other signs or symptoms of disease. Thus, providers whoperform prostate mapping using the first generation ProUroScan System likelywill seek Medicare coverage as a diagnostic, rather than a screening test,presuming that the patient presents with a sign or symptom of disease. Even asa diagnostic test, however, CMS or its contractors could determine thatprocedures using the ProUroScan System are not medically necessary andtherefore decide not to cover them.

 

Regardless of how they arecovered, we anticipate that procedures using the ProUroScan System will bereimbursed either based upon the value of their unique billing and procedurecode or as part of an office visit. Until a unique billing and procedure codeis established, we expect that providers will be able to bill for the procedureusing a miscellaneous Current Procedural Terminology (“CPT”) code. Claimssubmitted under a miscellaneous code are processed manually and the providermust include additional information to be used by the payor in determining themedical appropriateness of the procedure. The lack of a unique, permanentCPT code could slow market uptake of the ProUroScan System.

 

In order to apply for a new,unique code, an application must be submitted to the AMA’s CPT EditorialPanel. The process of obtaining a new CPT code typically takes14 months to three years. Once a new CPT code is created, the AMA’sRelative Value Scale Update Committee (“RUC”) recommends relative value units (“RVUs”)for it. CMS then takes these recommendations into account when establishing theMedicare Physician Fee Schedule values. The amount of reimbursement theprovider receives generally depends on the RVUs assigned to the proceduremultiplied by a conversion factor. Most private payers also base their paymentrates based on the RVUs adopted by CMS. There is a significant risk that thereimbursement rate that results from this process could be insufficient,hampering our ability to market and sell the ProUroScan System. In thealternative, CMS may decide that payment for the ProUroScan System procedureshould be bundled into the payment for a covered office visit furnished to thepatient on the same day. Such a determination would impede our ability tocommercialize the ProUroScan System as physicians and providers would probablynot want to absorb the additional expense of our product without additionalreimbursement.

 

Initially, we anticipateusing a “patient pay model” for physicians to receive payment for performingthe ProUroScan System procedure. Under a patient pay model, in the absence ofcoverage from their health insurance, patients pay for the scan out of theirown funds. Medicare beneficiaries would sign an Advanced Beneficiary Notice 

 

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(“ABN”) that would allow the provider to collect from the patient. Onlyone in four biopsies performed based on an abnormal PSA reading reveal prostatecancer, and only 50 percent of suspicious lesions found by DRE presentedcancer on prostate biopsy. Given these statistics, in cases where patients haveabnormal DRE or PSA test results or when a test result may not be clear, thereis a high incentive to seek additional information so that patients can make aninformed and reasonable decision for themselves and their family. We believethat a sufficient number of patients will be willing to pay for the ProUroScanSystem procedure out of their personal funds to support the launch of ourproduct in advance of receiving favorable coverage decisions from third-partyinsurers. The concept of a patient pay model has been used successfully for afew other procedures (e.g., computer-aided detection (“CAD”) formammography), and we expect this to be our approach for generating revenuesduring at least the early phases of product rollout. As described above,providers also will be able to bill under a miscellaneous CPT code until aunique CPT code is created for the ProUroScan System procedure.

 

*Commercial Insurers*

 

Many private payors look toMedicare as a guideline in setting their coverage policies and payment amounts.Unlike the Medicare program, however, private payors have no statutoryimpediment to covering screening tests. They do tend to seek guidance fromUSPSTF recommendations, however. The current coverage policies of these privatepayors may differ from the Medicare program, and the payment rates they makemay be higher, lower, or the same as the Medicare program. If CMS or otheragencies decrease or limit reimbursement payments for physicians, this mayaffect coverage and reimbursement determinations by many private payors.Additionally, some private payors do not follow the Medicare guidelines, andthose payors may reimburse only a portion of the costs associated with the useof our products, or not at all.

 

***Competition***

 

Although we expectcompetition to intensify in the prostate imaging and prostate diseasediagnostic market, we are not aware of any competitive product currently beingsold based on the same technology platform with comparable real-time colorimages or other product features that the ProUroScan System provides. Inaddition, we do not expect to market the ProUroScan System as a generalscreening tool, and therefore will not be positioning the system to competedirectly with currently available screening tests, including the DRE and PSAtests. The ProUroScan System will be positioned as an “adjunctive” toolfollowing an abnormal DRE to create a map of the prostate and an electronic recordof the image. More specifically, the proposed indication for use of theProUroScan System is for use as an aid to the physician in visualizing anddocumenting abnormalities of the prostate detected by a DRE.

 

Another test that usesinferred data to identify prostate cancer, yet to be approved in the UnitedStates, is the PCA3 Marker (the “PCA3”). The PCA3 is a non-codingribonucleic acid (“RNA”) believed to be a more accurate marker of prostatecancer than currently used diagnostics tests. The PCA3 marker was licensed in2000 by DiagnoCure Inc. of Quebec, Canada. In 2003, DiagnoCure granted aworldwide license to Gen-Probe, based in San Diego, CA, for the development andlicensing of a second generation PCA3-based test using their proprietary platform.In 2006, Gen-Probe made the test available in analyte specific reagent formatto U.S. laboratories and launched a full CE-marked PCA3 test in Europe.Although this test has not been approved in the United States, it potentiallyrepresents a significant advance in the development of more sophisticated andsensitive detection methods for identifying early stage prostate cancer. Genefusion is another discovery that may lead to a test that potentially will beused to diagnose prostate cancer more accurately than current tests as well aspredict prognosis. Gen-Probe has licensed this technology as well.

 

In contrast to the DRE, PSAand PCA3 tests, the ProUroScan System creates a visual and physical record ofthe prostate gland. We will seek expanded labeling claims on future generationsof the ProUroScan System so that it can also be used to conduct ongoingmonitoring and surveillance of the status of the abnormal tissue that is foundby 

 

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either a DRE or with the ProUroScan System. We believe that the currentgeneration of the ProUroScan System will have several features that arecomplementary to a traditional DRE examination, such as:

 

·                  itis designed to produce a real-time color image of the prostate; and

 

·                  itis designed to enable physicians to electronically store the images in patientfiles.

 

Aside from large-scaleimaging modalities such as magnetic resonance imaging, computed tomography andnuclear medicine, which due to their cost and limited availability will not bedirect competitors of the ProUroScan System, the only imaging system in commonuse for prostates is the transrectal ultrasound (“TRUS”). TRUS is employed byurologists following the referral of a patient that has had a positive resultfrom a DRE or PSA test, primarily to guide the placement of prostate biopsyneedles. We believe that the ProUroScan System will be easier to operate andrequire less training than TRUS. We also believe it will be less costly toacquire and maintain in a traditional medical office setting.

 

Subject to FDA clearance orapproval, we believe that future uses of the ProUroScan System will includeproviding a permanent record of the prostate that can be used to identifychanges over time. Nevertheless, technology is rapidly changing in the prostateimaging and the prostate disease diagnostic market, and other technology couldcome to market potentially displacing the ProUroScan System.

 

***Government Regulation***

 

The ProUroScan System issubject to the Federal Food, Drug, and Cosmetic Act (“FDCA”) as implemented andenforced by the FDA and by comparable agencies in various states and variousforeign countries. To ensure that medical products distributed domestically andinternationally are safe and effective for their intended use, FDA andcomparable authorities in other countries have imposed regulations that govern,among other things, the following activities that we or our third-partymanufacturers and suppliers perform or will perform:

 

·                  productdesign and development;

 

·                  producttesting;

 

·                  productmanufacturing;

 

·                  productlabeling;

 

·                  productstorage;

 

·                  premarketclearance or approval;

 

·                  advertisingand promotion;

 

·                  product marketing, sales and distribution;and

 

·                  post-market surveillance reporting death orserious injuries and medical device reporting.

 

*FDA Premarket Clearance and Approval Requirements*

 

Unless an exemption applies,each medical device we wish to market in the U.S. will require either 510(k) clearanceor approval of a Premarket Approval Application (“PMA”) from the FDA. The FDAclassifies medical devices into one of three classes:

 

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·                  Class I devices, which are subject toonly general controls (e.g., labeling, medical devices reporting, andprohibitions against adulteration and misbranding) and, in some cases, to the510(k) premarket clearance requirements;

 

·                  Class II devices, generally requiring510(k) premarket clearance before they may be commercially marketed in theUnited States (based on discussions between Artann and the FDA, we believe theuse of the ProUroScan System will be classified as a class II device); and

 

·                  Class III devices, consisting of devicesdeemed by the FDA to pose the greatest risk, such as life-sustaining,life-supporting or implantable devices, or devices deemed not substantiallyequivalent to a predicate device, generally requiring submission of a PMA supportedby clinical trial data.

 

Devices deemed to pose lowerrisks are placed in either class I or II, which typically requires themanufacturer to submit to the FDA a 510(k) requesting permission tocommercially distribute the device. This process is generally known as 510(k) clearance.Some low risk devices are exempted from this requirement. Devices deemed by theFDA to pose the greatest risks, or for which there is no predicate, are placedin class III, requiring approval of a PMA.

 

*510(k) Clearance Pathway*

 

When a 510(k) clearanceis required, we or Artann, as the case may be, will be required to submit a 510(k) demonstratingthat our proposed device is substantially equivalent to a previously cleared510(k) device or a device that was in commercial distribution before May 28,1976 for which the FDA has not yet called for the submission of PMAs. Byregulation, the FDA is required to clear or deny a 510(k) premarketnotification within 90 days of submission of the application. As apractical matter, clearance may take longer. The FDA may require furtherinformation, including clinical data, to make a determination regardingsubstantial equivalence.

 

Once filed, the FDA has90 days in which to review the 510(k) application and respond.Typically, the FDA’s response after reviewing a 510(k) is a request foradditional data or clarification. Depending on the complexity of theapplication and the amount of data required, the process may be lengthened byseveral months or more. If additional data, including clinical data, are neededto support our claims, the 510(k) application process may be significantlylengthened. Published FDA statistics from 2006 (the most recent available)indicate that the average total time from receipt of a 510(k) applicationto final action (not including the time a submission is on hold pending receiptof additional information) is 95 days.

 

If the FDA issues an orderdeclaring the device to be Not Substantially Equivalent (“NSE”) and places itinto a class III or PMA category, we can then request a de novoclassification of the product. De novo generally applies where there is nopredicate device and the FDA believes the device is sufficiently safe so thatno PMA should be required. The request must be in writing and sent within 30 daysfrom the receipt of the NSE determination. The request should include adescription of the device, labeling for the device, reasons for the recommendedclassification and information to support the recommendation. The de novoprocess has a 60 day review period. If the FDA classifies the device intoclass II, the Company will then receive an approval order to market thedevice. This device type can then be used as a predicate device for future 510(k) submissions.However, if the FDA subsequently determines that the device will remain in theclass III category, the device cannot be marketed until the Company hasobtained an approved PMA. If we are required to follow a de novo process, anadditional 60 to 90 days or more will be added on to the original90 days required for the initial 510(k) review.

 

Any modification to a510(k)-cleared device that would constitute a major change in its intended use,or any change that could significantly affect the safety or effectiveness ofthe device, requires a new 510(k) clearance and may even, in somecircumstances, require a PMA, if the change raises complex or novel scientificissues or the product has a new intended use. The FDA requires everymanufacturer to make the determination regarding the need for a new 510(k) submissionin the first instance, but the FDA may review any manufacturer’s decision. Ifthe FDA 

 

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were to disagree with any of our determinations that changes did notrequire a new 510(k), it could require us to cease marketing and distributionand/or recall the modified device until 510(k) clearance or PMA approvalis obtained. If the FDA requires us to seek 510(k) clearance or PMAapproval for any modifications, we may be required to cease marketing and/orrecall the modified device, if already in distribution, until 510(k) clearanceor PMA approval is obtained and we could be subject to significant regulatoryfines or penalties.

 

There is no guarantee thatthe FDA will grant 510(k) clearance of the ProUroScan System for a basicmapping and data maintenance claim, or 510(k) clearance or PMA approval,of any of our future products. Failure to obtain such clearances or approvalscould adversely affect our ability to grow our business. Delays in receipt orfailure to receive clearances or approvals, the loss of previously receivedclearances or approvals, or the failure to comply with existing or futureregulatory requirements could have a material adverse effect on our business.

 

*Premarket Approval (PMA) Pathway*

 

A PMA must be submitted tothe FDA if the device cannot be cleared through the 510(k) process. A PMAmust be supported by extensive data, including but not limited to, technical,preclinical, clinical trials, manufacturing and labeling to demonstrate to theFDA’s satisfaction the safety and effectiveness of the device for its intendeduse. During the review period, the FDA will typically request additional informationor clarification of the information already provided. Also, an advisory panelof experts from outside the FDA may be convened to review and evaluate theapplication and provide recommendations to the FDA as to the approvability ofthe device. The FDA may or may not accept the panel’s recommendation. Inaddition, the FDA will generally conduct a pre-approval inspection of themanufacturing facility or facilities to ensure compliance with the QSRs.

 

New PMAs or PMA supplementsare required for modifications that affect the safety or effectiveness of thedevice, including, for example, certain types of modifications to the device’sindication for use, manufacturing process, labeling and design. PMA supplementsoften require submission of the same type of information as a PMA, except thatthe supplement is limited to information needed to support any changes from thedevice covered by the original PMA and may not require as extensive clinicaldata or the convening of an advisory panel. There is no guarantee that the FDAwill grant PMA approval of any new indications for use of the ProUroScan Systemor for our future products. Failure to obtain such approvals would adverselyaffect our ability to grow our business. Delays in receipt or failure toreceive approvals, the loss of previously received approvals, or the failure tocomply with existing or future regulatory requirements could reduce our sales,profitability and future growth prospects.

 

*Clinical Trials*

 

Clinical trials aregenerally required to support a PMA application and are sometimes required for510(k) clearance. If the device presents a “significant risk,” as definedby the FDA, to human health, the FDA requires the device sponsor to file aninvestigational device exemption (an “IDE”) application with the FDA and obtainIDE approval prior to commencing the human clinical trials. Such trialsgenerally require an IDE application approved in advance by the FDA for aspecified number of patients and study sites, unless the product is deemed anon-significant risk device eligible for more abbreviated IDE requirements.Clinical trials are subject to extensive monitoring, recordkeeping andreporting requirements. Clinical trials must be conducted under the oversightof an institutional review board (“IRB”) for the relevant clinical trial sitesand must comply with FDA regulations, including but not limited to thoserelating to good clinical practices. To conduct a clinical trial, we also arerequired to obtain the patients’ informed consent in form and substance thatcomplies with both FDA requirements and state and federal privacy and humansubject protection regulations. If the clinical trial is not performed inaccordance with the FDA’s IDE regulations, the FDA could seek an enforcementaction against the sponsor and the investigators. In addition, the sponsor, theFDA or the IRB could suspend a clinical trial at any time for various reasons,including a belief that the risks to study subjects outweigh the anticipatedbenefits. Even if a trial is completed, the results of clinical testing may notadequately demonstrate the safety and efficacy of the device or may otherwisenot be sufficient to obtain FDA approval to market the product in the U.S.Similarly, in Europe the clinical study must be 

 

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approved by a local ethics committee and in some cases, includingstudies with high-risk devices, by the ministry of health in the applicablecountry.

 

*Pervasive and Continuing Regulation*

 

Aftera device is placed on the market, numerous regulatory requirements apply. Theseinclude:

 

·                  product listing and establishmentregistration, which helps facilitate FDA inspections and other regulatoryaction;

 

·                  QSR, which requires manufacturers, includingthird-party manufacturers, to follow stringent design, testing, control,documentation and other quality assurance procedures during all aspects of themanufacturing process;

 

·                  labeling regulations and FDA prohibitionsagainst the promotion of products for uncleared, unapproved or off-label use orindication;

 

·                  clearance of product modifications that couldsignificantly affect safety or efficacy or that would constitute a major changein intended use of our cleared devices;

 

·                  approval of product modifications that affectthe safety or effectiveness of our approved devices;

 

·                  medical device reporting regulations, whichrequire that manufacturers comply with FDA requirements to report if theirdevice may have caused or contributed to a death or serious injury, or hasmalfunctioned in a way that would likely cause or contribute to a death orserious injury if the malfunction of the device or a similar device were torecur;

 

·                  post-approval restrictions or conditions,including post-approval study commitments;

 

·                  post-market surveillance regulations, whichapply when necessary to protect the public health or to provide additionalsafety and effectiveness data for the device; and

 

·                  the FDA’s recall authority, whereby it canask, or under certain conditions order, device manufacturers to recall from themarket a product that is in violation of governing laws and regulations.

 

Advertising and promotion ofmedical devices, in addition to being regulated by the FDA, are also regulatedby the Federal Trade Commission and by state regulatory and enforcementauthorities. Recently, promotional activities for FDA-regulated products ofother companies have been the subject of enforcement action brought underhealthcare reimbursement laws and consumer protection statutes. In addition,under the federal Lanham Act and similar state laws, competitors and others caninitiate litigation relating to advertising claims. In addition, we arerequired to meet regulatory requirements in countries outside the U.S., whichcan change rapidly with relatively short notice. If the FDA determines that ourpromotional materials or training constitutes promotion of an unapproved oruncleared use, it could request that we modify our training or promotionalmaterials or subject us to regulatory or enforcement actions, including theissuance of an untitled letter, a warning letter, injunction, seizure, civilfine or criminal penalties. It is also possible that other federal, state orforeign enforcement authorities might take action if they consider ourpromotional or training materials to constitute promotion of an unapproved use,which could result in significant fines or penalties under other statutoryauthorities, such as laws prohibiting false claims for reimbursement. In thatevent, our reputation could be damaged and adoption of the products would beimpaired.

 

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Furthermore, our productscould be subject to voluntary recall if we or the FDA determine, for anyreason, that our products pose a risk of injury or are otherwise defective.Moreover, the FDA can order a mandatory recall if there is a reasonableprobability that our device would cause serious adverse health consequences ordeath.

 

The FDA has broadpost-market and regulatory enforcement powers. Our facilities and themanufacturing facilities of our subcontractors will be subject to unannouncedinspections by the FDA to determine our level of compliance with the QSR andother regulations. Failure by us or by our third-party manufacturers andsuppliers to comply with applicable regulatory requirements can result inenforcement action by the FDA or other regulatory authorities, which may resultin sanctions including, but not limited to:

 

·                  warning letters or untitled letters;

 

·                  fines and civil penalties;

 

·                  unanticipated expenditures to address ordefend such actions;

 

·                  delays in clearing or approving, or refusalto clear or approve, our products;

 

·                  withdrawal or suspension of approval of ourproducts or those of our third-party suppliers by the FDA or other regulatorybodies;

 

·                  product recall or seizure;

 

·                  orders for physician notification or devicerepair, replacement or refund;

 

·                  interruption of production;

 

·                  operating restrictions;

 

·                  injunctions; and

 

·                  criminal prosecution.

 

*Regulation of the ProUroScan System*

 

The ProUroScan System isbeing developed under development contracts with Artann. We are implementing aregulatory strategy to obtain 510(k) clearance of the ProUroScan Systemfor a basic mapping and data maintenance claim and for the ProUroScan System toserve as an adjunct to a DRE. We believe that this basic mapping and datamaintenance claim reflects the current needs of the market and the capabilitiesof the system. Based on discussions between Artann and representatives from theFDA, we believe that the ProUroScan System with a basic mapping and datamaintenance claim will be regulated by the FDA as a class II device. Class IIdevices typically are cleared for marketing by the FDA through a 510(k) application.

 

In an April 2008,representatives from Artann met with the FDA to solicit feedback from theagency regarding the proposed clinical testing that the FDA will require tosupport a 510(k). At that meeting, the FDA indicated that Artann will need toconduct a 40 patient clinical trial on the ProUroScan System. In thisstudy, which will be conducted by Artann, clinical investigators from at leastthree different sites will be trained to use the ProUroScan System on prostatemodels. Subsequently, each of the trained investigators will be asked toperform a standard DRE examination followed by the ProUroScan System on studypatients with a DRE detected abnormality. The study subjects will also havepathology characterization of the DRE detected prostate abnormality as thepatients included in the study will have been referred for a TRUS guided biopsyor radical prostatectomy. Artann intends to conduct this study as anon-significant risk study. As a result, FDA approval of an IDE is notrequired. However, Artann will still 

 

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be required to comply with FDA’s abbreviated IDE regulations,including, among other things, protecting the rights and welfare of allparticipants and obtaining IRB approval from each study center.

 

In order to meet therequirements established by the FDA for the 510(k) clinical study, threecenters were identified to participate in the study and to serve as futuretraining and referral sites for the eventual market rollout of the ProUroScanSystem. The sites include the Mayo Clinic in Rochester, Minnesota, the RobertWood Johnson Medical Center in New Brunswick, New Jersey and the VA MedicalCenter in Minneapolis, Minnesota. Institutional Review Board (“IRB”) approvalshave been obtained, and ProUroScan Systems have been installed, at all threesites. Physician training has also been completed at all three sites and formalclinical studies have commenced at the Robert Wood Johnson Medical Center andthe VA Medical Center. It is expected that clinical studies will commenceat the Mayo Clinic in late March or early April 2009. We expect tocomplete this study in May 2009.

 

In accordance with theArtann Development Agreement, Artann is responsible for submitting andobtaining the initial 510(k) clearance for the ProUroScan System. Webelieve that this 510(k) will be submitted to the FDA shortly aftercompletion of the clinical studies. Once submitted, the FDA will have90 days to review and grant clearance. However, the 510(k) applicationprocess may be significantly longer if the FDA has questions upon its review ormakes a request for additional information, including clinical data, fromArtann. Once cleared, in accordance with the Artann Development Agreement,Artann will transfer the 510(k) for the ProUroScan System upon ProUroCare’sfirst commercial sale of a ProUroScan System unit.

 

Depending on the exact natureof future claims, the approval process may require more extensive clinicalstudies and possibly the submission of a PMA. Such an application will likelytake significantly more time to prepare and review and be more comprehensivethan the 510(k) clearance process.

 

Once we obtain the 510(k) forthe ProUroScan System, or obtain FDA clearance or approval for future products,the manufacturing, sale and performance of our products will be subject to theongoing FDA regulation and inspection processes as described above.

 

*Fraud and Abuse Laws*

 

Because of the significantfederal funding involved in Medicare and Medicaid, Congress and the states haveenacted, and actively enforce, a number of laws whose purpose is to eliminatefraud and abuse in federal health care programs. Once we commercialize theProUroScan System, our business is subject to compliance with these laws.

 

*Anti-Kickback Statutes and Federal False Claims Act*

 

The federal healthcareprograms Anti-Kickback Statute prohibits persons from knowingly and willfullysoliciting, offering, receiving or providing remuneration, directly orindirectly, in exchange for or to induce either the referral of an individual,or the furnishing or arranging for a good or service, for which payment may bemade under a federal healthcare program such as Medicare or Medicaid. Thedefinition of “remuneration” has been broadly interpreted to include anythingof value, including for example gifts, discounts, the furnishing of freesupplies, equipment or services, credit arrangements, payments of cash andwaivers of payments. Several courts have interpreted the statute’s intentrequirement to mean that if any one purpose of an arrangement involvingremuneration is to induce referrals of federal healthcare covered business, thestatute has been violated. Penalties for violations include criminal penaltiesand civil sanctions such as fines, imprisonment and possible exclusion fromMedicare, Medicaid and other federal healthcare programs. In addition, somekickback allegations have been claimed to violate the Federal False Claims Act,discussed in more detail below.

 

The Anti-Kickback Statute isbroad and prohibits many arrangements and practices that are lawful inbusinesses outside of the healthcare industry. Recognizing that theAnti-Kickback Statute is broad and may technically prohibit many innocuous orbeneficial arrangements, Congress authorized the Office of Inspector General ofthe 

 

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U.S. Department of Health and Human Services, or OIG, to issue aseries of regulations, known as “safe harbors.” These safe harbors, issued bythe OIG beginning in July 1991, set forth provisions that, if all theirapplicable requirements are met, will assure healthcare providers and otherparties that they will not be prosecuted under the Anti-Kickback Statute. Thefailure of a transaction or arrangement to fit precisely within one or moresafe harbors does not necessarily mean that it is illegal or that prosecutionwill be pursued. However, conduct and business arrangements that do not fullysatisfy each applicable safe harbor may result in increased scrutiny bygovernment enforcement authorities such as the OIG.

 

Many states have adoptedlaws similar to the Anti-Kickback Statute. Some of these state prohibitionsapply to referral of patients for healthcare items or services reimbursed byany source, not only the Medicare and Medicaid programs.

 

Government officials havefocused their enforcement efforts on marketing of healthcare services andproducts, among other activities, and recently have brought cases againstcompanies, and certain sales, marketing and executive personnel, for allegedlyoffering unlawful inducements to potential or existing customers in an attemptto procure their business.

 

Another developmentaffecting the healthcare industry is the increased use of the federal CivilFalse Claims Act and, in particular, actions brought pursuant to the FalseClaims Act’s “whistleblower” or “*qui tam*”provisions. The False Claims Act imposes liability on any person or entity who,among other things, knowingly presents, or causes to be presented, a false orfraudulent claim for payment by a federal healthcare program. The qui tamprovisions of the False Claims Act allow a private individual to bring actionson behalf of the federal government alleging that the defendant has submitted afalse claim to the federal government and to share in any monetary recovery. Inrecent years, the number of suits brought against healthcare providers byprivate individuals has increased dramatically. In addition, various stateshave enacted false claim laws analogous to the Civil False Claims Act, althoughmany of these state laws apply where a claim is submitted to any third-partypayor and not merely a federal healthcare program.

 

When an entity is determinedto have violated the False Claims Act, it may be required to pay up to threetimes the actual damages sustained by the government, plus civil penalties ofbetween $5,500 to $11,000 for each separate false claim. There are manypotential bases for liability under the False Claims Act. Liability arises,primarily, when an entity knowingly submits, or causes another to submit, afalse claim for reimbursement to the federal government. The False Claims Acthas been used to assert liability on the basis of inadequate care, kickbacksand other improper referrals, and improper use of Medicare numbers whendetailing the provider of services, in addition to the more predictableallegations as to misrepresentations with respect to the services rendered. Inaddition, companies have been prosecuted under the False Claims Act inconnection with alleged off-label promotion of products. Our future activitiesrelating to the reporting of wholesale or estimated retail prices for ourproducts, the reporting of discount and rebate information and otherinformation affecting federal, state and third-party reimbursement of ourproducts, and the sale and marketing of our products, may be subject toscrutiny under these laws. We are unable to predict whether we would be subjectto actions under the False Claims Act or a similar state law, or the impact ofsuch actions. However, the costs of defending such claims, as well as anysanctions imposed, could significantly affect our financial performance.

 

*HIPAA and Other Fraud and Privacy Regulations*

 

Among other things, theHealth Insurance Portability and Accountability Act of 1996, or HIPAA, createdtwo new federal crimes: healthcare fraud and false statements relating tohealthcare matters. The HIPAA health care fraud statute prohibits, among otherthings, knowingly and willfully executing, or attempting to execute, a schemeto defraud any healthcare benefit program, including private payors. Aviolation of this statute is a felony and may result in fines, imprisonmentand/or exclusion from government-sponsored programs. The HIPAA false statementsstatute prohibits, among other things, knowingly and willfully falsifying,concealing or covering up a material fact or making 

 

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any materially false, fictitious or fraudulent statement orrepresentation in connection with the delivery of or payment for healthcarebenefits, items or services. A violation of this statute is a felony and mayresult in fines and/or imprisonment.

 

In addition to creating thetwo new federal healthcare crimes, regulations implementing HIPAA alsoestablish uniform standards governing the conduct of certain electronichealthcare transactions and protecting the security and privacy of individuallyidentifiable health information maintained or transmitted by healthcareproviders, health plans and healthcare clearinghouses, which are referred to as“covered entities.” Three standards have been promulgated under HIPAA’sregulations: the Standards for Privacy of Individually Identifiable HealthInformation, which restrict the use and disclosure of certain individuallyidentifiable health information, the Standards for Electronic Transactions,which establish standards for common healthcare transactions, such as claimsinformation, plan eligibility, payment information and the use of electronicsignatures, and the Security Standards, which require covered entities toimplement and maintain certain security measures to safeguard certainelectronic health information. Although we are not a covered entity andtherefore not directly subject to these standards, we expect that our customersgenerally will be covered entities and may ask us to contractually comply withcertain aspects of these standards, particularly because we expect that theProUroScan System will store patient information and scan results. Thegovernment intended this legislation to reduce administrative expenses andburdens for the healthcare industry; however, our compliance with certainprovisions of these standards entails significant costs for us.

 

In addition to federalregulations issued under HIPAA, some states have enacted privacy and securitystatutes or regulations that, in some cases, are more stringent than thoseissued under HIPAA. In those cases, it may be necessary to modify our plannedoperations and procedures to comply with the more stringent state laws. If wefail to comply with applicable state laws and regulations, we could be subjectto additional sanctions.

 

***Employees***

 

We currently have only twofull-time employees, and expect to conduct much of our research anddevelopment, market research, clinical and regulatory function, and otherbusiness operations through the use of a variety of consultants andmedical-device development contractors. We believe that using consultants andcontractors, including the significant scientific and engineering resources ofArtann, to perform these functions is more cost effective than hiring full-timeemployees, and affords us flexibility in directing our resources toward specificand changing goals during our development stage. We anticipate hiringapproximately eight additional employees during the remainder of 2009 in theareas of manufacturing management, marketing, sales training, administrationand quality assurance. Some or all of these functions may be performed bycontracted individuals or consultants as management deems most effective. Todate, we have conducted our research and development activities related to ouracquired technologies and proposed products on a contract basis with Artann,Devicix, LLC and Minnetronix, Inc.

 

**ITEM 1A.           RISKFACTORS**

 

***ImportantNotices to Investors; Safe Harbor Statement***

 

Statements in this Annual Report on Form 10-K which are not purelyhistorical are forward-looking statements. These statements with respect to the goals, plan objectives, intentions,expectations, financial condition, results of operations, future performanceand business of our Company, including, without limitation: (i) ourability to successfully complete all clinical trials and commercial developmentof our products and secure all necessary federal and other regulatory approvalsto introduce and market our products in the United States and around the world;(ii) our ability to fund our working capital needs over the next 12 to 24months; (iii) our ability to successfully introduce our products into themedical device markets; and (iv) all statements preceded by, followed byor that include the words “may,” “would,” “could,” “should,” “expects,” “projects,”“anticipates,” “believes,” “estimates,” “plans,” “intends,” “targets” orsimilar expressions.

 

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Forward-looking statements involve inherent risks and uncertainties,and important factors (many of which are beyond our control) that could causeactual results to differ materially from those set forth in the forward-lookingstatements, including the following, in addition to those contained in ourCompany’s reports on file with the Securities and Exchange Commission: generaleconomic or industry conditions, nationally and in the physician, urology andmedical device communities in which we intend to do business; our ability tofund our working capital needs over the next 12 to 24 months; our ability tocomplete the development of our existing and proposed products on a timelybasis if at all; legislation or regulatory requirements, including our securingall FDA and other regulatory approvals on a timely basis, if at all, prior tobeing able to market and sell our products in the United States; competitionfrom larger and more well established medical device and other competitors; thedevelopment of products that may be superior to the products offered by us;securing and protecting our intellectual property and assets and enforcingbreaches of the same; clinical results not anticipated by management of theCompany; the quality or composition of our products and the strength andreliability of our contract vendors and partners; ability to raise capital tofund our 2009 and 2010 working capital needs and launch our products into themarketplace in subsequent years; changes in accounting principles, policies orguidelines; financial or political instability; acts of war or terrorism; andother economic, competitive, governmental, regulatory and technical factorsaffecting our operations, proposed products and prices.

 

Accordingly, results actually achieved may differ materially fromexpected results in these statements. Forward-looking statements speak only as of the date they are made.  We do not undertake, and specificallydisclaim, any obligation to update any forward-looking statements to reflectevents or circumstances occurring after the date of such statements.

 

***Risk Factors Associated with our Business,Operations and Securities***

 

**We are a development stage company. We have nooperating history and our business plan has not yet been fully tested. Weanticipate incurring future losses and may continue incurring losses after ourproducts are completed, regulatory clearance or approval is secured and ourproducts are introduced and accepted in the United States and worldwidemarkets.**

 

We are a development-stagecompany. We have yet to commence active operations to manufacture or sell anyproducts associated with the proprietary urology-based imaging technologiesthat we intend to market. We have no prior operating history from which toevaluate our likelihood of success in operating our business, generating anyrevenues or achieving profitability. As of December 31, 2008, we havegenerated no revenue and have recorded losses since inception of approximately$21 million. There can be no assurance that our plans for developing andmarketing our urology-based products will be successful, or that we will everattain significant sales or profitability. We anticipate that we will incurlosses in the near future.

 

**We have a history of operating losses and havereceived a “going-concern” qualification from our independent registered publicaccounting firm.**

 

We have incurred operatinglosses and negative cash flows from operations since inception. As of December 31,2008, we had an accumulated shareholders’ deficit of approximately$7.3 million. We have not yet generated any revenues. These factors, amongothers, raise substantial doubt about our ability to continue as a goingconcern. Our consolidated financial statements included in this Annual Reporton Form 10-K do not include any adjustments related to recoverability andclassification of asset carrying amounts or the amount and classification ofliabilities that might result should we be unable to continue as a goingconcern.

 

Our independent registeredpublic accounting firm included an explanatory paragraph in their report on ourfinancial statements indicating that such deficit accumulated during thedevelopment stage raises substantial doubt as to our ability to continue as agoing concern. The likelihood of our success must be considered in light of theexpenses, difficulties and delays frequently encountered in connection withdevelopment stage businesses and the 

 

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competitive environment in which we will operate. Our ability toachieve profitability is dependent in large part on obtaining FDA clearance orapproval for the ProUroScan System, implementing a “patient pay” sales model,achieving third party coverage and reimbursement, establishing distributionchannels, forming relationships with third-party manufacturers and gainingmarket acceptance of the ProUroScan System. There can be no assurance that theCompany will successfully market the ProUroScan System or operate profitably.

 

**We will need additional financing, and any suchfinancing will likely be dilutive to our existing shareholders.**

 

As of February 28,2009, we had approximately $774,000 of cash on hand and current liabilities of$3.5 million, including $2.2 million of secured debt that was due on thatdate.  In March 2009, we renewed$1.8 million of the secured debt to mature on March 28, 2010, andtemporarily paid down $400,000 of the secured debt pending the Companyobtaining a satisfactory guaranty of that amount.  It is our intent to renew the $400,000secured debt before the end of May 2009; however, there can be noassurance that a satisfactory guaranty can be obtained.  We expect that our existing cash will besufficient to allow us to complete the ProUroScan system clinical trials,submit a 510(k) application to the FDA and obtain clearance for a basicmapping and data maintenance claim. However, if our clinical trials experienceunforeseen delays, or FDA regulatory clearance delays, or are unable toestablish a satisfactory guaranty of the secured debt, we may not havesufficient funds to complete these objectives, and will require additionalfinancing. In addition, we will need funding to pay, for example, up to$1,000,000 of future payments to Artann related to FDA 510(k) clearancemilestones.

 

If product development iscompleted on schedule, we expect to pursue one or more additional rounds offunding in 2009 and 2010 to provide the working capital needed to repay ourexisting debt and to fund a commercial launch into the urology market. Inaddition, if we fail to secure a distribution partner on terms acceptable tous, or at all, we could be required to undertake distribution activity at ourexpense, which could significantly increase our capital requirements and maydelay the commercialization of our products.

 

Ifadditional funds are raised by the issuance of convertible debt or equitysecurities, such as the issuance of stock, or the issuance and exercise ofwarrants, the issuance and conversion of convertible debentures, then existingshareholders will experience dilution in their ownership interest. Ifadditional funds are raised by the issuance of debt or certain equityinstruments, we may become subject to certain operational limitations, and suchsecurities may have rights senior to those of existing holders of common stock.There can be no assurance that we will be successful in obtaining suchadditional financing, if needed. Additional financing may not be available tous, may not be available on favorable terms and will likely be dilutive toexisting shareholders.

 

**Our assets are pledged to secure $1.6 million ofsenior bank notes and a $600,000 note issued to an investor which become due inMarch 2010 and, as a result, are not available to secure other senior debtfinancing. Upon the occurrence of an event of default, our assets will beassigned to guarantors of the senior bank note and the holder of such $600,000promissory note.**

 

Our $1.6 million seniordebt financing through Crown Bank, Minneapolis, Minnesota, has required us topledge all of our assets and certain licenses, as well as to provide personalguarantees of certain shareholders. In addition, we have issued a subordinatedpromissory note in the amount of $600,000 to an investor. Such note has asubordinated interest in all of our assets and certain licenses. Both the$1.6 million senior bank notes and the $600,000 note issued to an investorbecome due on March 28, 2010. Due to such security interests, the Companywill not be in a position in the future to pledge its assets to secure any debtor lending facility, in the event we desire or need to borrow such funds on asecured lending basis. It is doubtful that the Company would be able to obtain significantadditional debt financing on an unsecured basis.

 

Moreover, under the termsand conditions of the Crown Bank facility, and our agreement with suchguarantors, in the event of any default by us with our senior lender thatcauses the personal guarantees to be called and honored, we and our lender haveagreed that all of the Company’s assets shall be assigned to such guarantors,pro rata, 

 

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in consideration of such breach and obligation to pay under therespective guarantees. In addition, the holder of the $600,000 promissory notehas a subordinated interest in all of the Company’s assets in the event of adefault under the note. Thus, our common shareholders, and any existing andfuture investors in our common stock, would, if the foregoing breach andcircumstances occurred, not have access or recourse to the Company’s assets andcollateral, and thus, would likely face a complete loss of their investment inthe Company.

 

**If adequate funds are not available on a timely basis,we could potentially be forced to cease operations.**

 

If adequate funds are notavailable on a timely basis, or are not available on acceptable terms, we may beunable to repay our existing debt, to fund expansion, or to develop or enhanceour products. If we are forced to slow our development programs, or put them onhold, it would delay our efforts to obtain regulatory clearances or approvalsneeded, and thus delay market entry for our products. Ultimately, if adequatefinancing is not obtained, we could potentially be forced to cease operations.

 

**The current unprecedented volatility in the worldwidecredit and equity markets may have an impact on our ability to obtain futurefinancing.**

 

We do not know what impactthe current unprecedented volatility in worldwide credit and equity markets mayhave on our ability to obtain future financing. Since September 2008, wehave seen unprecedented turmoil in equity and credit markets that has resultedin record-setting losses in the stock markets, dramatic decreases of liquidityin the credit markets, bank failures, hedge fund closures and massive marketintervention by the United States and foreign governments. Because of theunprecedented nature of these market events, and because the markets remainhighly-volatile today, we cannot predict what effect these events will have onour ability to obtain financing in the future. If we are unable to raisesufficient capital, including funds necessary to repay our loans due on March 28,2010**,** it will have a material adverseeffect on our financial condition and our ability to remain in business.

 

**The ProUroScan System has not been, and may never be,fully commercially completed and developed.**

 

Only a limited number ofcomplete ProUroScan Systems have been built for testing, clinical validationsand demonstration purposes to assess the feasibility of the device and toprovide a means to test and develop future systems and we have not built anysystems for commercial sale. The completion of development of the ProUroScanSystem, or future generations of the ProUroScan System, remains subject to allthe risks associated with the development and manufacture of new products basedon innovative technologies, including unanticipated technical or otherproblems, failures to meet FDA requirements or performance objectives and thepossible insufficiency of the funds allocated for the completion of suchdevelopment, which could result in a change in the design, delay in thedevelopment or abandonment of such applications and products. Consequently,there can be no assurance that the ProUroScan System will be successfullydeveloped or manufactured. Our failure to complete the development of the ProUroScanSystem, or to work with Artann or other third parties to develop new products,will have a materially adverse effect on our business.

 

**We are relying upon Artann to submit and obtain 510(k) clearanceof the ProUroScan System. There is no guarantee that the FDA will grant timely510(k) clearance of the ProUroScan System, if at all, and failure toobtain such timely clearance would adversely affect our ability to market thatproduct and expand utilization of the technology in other prostate applicationsor in other soft tissue organs in the body, which may affect our ability togrow our business.**

 

The ProUroScan System issubject to regulation by the FDA and by comparable agencies in various foreigncountries. The process of complying with the requirements of the FDA andcomparable agencies is costly, time consuming and burdensome. We believe theProUroScan System with a basic mapping and data maintenance claim will beregulated by the FDA as a class II device and will require the clearanceof a 510(k) application. By regulation, 

 

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the FDA is required to clear or deny a 510(k) application within90 days of submission of the application, but as a practical matter,clearance may take much longer.

 

Under our currentdevelopment and commercialization agreement, dated July 25, 2008, withArtann (the “Artann Development Agreement”), Artann is responsible for filingthe initial 510(k) for the ProUroScan System with the FDA. Artann has notyet submitted that 510(k) to obtain FDA clearance and no assurances can begiven that such filing will be submitted, and, once submitted, will beacceptable to the FDA. Prior to submitting such a 510(k) to the FDA,Artann will need to conduct additional preclinical and clinical testing of thedevice to support clearance of the current device. In addition, although Artannis contractually obligated to perform certain tasks for us under the ArtannDevelopment Agreement, there can be no assurance that Artann’s existinggrant-based resources or other funding will be adequate to enable Artann tocomplete these tasks on a timely basis or at all.

 

There is no guarantee thatthe FDA will grant 510(k) clearance in a timely manner, if at all, for theProUroScan System with basic mapping and data maintenance claims. Failure toobtain clearance for the ProUroScan System would require Artann to re-apply for510(k) clearance with additional supporting data or information or for adifferent labeling claim, submit a Premarket Approval Application (a “PMA”) forFDA approval, or abandon the product. Even if FDA 510(k) clearance isreceived, Artann may encounter significant delays in receiving such clearance.If unexpected clearance delays occur, or if Artann needs to re-apply for FDAclearance or submit a PMA, it could have a material adverse effect on ourbusiness as Artann is to transfer such clearance or approval to us once we makethe first commercial sale of the ProUroScan System. If such delays occur, wewould need to obtain additional financing to continue operations.

 

**Even if successfully developed, our products may notbe commercially viable or may not be accepted by the marketplace.**

 

Even if Artann is able tosuccessfully develop the ProUroScan System and we are able to successfullydevelop future products, we may not be able to contract for the manufacture ofsuch products in commercial quantities at prices that will be commerciallyviable. Further, there is risk that the ProUroScan System and our futureproducts may not prove to be as effective as currently available medical ordiagnostic products or those developed in the future. The inability tosuccessfully complete development of a product or application or adetermination by us, for financial, technical or other reasons not to completedevelopment of any product or application, particularly in instances in whichwe have made sufficient capital expenditures, could have a material adverseeffect on our business. With respect to the ProUroScan System, under ourcurrent Artann Development Agreement, Artann is to transfer the 510(k) tous once we make the first commercial sale of the ProUroScan System. If we arenot able to procure a commercial sale of at least one ProUroScan System, Artannwould not be obligated to transfer the 510(k) to us and might not do so,thus inhibiting our ability to develop future generations of the product.

 

Even if successfullydeveloped, the ProUroScan System and our future products will be competingagainst other imaging and diagnostic products in the medical devicemarketplace, including those developed in the future that may render theProUroScan System obsolete. The DRE, in combination with a PSA test, is part oftoday’s “standard of care” to evaluate patients over the age of 50 for prostatecancer or other ailments relating to the prostate. In addition, othermodalities that can be used for diagnostic imaging include transrectalultrasound (“TRUS”), magnetic resonance imaging, computed tomography andnuclear medicine. Therefore, there can be no assurance that physicians,providers, patients, third party payors or the medical device market, ingeneral, will accept our products.

 

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**There is no guarantee that the FDA will grant 510(k) clearanceor PMA approval of our future products and claims and failure to obtainnecessary clearances or approvals for our future products and claims wouldadversely affect our ability to expand utilization of the technology in otherprostate applications or in other soft tissue organs in the body, which mayaffect our ability to grow our business.**

 

In the future, we may seekto obtain additional indications for use of the ProUroScan System beyond thebasic mapping and data maintenance claim, as well as clearance and approval ofnew products. Some of these expanded claims and future products may require FDAclearance of a 510(k). Other claims and future products will require FDAapproval of a PMA. Moreover, some of our future products and the additionalclaims on the ProUroScan System we may seek may require clinical trials tosupport regulatory approval, and we may not successfully complete theseclinical trials. The FDA may not approve or clear these future products, orfuture generations of the ProUroScan System for the indications that arenecessary or desirable for successful commercialization. Indeed, the FDA mayrefuse our requests for 510(k) clearance or PMA approval of new products.Failure to receive clearance or approval for additional claims for theProUroScan System, or for our future products, would have an adverse effect onour ability to expand our business.

 

**We are relying upon Artann to conduct anon-significant risk clinical trial necessary to obtain the initial 510(k) clearanceof the ProUroScan System. The results of that clinical trial may not support abasic mapping and data maintenance claim or may result in the discovery ofadverse side effects.**

 

Under the Artann DevelopmentAgreement, Artann is responsible for conducting all clinical trials necessaryto support an initial 510(k) for the ProUroScan System with a basicmapping and data maintenance claim.  Wecannot be certain that the results will support a basic mapping claim. Successin early clinical trials does not ensure that later clinical trials will besuccessful, and we cannot be sure that Artann’s 40 patient trial will replicatethe results of the earlier study at the Robert Wood Johnson Medical Center. Theclinical trial process may fail to meet its desired endpoints, which couldcause us to abandon, or delay the development of the ProUroScan System, ornecessitate modifications thereto. Any delay or termination of Artann’sclinical trial will delay their filing of the 510(k) and ultimately, ourability to commercialize the product and generate revenues. It is also possiblethat patients enrolled in that clinical trial will experience adverse sideeffects that are not currently part of the ProUroScan System’s profile. Inaddition, the clinical trials for the ProUroScan System involve a relativelysmall patient population. Because of the small sample size, these results maynot be indicative of future results.

 

**If Artanndoes not perform, or if any third parties on which we will rely to conduct ourclinical trials in the future do not perform, as contractually required orexpected, we may not be able to obtain regulatory clearance or approval for, orcommercialize, our products.**

 

We are highly dependent onthe services provided by Artann. In addition, we intend to rely on thirdparties, such as contract research organizations, medical institutions,clinical investigators and contract laboratories, to conduct clinical trials.If Artann or these third parties do not successfully carry out theircontractual duties or regulatory obligations or meet expected deadlines, ifArtann or any of these third parties need to be replaced, or if the quality oraccuracy of the data they obtain is compromised due to the failure to adhere toour clinical protocols or regulatory requirements or for other reasons, ourpre-clinical development activities or clinical trials may be extended,delayed, suspended or terminated, and we may not be able to obtain regulatoryapproval for, or successfully commercialize, our products on a timely basis, ifat all, and our business, operating results and prospects may be adverselyaffected. If our clinical trials are not conducted in accordance with the FDA’sIDE regulations, the FDA may seek an enforcement action, such as the issuance ofa warning letter, against us or the third parties conducting our trials.Furthermore, our third-party clinical trial investigators may be delayed inconducting our clinical trials for reasons outside of their control.

 

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**Clinical trials necessary to support our futureproducts and claims will be expensive and may require the enrollment of largenumbers of patients, and suitable patients may be difficult to identify andrecruit. These trials may require the submission of an IDE, for which there isnot guarantee that the FDA will approve. Delays or failures in our clinicaltrials will prevent us from commercializing any modified or new products andwill adversely affect our business, operating results and prospects.**

 

Initiating and completingclinical trials necessary to support 510(k)s or PMAs for future generations ofthe ProUroScan System will be time consuming and expensive and the outcomeuncertain. Moreover, the results of early clinical trials are not necessarilypredictive of future results, and any product we advance into clinical trialsmay not have favorable results in later clinical trials.

 

Conducting successfulclinical studies may require the enrollment of large numbers of patients, andsuitable patients may be difficult to identify and recruit. Patient enrollmentin clinical trials and completion of patient participation and follow-updepends on many factors, including: the size of the patient population; thenumber of patients to be enrolled; the nature of the trial protocol; theattractiveness of, or the discomforts and risks associated with, the treatmentsreceived by enrolled subjects; the availability of appropriate clinical trialinvestigators, support staff, and proximity of patients to clinical sites; andthe patients’ ability to meet the eligibility and exclusion criteria forparticipation in the clinical trial and patient compliance. For example,patients may be discouraged from enrolling in our clinical trials if the trialprotocol requires them to undergo extensive post-treatment procedures orfollow-up to assess the safety and effectiveness of our products or if theydetermine that the treatments received under the trial protocols are notattractive or involve unacceptable risks or discomforts. In addition, patientsparticipating in clinical trials may die before completion of the trial orsuffer adverse medical events unrelated to investigational products.

 

Development of sufficientand appropriate clinical protocols to demonstrate safety and efficacy arerequired, and we may not adequately develop such protocols to support clearanceand approval. Significant risk trials will require the submission and approval ofan IDE from the FDA. There is no guarantee that the FDA will approve our futureIDE submissions. Further, the FDA may require us to submit data on a greaternumber of patients than we originally anticipated and/or for a longer follow-upperiod or change the data collection requirements or data analysis applicableto our clinical trials. Delays in patient enrollment or failure of patients tocontinue to participate in a clinical trial may cause an increase in costs anddelays in the approval and attempted commercialization of our products orresult in the failure of the clinical trial. In addition, despite considerabletime and expense invested in our clinical trials, the FDA may not consider ourdata adequate to demonstrate safety and efficacy. Such increased costs anddelays or failures could adversely affect our business, operating results andprospects.

 

**We have no manufacturing experience, and will rely onthird parties to manufacture the ProUroScan System in an efficient manner. Ifdesign specification changes are needed to develop an efficient manufacturingprocess, those changes may require FDA clearance of a new 510(k) orapproval of a PMA, which we may not be able to obtain in a timely manner, if atall.**

 

To be successful, theProUroScan System will need to be manufactured in sufficient quantities, incompliance with regulatory requirements and at an acceptable cost. We have nomanufacturing experience. We are in the process of identifying a third-partymanufacturer to produce commercial units of the ProUroScan System fordistribution after 510(k) clearance or PMA approval is obtained. Prior tocommercialization, this third-party manufacturer will identify the mostefficient manufacturing process to produce commercial ProUroScan Systems. Ifdevice design changes are required to implement an efficient manufacturingprocess, these design changes will need to be evaluated and implemented inaccordance with applicable Quality Systems Regulation (“QSR”) requirements. Ifwe implement design changes after the FDA has cleared the ProUroScan System510(k), we will need to assess whether those design changes could significantlyaffect the safety or effectiveness of the device, and require the submissionand clearance of a new 510(k), or even require the submission of a PMA. If wedetermine that these modifications require a new 510(k) clearance or PMAapproval, we may not be able to obtain this additional clearance in a timelymanner, or at all. In general, obtaining additional clearances can be a timeconsuming process, and delays in obtaining required 

 

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future clearances would adversely affect our ability to market theProUroScan System in a timely manner, which in turn would harm our futuregrowth.

 

**If we or our third-party manufacturers or suppliersfail to comply with ongoing FDA or other foreign regulatory authorityrequirements, or if we experience unanticipated problems with our products,these products could be subject to restrictions or withdrawal from the market.**

 

Any product for which weobtain FDA clearance or approval, and the manufacturing processes, reportingrequirements, post-approval clinical data and promotional activities for suchproduct, will be subject to continued regulatory review, oversight and periodicinspections by the FDA and other domestic and foreign regulatory bodies. Inparticular, we and our third-party manufacturers and certain of our supplierswill be required to comply with the FDA’s QSR, regulations for the manufactureof our products and other regulations which cover the methods and documentationof the design, testing, production, control, quality assurance, labeling,packaging, storage and shipping of any product for which we obtain clearance orapproval. Regulatory bodies, such as the FDA, enforce the QSR and otherregulations through periodic inspections. The failure by us or one of ourthird-party manufacturers or suppliers to comply with applicable statutes andregulations administered by the FDA and other regulatory bodies, or the failureto timely and adequately respond to any adverse inspectional observations orproduct safety issues, could result in, among other things, any of thefollowing enforcement actions:

 

·                  warning letters or untitled letters;

 

·                  fines and civil penalties;

 

·                  unanticipated expenditures to address ordefend such actions;

 

·                  delays in clearing or approving, or refusalto clear or approve, our products;

 

·                  withdrawal or suspension of approval of ourproducts or those of our third-party suppliers by the FDA or other regulatorybodies;

 

·                  product recall or seizure;

 

·                  orders for physician notification or devicerepair, replacement or refund;

 

·                  interruption of production;

 

·                  operating restrictions;

 

·                  injunctions; and

 

·                  criminal prosecution.

 

If any of these actions wereto occur it would harm our reputation and cause our product sales andprofitability to suffer and may prevent us from generating revenue.Furthermore, our third-party manufacturers and suppliers may not be incompliance with all applicable regulatory requirements which could result infailure to supply our products in required quantities, if at all.

 

Even if regulatory clearanceor approval of a product is granted, such clearance or approval may be subjectto limitations on the intended uses for which the product may be marketed andreduce our potential to successfully commercialize the product and generaterevenue from the product. If the FDA determines that our promotional materials,labeling, training or other marketing or educational activities constitutepromotion of an unapproved use, it could request that we cease or modify ourtraining or promotional materials or subject us to serious regulatory 

 

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enforcement actions, including some of those listed above. It is alsopossible that other federal, state or foreign enforcement authorities mighttake action if they consider our training or other promotional materials toconstitute promotion of an unapproved use, which could result in significantfines or penalties under other statutory authorities, such as laws prohibitingfalse claims for reimbursement.

 

In addition, we may berequired to conduct costly post-market testing and surveillance to monitor thesafety or effectiveness of our products, and we must comply with medical devicereporting requirements, including the reporting of adverse events andmalfunctions related to our products. Later discovery of previously unknownproblems with our products, including unanticipated adverse events or adverseevents of unanticipated severity or frequency, manufacturing problems, orfailure to comply with regulatory requirements such as QSR, may result inchanges to labeling, restrictions on such products or manufacturing processes,withdrawal of the products from the market, or regulatory enforcement actions.

 

**Our products may in the future be subject to productrecalls that could harm our reputation, business and financial results.**

 

The FDA and similar foreigngovernmental authorities have the authority to require the recall ofcommercialized products in the event of material deficiencies or defects indesign or manufacture. In the case of the FDA, the authority to require amandatory recall must be based on an FDA finding that there is a reasonableprobability that the device would cause serious adverse health consequences ordeath. In addition, foreign governmental bodies have the authority to requirethe recall of our products in the event of material deficiencies or defects indesign or manufacture. Manufacturers may, under their own initiative, initiatea field correction or removal, known as a recall, for a product if any materialdeficiency in a device is found. A government-mandated or voluntary recall byus or one of our third-party manufacturers or suppliers could occur as a resultof component failures, manufacturing errors, design or labeling defects orother deficiencies and issues. Recalls of any of our products would divertmanagerial and financial resources and have an adverse effect on our financialcondition and results of operations. The FDA requires that certainclassifications of recalls be reported to the FDA within 10 working days afterthe recall is initiated. Companies are required to maintain certain records ofrecalls, even if they are not reportable to the FDA. We may initiate voluntaryrecalls involving our products in the future that we determine do not requirenotification of the FDA. If the FDA disagrees with our determinations, theycould require us to report those actions as recalls. A future recallannouncement could harm our reputation with customers and negatively affect oursales. In addition, the FDA could take enforcement action for failing to reportthe recalls when they were conducted.

 

**If our marketed products cause or contribute to adeath or a serious injury, or malfunction in certain ways, we will be subject tomedical device reporting regulations, which can result in voluntary correctiveactions or agency enforcement actions.**

 

Under the FDA medical devicereporting regulation, medical device manufacturers are required to report tothe FDA information that a device has or may have caused or contributed to adeath or serious injury or has malfunctioned in a way that would likely causeor contribute to death or serious injury if the malfunction of the device orone of our similar devices were to recur. If we fail to report these events tothe FDA within the required timeframes, or at all, the FDA could takeenforcement action against us. Any such adverse event involving our productsalso could result in future voluntary corrective actions, such as recalls orcustomer notifications, or agency action, such as inspection or enforcementaction. Any corrective action, whether voluntary or involuntary, as well asdefending ourselves in a lawsuit, will require the dedication of our time andcapital, distract management from operating our business, and may harm ourreputation and financial results.

 

**We will depend upon others for the manufacturing ofour products, which will subject our business to the risk that we will beunable to fully control the supply of our products to the market.**

 

Our ability to develop,manufacture and successfully commercialize our future products depends upon ourability to enter into and maintain contractual and collaborative arrangementswith others. We do not intend to establish any of our own manufacturingfacilities for the ProUroScan System or any of our future products. Instead, 

 

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we intend to retain QSR compliant and FDA registered contractmanufacturers. We may also have to rely on a sole supplier for certaincomponents of our ProUroScan System. There can be no assurance that suchmanufacturers will be able to supply our products in the required quantities,at appropriate quality levels or at acceptable costs. We may be adverselyaffected by any difficulties encountered by such third-party manufacturers thatresult in product defects, production delays or the inability to fulfill orderson a timely basis. If a manufacturer cannot meet our quality standards anddelivery requirements in a cost-efficient manner, we could suffer interruptionsof delivery while we arrange for alternative manufacturing sources. Anyextended disruption in the delivery of our products could result in ourinability to satisfy customer demand for our products. Consequently, ourinability to obtain alternative sources on a timely basis may have a materialadverse effect on our business.

 

**We may incur significant liability if it is determinedthat we are promoting off-label use of our products in violation of federal andstate regulations in the United States or elsewhere.**

 

Artann initially intends toseek clearance of the ProUroScan System from the FDA solely for a basic mappingand data maintenance claim. We believe that seeking 510(k) clearance forthis limited indication is the least burdensome path to initial regulatoryclearance. Our business and future growth, however, will depend primarily onthe use or enhancement of the ProUroScan System to identify the specific3-dimensional location of lesions in the prostate, to create a 3-dimensionalimage of the position of the lesions, and allow the physician to rotate theimage to assist in identifying the actual position of the lesion in theprostate gland in order to provide a diagnosis of the patient’s condition. Once510(k) clearance is obtained and the ProUroScan System 510(k) istransferred to us from Artann, we intend to subsequently seek regulatoryclearance or PMA approval for use of the ProUroScan System for a variety ofother prostate related indications. Unless and until we receive regulatoryclearance or approval for use of the ProUroScan System in these procedures,uses in procedures other than basic mapping and data maintenance will beconsidered off-label uses of the ProUroScan System. Under the Federal Food,Drug, and Cosmetic Act (the “FDCA”) and other similar laws, we are prohibitedfrom labeling or promoting our products, or training physicians, for suchoff-label uses. This prohibition means that the FDA could deem it unlawful forus to make claims about the safety or effectiveness of the ProUroScan System inthe diagnosis of lesions or proactively discuss or provide information ortraining on the use of the ProUroScan System for the diagnosis of prostatelesions, with very limited exceptions. However, although manufacturers are notpermitted to promote for off-label uses, in their practice of medicine,physicians may lawfully choose to use medical devices for off-label uses. Evenif the FDA grants 510(k) clearance for the ProUroScan System for use in abasic mapping and data maintenance claim, a physician could use the ProUroScanSystem for uses not covered by the cleared labeling. This would constitute anoff-label use. We expect that hospitals and physicians will use the ProUroScanSystem for a variety of uses beyond mapping prostate anatomy.

 

The FDA and other regulatoryagencies actively enforce regulations prohibiting promotion of off-label usesand the promotion of products for which marketing clearance has not beenobtained. A company that is found to have improperly promoted off-label usesmay be subject to significant liability, including civil and administrativeremedies as well as criminal sanctions. Due to these legal constraints, oursales and marketing efforts will focus only on the general technical attributesand benefits of the ProUroScan System and the FDA cleared or approvedindications for use.

 

**Federal regulatory reforms may adversely affect ourability to sell our products profitably.**

 

From time to time,legislation is drafted and introduced in Congress that could significantlychange the statutory provisions governing the clearance or approval,manufacture and marketing of a medical device. In addition, FDA regulations andguidance are often revised or reinterpreted by the agency in ways that maysignificantly affect our business and our products. It is impossible to predictwhether legislative changes will be enacted or FDA regulations, guidance or interpretationschanged, and what the impact of such changes, if any, may be.

 

Without limiting thegenerality of the foregoing, last year, the Food and Drug AdministrationAmendments Act of 2007 (the “Amendments”) were enacted. The Amendments require,among other things, that the FDA propose, 

 

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and ultimately implement, regulations that will require manufacturers tolabel medical devices with unique identifiers unless a waiver is received fromthe FDA. Once implemented, compliance with those regulations may require us totake additional steps in the manufacture of our products and labeling Thesesteps may require additional resources and could be costly. In addition, theAmendments will require us to, among other things, comply with clinical trialregistration requirements once our clinical trials are initiated.

 

**A failure to successfully implement a “patient pay” salesmodel prior to establishing third party reimbursement would have a materialadverse effect on our product sales and financial results.**

 

Until third-partyreimbursement coverage for the ProUroScan System procedure is established, ifat all, we anticipate using a “patient pay model” for physicians to receivepayment. Under a patient pay model, in the absence of coverage from theirhealth insurance, patients pay for the scan out of their own funds. Any failureto successfully establish a patient pay model would have a material adverseeffect on our product sales and financial results.

 

**The financial success of the ProUroScan System andother future medical device products will materially depend on our ability toobtain coverage and reimbursement for them.**

 

The financial success of theProUroScan System and other medical device products will materially depend onthe scope of coverage for each device and the ability of medical serviceproviders to obtain third-party reimbursement from private and public insurancesources, such as Medicare, Medicaid and private payors. It is difficult topredict the timing and outcome of coverage and reimbursement decisions. Therecan be no assurance that coverage and reimbursement will be obtained or will beobtained at a level that will provide a suitable return to providers ofservices using our technology.

 

Because the incidence ofprostate cancer increases with age, we expect that a significant percentage ofour patients will be Medicare beneficiaries. Obtaining Medicare coverage andreimbursement will be critical to our success. Ensuring adequate Medicarecoverage and reimbursement, however, can be a lengthy and expensive endeavorand we cannot provide assurances that we will be successful.

 

Significantly, the U.S.Congress may pass laws that impact coverage and reimbursement for healthcareservices, including Medicare reimbursement to physicians and hospitals.Furthermore, many private payors look to Medicare’s coverage and reimbursementpolicies in setting their coverage policies and reimbursement amounts. If theCenters for Medicare and Medicaid Services (“CMS”), the federal agency thatadministers the Medicare program, or Medicare contractors limit coverage orpayments to physicians for the ProUroScan System, private payors may similarlylimit coverage or payments. In addition, state legislatures may enact lawslimiting or otherwise affecting the level of Medicaid reimbursement forprocedures using the ProUroScan System. As a result, physicians may notpurchase our ProUroScan System, and, consequently, our business and financialresults would be adversely affected.

 

We do not currently receivecoverage and reimbursement from any party for the use of our products becausewe have no products fully developed and currently available for sale in themarketplace. As a result, we have not taken any steps to obtain approval forcoverage and reimbursement for the use of the ProUroScan System.

 

**Our failure to receive the third-party coverage forour products could result in diminished marketability of our products.**

 

Generally, Medicare does notcover and pay for items and services that are not reasonable or necessary forthe diagnosis or treatment of illness or injury or to improve the functioningof a malformed body member. This means that Medicare does not usually cover andpay for preventative services, including routine screening tests for patientswho do not present with any signs or symptoms of disease, unless the lawspecifically provides for such preventative coverage. Such statutory coveragecurrently exists for prostate cancer screening tests. Specifically, the lawstates that Medicare will cover a prostate screening test that consists of aDRE and/or a PSA test provided for the purpose of early detection of prostatecancer to a man over 50 years of age who has not had such test during thepreceding year. In addition, the law provides the Secretary of Health and HumanServices (the “Secretary”) the authority to cover 

 

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other prostate screening tests based upon changes in technology andstandards of medical practice, availability, effectiveness, costs and otherfactors deemed appropriate by the Secretary. Thus, for the ProUroScan System toreceive Medicare coverage as a prostate screening test, the Secretary wouldneed to add the scan to the list of appropriate procedures for prostate cancerscreening. This could be a significant hurdle for the ProUroScan System toreceive Medicare coverage as a prostate screening test. Additionally, Congressrecently created an alternative pathway for Medicare to cover preventativeservices. Preventative services that receive a grade “A” or “B” by the UnitedStates Preventive Services Task Force (USPSTF) are eligible for Medicarecoverage. The USPSTF does not currently recommend prostate cancer screeningwith either grade.

 

We anticipate, however, thatthe ProUroScan System may be covered by Medicare as a diagnostic test forpatients who have clinical signs or symptoms of disease. Obtaining Medicarecoverage as a diagnostic test is more straightforward as long as the test isreasonable and necessary. For example, the PSA test is covered as a diagnostictest when used to differentiate benign from malignant disease in men with lowerurinary tract signs and symptoms (e.g., hematuria, slow urine stream,hesitancy, urgency, frequency, nocturia and incontinence) as well as withpatients with palpably abnormal prostate glands on physician exam, and inpatients with other laboratory or imaging studies that suggest the possibilityof a malignant prostate disorder. We anticipate that the first generation ofthe ProUroScan System will be used to map the prostate and to maintainhistorical records for future tracking for men who have an abnormal DRE orother signs or symptoms of disease. Thus, providers who perform prostatemapping using the first generation ProUroScan System likely will seek Medicarecoverage and payment as a diagnostic, rather than a screening test. Even as adiagnostic test, however, CMS or its contractors could determine thatprocedures using the ProUroScan System are not medically necessary andtherefore decide not to cover them.

 

**Even if covered, our failure to receive appropriatereimbursement from third-party payors could slow market uptake of our products.**

 

Regardless of whether theProUroScan System is covered as a screening tool or a diagnostic test, there isa risk that Medicare and other payors will bundle payment for it into thepayment for a covered office visit furnished to the patient on the same day.For example, Medicare currently bundles billing and payment for a DRE intopayment for a covered evaluation and management office visit when the twoservices are furnished to a Medicare beneficiary on the same day. If the DRE isthe only service or is provided as part of an otherwise non-covered service, itmay be separately paid if other coverage requirements are met. On the otherhand, the PSA typically is separately paid as a clinical diagnostic laboratoryservice. Specifically, CMS could determine that due to the ease and shortamount of time needed to perform the ProUroScan System procedure, separatereimbursement is not warranted if the physician already is billing an officevisit.

 

In order for physicians andproviders who perform procedures using the ProUroScan System to receiveseparate reimbursement, they must bill a Current Procedure Terminology (“CPT”)code that appropriately describes the service performed. Although initiallyphysicians and providers will be able to bill a miscellaneous code to submitclaims for ProUroScan System procedures, eventually we will want to apply for aunique CPT code. The CPT application process is lengthy, and there is noguarantee that we will receive a unique CPT code or that we will receive aunique CPT code in a timely manner. Should we receive a unique CPT code, thecode is then valued for purposes of receiving reimbursement by the AmericanMedical Association’s Relative Value Scale Update Committee. The valuationprocess depends on the amount of time the procedure takes and difficulty ofwork involved, the practice expense and the malpractice expense associated withusing the ProUroScan System. CMS then takes the recommendation of thiscommittee into account when establishing the reimbursement amount. The amountof reimbursement the physician will receive generally depends on the valuesassigned to the various components of the procedure multiplied by a conversionfactor. This value is updated annually as part of the Medicare Physician FeeSchedule. There is no guarantee that this process will result in an appropriatelevel of reimbursement or an amount that supports the price and revenues wehave projected.

 

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**Even if a unique CPT code is obtained for the test,the level of reimbursement established may not provide adequate economicincentive to physicians, which could deter them from using our products andlimit our sales growth.**

 

At this time, we do not knowthe extent to which physicians or providers would consider third-partyreimbursement levels adequate to cover the cost of our products. Failure byphysicians or providers to receive an amount that they consider to be adequatereimbursement could deter them from using our products and limit our salesgrowth. In addition, Medicare physician fee schedule payments may decline overtime, which could deter physicians from using the ProUroScan System. Ifphysicians or providers are unable to justify the costs of the ProUroScanSystem or they are not adequately compensated for using our product, they mayexperience an economic disincentive to purchase or use them, which wouldsignificantly harm our business.

 

Notwithstanding current orfuture FDA clearances, if granted, third-party payors may deny reimbursement ifthe payor determines that the ProUroScan System is unnecessary, inappropriate,not cost-effective or experimental, or is used for a non-approved indication.Further, all third-party payors, whether governmental or private, whetherinside the U.S. or outside, are developing increasingly sophisticated methodsof controlling healthcare costs. These cost control methods include prospectivepayment systems, capitated rates, benefit redesigns, or pre-authorizationrequirements. Increased scrutiny particularly is being placed on medicalimaging. Additionally, payors are emphasizing and covering wellness andhealthier lifestyle interventions and other cost-effective methods ofdelivering healthcare in exchange for covering more procedures. These costcontrol methods also potentially limit the amount that healthcare providers maybe willing to pay for medical technology which could, as a result, adverselyaffect our business and financial results. In addition, in the U.S., no uniformpolicy of coverage and reimbursement for medical technology exists among allthird party payors. Therefore, coverage and reimbursement for medicaltechnology can differ significantly from payor to payor. There also can be noassurance that current levels of reimbursement will not be decreased oreliminated in the future, or that future legislation, regulation, orreimbursement policies of third-party payors will not otherwise adverselyaffect the demand for the ProUroScan System or our ability to sell theProUroScan System on a profitable basis.

 

**If we commercialize the ProUroScan System, we will besubject, directly or indirectly, to federal and state healthcare fraud andabuse laws and regulations and could face substantial penalties if we areunable to fully comply with such laws.**

 

Although we do not controlreferrals of healthcare services or directly bill Medicare, Medicaid or otherthird-party payors directly, many healthcare laws and regulations will apply toour business. For example, we could be subject to healthcare fraud and abuseand patient privacy regulation and enforcement by both the federal governmentand the states in which we conduct our business. The healthcare laws andregulations that may affect our ability to operate include:

 

·                  the federal healthcare programs’Anti-Kickback Law, which prohibits, among other things, persons or entitiesfrom soliciting, receiving, offering or providing remuneration, directly orindirectly, in return for or to induce either the referral of an individualfor, or the purchase order or recommendation of, any item or service for whichpayment may be made under a federal healthcare program such as the Medicare andMedicaid programs;

 

·                  federal false claims laws which prohibit,among other things, individuals or entities from knowingly presenting, orcausing to be presented, claims for payment from Medicare, Medicaid, or otherthird-party payors that are false or fraudulent, or are for items or servicesnot provided as claimed, and which may apply to entities like us to the extentthat our interactions with customers may affect their billing or codingpractices;

 

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·                  the federal Health Insurance Portability andAccountability Act of 1996, or HIPAA, which established new federal crimes forknowingly and willfully executing a scheme to defraud any healthcare benefitprogram or making false statements in connection with the delivery of orpayment for healthcare benefits, items or services, as well as leading toregulations imposing certain requirements relating to the privacy, security andtransmission of individually identifiable health information; and

 

·                  state law equivalents of each of the abovefederal laws, such as anti-kickback and false claims laws which may apply toitems or services reimbursed by any third-party payor, including commercialinsurers, and state laws governing the privacy of health information in certaincircumstances, many of which differ from each other in significant ways andoften are not preempted by HIPAA, thus complicating compliance efforts.

 

The healthcare sector is,and in recent years has been, under heightened scrutiny as the subject of governmentinvestigations and enforcement actions involving manufacturers who allegedlyoffered unlawful inducements to potential or existing customers in an attemptto procure their business, including specifically arrangements with physicianconsultants. We may have arrangements with physicians and other entities whichmay be subject to scrutiny. For example, we may lease the ProUroScan System tophysicians or others through consulting agreements. Payment for theseconsulting services sometimes may be in the form of cash, stock options orroyalties. If our operations are found to be in violation of any of the lawsdescribed above or any other governmental regulations that apply to us, we maybe subject to penalties, including civil and criminal penalties, damages,fines, exclusion from the Medicare and Medicaid programs, and the curtailmentor restructuring of our operations. Any penalties, damages, fines, exclusions,curtailment or restructuring of our operations could adversely affect ourability to operate our business and our financial results. The risk of ourbeing found in violation of these laws is increased by the fact that many ofthese laws are broad and their provisions are open to a variety ofinterpretations. Any action against us for violation of these laws, even if wesuccessfully defend against it, could cause us to incur significant legalexpenses and divert our management’s attention from the operation of ourbusiness. If the physicians or other providers or entities with whom we dobusiness are found to be non-compliant with applicable laws, they may besubject to sanctions, which could also have a negative impact on our business.

 

**Any failure in our efforts or our contractor’s effortsto train physicians or other medical staff could result in lower than expectedproduct sales.**

 

A critical component of oursales and marketing efforts is the training of a sufficient number ofphysicians and other medical staff to properly use the ProUroScan System. Werely on physicians and other medical staff to devote adequate time to learn touse our products. Convincing physicians and other medical staff to dedicate thetime and energy for adequate training in the use of our system may bechallenging, and we cannot guarantee that this will occur. If physicians andother medical staff are not properly trained, they may misuse or ineffectivelyuse our products. Insufficient training may result in unsatisfactory patientoutcomes, patient injury and related liability or negative publicity, whichcould have an adverse effect on our product sales or create substantialpotential liabilities.

 

**Rapid technological change in our competitivemarketplace may render the ProUroScan System obsolete or may diminish ourability to compete in the marketplace.**

 

The prostate cancerdetection, imaging and medical device markets are extremely competitive,dominated by large and well financed competition and are subject to rapidtechnological advances and changes. The discovery of new technologies andadvances in the application of such technologies to the medical marketplace ingeneral, and the market for urology-based imaging products in particular, mayrender our products obsolete or non-competitive. Any such changes and advancescould force us to abandon our currently proposed products, which would have amaterial adverse effect on our business.

 

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**We may not be able to enter into manufacturingagreements or other collaborative agreements on terms acceptable to us, if atall, which could have a material adverse effect on our business.**

 

We cannot be sure that wewill be able to enter into manufacturing or other collaborative arrangementswith third parties on terms acceptable to us, if at all. If we fail toestablish such arrangements when, and as necessary, we could be required toundertake these activities at our own expense, which would significantlyincrease our capital requirements and may delay the development, manufacturingand commercialization of our products. If we are unable to address thesecapital requirements, it may have a material adverse effect on our business.

 

**We expect to rely materially on Artann and otherconsultants and contractors, some of whom may be partially or wholly paidthrough issuances of common stock dilutive to our shareholders.**

 

We materially rely onconsultants and contractors to perform a significant amount of research anddevelopment, pre-manufacturing, clinical, regulatory and marketing activities.Specifically, over the contract periods of the Artann License Agreement and theArtann Development Agreement, we expect to issue equity securities to Artannvalued up to $2.5 million ($500,000 of which was issued in January, 2009).We expect that certain other consultants and contractors will also acceptpayment of a portion of their compensation in the form of our equitysecurities. Any such issuances would be dilutive to shareholders.

 

**We are highly dependent on the services provided bycertain key personnel.**

 

We are highly dependent uponthe services of our sole executive officers, Richard Carlson and Richard Thon.We have not obtained “key-man” life insurance policies insuring the lives ofeither of these persons. If the services of either of these persons becomeunavailable to us, for any reason, our business could be adversely affected.

 

**If we lose our right to license and use from Artanncertain critical intellectual property for any reason, our entire businesswould be in jeopardy.**

 

If we breach or fail toperform the material conditions including payment obligations of, or fail toextend the term of, the agreement with Artann that licenses criticalintellectual property, we may lose all or some of our rights to such criticalintellectual property and our license may terminate. If we should lose ourright to license and use technology covered by such license that is critical toour business, such loss would have a materially adverse effect on our business.In such a case, the viability of the Company would be in question. Our onlyalternatives would be to find existing and non-infringing technology to replacethat lost, if any exists, or develop new technology ourselves. The pursuit ofany such alternative would likely cause significant delay in the developmentand introduction of our proposed products.

 

**The protections for our key intellectual property maybe successfully challenged by third parties.**

 

We own various keyintellectual properties. No assurance can be given that any intellectualproperty claims will not be successfully challenged by third parties. Anychallenge to our intellectual property, regardless of merit, would likelyinvolve costly litigation which could have a material adverse effect on our business.If a successful challenge were made to intellectual property that is criticalto our proposed products, the pursuit of any such alternative would likelycause significant delay in the development and introduction of such products.Moreover, a successful challenge could call into question the validity of ourbusiness.

 

**As we lose patent protection on our criticaltechnologies, it may have a material adverse effect on our business.**

 

We rely on certain patentsto provide us with exclusive rights for our technology. The first of ourprimary patents on our core technology will expire in December 2012. As webegin to lose certain patent protections on our prostate-imaging systems andrelated critical patented technologies, we may face strong competition as aresult, which could have a material adverse effect our business.

 

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**The government has rights to certain of our patents.**

 

Certain of our patentsemanated from work performed by Artann under grants from the NationalInstitutes of Health (“NIH”). As a result, certain standard NIH grantobligations apply, which are designed to ensure that the U.S. investment isused in the interest of U.S. industry and labor and that inventions arereported to NIH. Additionally, the U.S. government retains a non-exclusivelicense to these patents. As a non-exclusive licensee of certain of thesepatents, the U.S. government, in addition to utilizing the inventions itself,could in certain limited circumstances, request additional licenses to thepatents be granted to other parties and, if such license request is refused,grant the licenses itself. Any actions by the U.S. government to require thegrant of additional licenses could materially and adversely affect ourbusiness.

 

**We may not be able to successfully compete againstcompanies in our industry with greater resources, or with any competition.**

 

If our development plan issuccessful, we expect to experience significant competition in the medicaldevice market. Although we believe that we may currently have a niche in theprostate-imaging marketplace, many factors beyond our control will likelyencourage new competitors. In particular, there are several large companiesthat have indicated an interest in the prostate-imaging business. Therefore, noassurance can be given that we will be able to successfully compete with these,or any other companies in the marketplace, if at all.

 

**The Shares and Warrants issued in the 2009 PublicOffering constitute an “ownership change” as defined by the Internal RevenueCode of 1986, as amended (the “Code”) and our ability to use operating losscarryforwards to offset income in future years will be limited.**

 

As of December 31,2008, the Company had generated net operating loss carryforwards ofapproximately $5.0 million which, if not used, will begin to expire in2021. Federal and state tax laws impose significant restrictions on theutilization of net operating loss carryforwards in the event of a change inownership of the Company that constitutes an “ownership change,” as defined by Section 382of the Code. The Company has analyzed the public offering of approximately $3.1million of our equity securities with net proceeds to the Company ofapproximately $1.9 million (the “2009 Public Offering”) along with previouschanges and believes that such an ownership change has not occurred, and thatthe Company’s use of its net operating loss carryforwards is not subject tosuch restrictions.

 

**Our business and products subject us to the risk ofproduct liability claims.**

 

The manufacture and sale ofmedical products and the conduct of clinical trials using new technology involvecustomary risks of product liability claims. There can be no assurance that ourinsurance coverage limits will be adequate to protect us from any liabilitieswhich we might incur in connection with the clinical trials or thecommercialization of any of our products. Product liability insurance isexpensive and in the future may not be available on acceptable terms, if atall. A successful product liability claim or series of claims brought againstus in excess of our insurance coverage would have a material adverse effect onour business. In addition, any claims, even if not ultimately successful, couldhave a material adverse effect on the marketplace’s acceptance of our products.

 

**We have never paid dividends and do not expect to paydividends in the foreseeable future.**

 

We have never paid dividendson our capital stock and do not anticipate paying any dividends for theforeseeable future. Future debt covenants may prohibit payment of dividends.

 

**ITEM 1B:                              UNRESOLVED STAFFCOMMENTS**

 

Not applicable.

 

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** **

**ITEM 2:  PROPERTIES**

 

Our executive offices are located at 6440 FlyingCloud Drive, where we rent approximately 500 square feet of office space on amonth-to-month basis.  Our rental costfor this office space is approximately $550 per month, which we believe is atmarket for similar office space in Minneapolis, Minnesota.  We do not own any real property.

 

**ITEM 3:  LEGAL PROCEEDINGS**

** **

Althoughwe are subject to litigation or other legal proceedings from time to time inthe ordinary course of our business, we are not a party to any pending legalproceedings and are not aware of any threatened legal proceeding.

 

**ITEM 4:  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

None.

 

**PART II**

 

**ITEM 5: MARKET FOR REGISTRANT’SCOMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITYSECURITIES**

 

***General***

 

Our common stock has beenquoted on the Over-The-Counter Bulletin Board (the “OTCBB”) since December 2003.Our common stock is currently quoted under the symbol “PUMD.” The followingtable lists the high and low bid information for our common stock as quoted onthe OTCBB by quarter from January 1, 2007 through December 31, 2008

 
| **Quarter**              | ** ** | **Price Range** | ** ** |
|--------------------------|------------|----------------------|------------|
| **Ended**                | ** ** | **High**             | ** ** | **Low** | ** ** |
| March 31,  2007     |       | $                    | 4.50       |   | $ | 2.60 |   |
| June 30,  2007      |       | $                    | 5.10       |   | $ | 2.00 |   |
| September 30,  2007 |       | $                    | 3.00       |   | $ | 0.50 |   |
| December 31,  2007  |       | $                    | 2.50       |   | $ | 0.51 |   |
| March 31,  2008     |       | $                    | 0.95       |   | $ | 0.30 |   |
| June 30,  2008      |       | $                    | 2.01       |   | $ | 0.30 |   |
| September 30,  2008 |       | $                    | 3.05       |   | $ | 0.30 |   |
| December 31,  2008  |       | $                    | 1.85       |   | $ | 0.41 |   |

 

The above quotations fromthe OTCBB reflect inter-dealer prices, without retail mark-up, mark-down orcommission, and may not represent actual transactions. The number of holders ofrecord of our common stock as of March 23, 2009 wasapproximately 165.

 

***Dividend Policy***

 

We have never declared orpaid any cash dividends on our capital stock and do not expect to pay anydividends for the foreseeable future. We intend to use future earnings, if any,in the operation and expansion of our 

 

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business. Any future determination relating to our dividend policy willbe made at the discretion of our board of directors, based on our financialcondition, results of operations, contractual restrictions, capitalrequirements, business properties, restrictions imposed by applicable law andother factors our board of directors may deem relevant. Future debt covenantsmay prohibit payment of dividends.

 

**Recent Sales ofUnregistered Securities**

 

The issuances of oursecurities listed below were made in reliance on exemption from registrationunder Section 4(2) of the Securities Act of 1933, as amended (the “SecuritiesAct”), as we reasonably believed that the investors were sophisticated, that nogeneral solicitations were involved and the transactions did not otherwiseinvolve a public offering.

 

***Common Stock and Warrant Issuances***

 

On October 24, 2008,pursuant to a June 1, 2006 promissory note and amendments thereto, weissued to Roman Pauly a 5-year warrant (immediately exercisable) topurchase 31,817 shares of our common stock at an exercise price of $5.00 pershare and a 5-year warrant (immediately exercisable) to purchase 3,000 sharesof our common stock at an exercise price of $1.50 per share.

 

On October 31, 2008, weissued a total of 17,778 shares of our common stock and five-year,immediately exercisable warrants to purchase in the aggregate44,445 shares of our common stock at a price of $2.00 per share to JamesDavis, Bruce Culver and William Reiling pursuant to the terms of the October 31,2007 extensions of their guarantees of our Crown Bank loans.

 

On October 31, 2008, weissued 6,667 shares of our common stock and a five-year, immediatelyexercisable warrant to purchase 16,667 shares of our common stock at aprice of $2.00 per share to the Smith Family Trust pursuant to the terms of a$600,000 promissory note dated October 31, 2007.

 

***Unit Put Agreements***

 

On September 16, 2008,we received $325,000 of funding commitments to purchase $325,000 of units inaccordance with the terms of a unit put agreement (the “Unit Put Agreement”).Upon our exercise of the put, each investor that has signed a Unit PutAgreement agreed to purchase the units being put by us on a pro rata basiswithin 5 days after receiving the put notice from us.

 

Each unit consists of a notein the principal amount of $9,500 and a warrant to purchase 2,000 sharesof our common stock. The purchase price of the warrant portion of each unit is$500. The notes bore interest at ten percent per year, mature on the18-month anniversary of the date of the Unit Put Agreement, and converted intocommon stock at $0.70 per share (based on 70% of the 2009 Public Offeringprice). The warrants will be exercisable immediately upon issuance and willremain exercisable until December 31, 2012 at an exercise price of$1.00 per share.

 

In consideration of eachpurchaser’s future funding commitment, each purchaser received an originationwarrant (“Origination Warrants”) to purchase 1,000 shares of our commonstock for each $10,000 unit that an investor committed to purchase. EachOrigination Warrant is exercisable until December 31, 2012 at an exerciseprice of $1.00 per share. We have issued Origination Warrants to purchasean aggregate 32,500 shares of our common stock, although 1,000 of suchwarrants were forfeited due to a failure to fulfill a $10,000 obligation underthe Unit Put Agreement.

 

On September 16, 2008,we exercised $162,500 of our put options under the Unit Purchase Agreement, andupon the September 24, 2008 closing thereof, issued Unit Put Notes in theprincipal amount of $154,375 and 32,500 

 

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Unit Put Warrants. On October 17,2008, we exercised the remaining $162,500 of our put options and on October 28,2008 and December 11, 2008, closed on put options of $127,500 and $25,000,respectively. Pursuant to the October 28, 2008 and December 11, 2008closings, we issued Unit Put Notes in the principal amount of $121,125 and$23,750, respectively, along with 25,500 and 5,000 Unit Put Warrants,respectively.

 
| **ITEM 6:** | ** ** | **SELECTED FINANCIAL DATA** |
|-------------|------------|-----------------------------|

 

Not applicable.

 
| **ITEM  7:** | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION****AND RESULTS OF OPERATIONS** |
|--------------|------------|----------------------------------------------------------------------------------------------------|

 

The following discussion ofour financial condition and results of operations should be read in conjunctionwith our consolidated financial statements, and notes thereto, included in thisAnnual Report on Form 10-K. This discussion should not be construed toimply that the results discussed herein will necessarily continue into thefuture, or that any conclusion reached herein will necessarily be indicative ofactual operating results in the future.

 

***Results of Operations***

 

*Current Operations*

 

We currently employ only twoemployees. We conduct our research and development, market research, regulatoryand other business operations through the use of consultants and medical devicedevelopment contractors, primarily Artann. We believe that using consultantsand contractors to perform these functions is more cost effective than hiringfull-time employees and affords us flexibility in directing our resourcesduring our development stage. During the first half of 2009, we expect tocomplete the clinical and regulatory process leading to FDA 510(k) marketclearance and establish strategic marketing and contract manufacturingrelationships in anticipation of regulatory clearance to enter the market.

 

We incur ongoing expensesthat are directly related to being a publicly traded company, includingprofessional audit and legal fees, financial printing, press releases andtransfer agent fees. We currently rent approximately 500 square feet of officespace on a month-to-month basis at a cost of approximately $550 per month.Other expenses incurred include executive officer compensation, travel,insurance, telephone, supplies and other miscellaneous expenses.

 

Pursuant to the terms of theArtann Development Agreement, we are required to make cash and equity paymentsupon the achievement of several project milestones along with a monthlyretainer fee.  Upon the submission of our510(k) application to the FDA, we are to make a cash payment to Artann of$250,000 and an equity payment of our common shares valued at $1,000,000. Uponreceipt of FDA 510(k) clearance, we are to make a further cashpayment of $750,000 and a second $1,000,000 equity payment.  In addition, we expect to make cash paymentsto Artann totaling approximately $150,000 for development services they are toprovide during the last nine months of 2009. See “ProUroScan System Development Partner” for more information.

 

During the remainder of2009, assuming that we are successful in obtaining FDA clearance on ourProUroScan system, we expect to engage contract manufacturing, engineering andclinical resources to produce our products as we begin to commercialize ourproduct.  As we build inventory, andultimately accounts receivable as a result of our commercialization activity,we will require an estimated $800,000 by year end to fund this build-up ofworking capital.  In addition, we expectto hire approximately eight employees in the areas of manufacturing management,marketing, sales training, administration and quality assurance. Consequently,our operating expenses will increase sharply during the second half of theyear.  We estimate that we will requirebetween $600,000 and $650,000 to fund staff compensation costs over the lastthree quarters of 2009.  During this sameperiod, we expect to 

 

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supplement our internal resources by the use of consultant andcontracted personnel.  We estimate thecost of such contracted resources to be approximately $400,000.

 

*Year endedDecember 31, 2008 compared to the year ended December 31, 2007:*

 

*OperatingExpenses/Operating Loss.*  Our operating loss equals our operatingexpenses because we have no revenue. For the year ended December 31, 2008,our operating expenses (and our operating loss) were $4,657,717, an increased lossof $1,544,420 or 50 percent, compared to $3,113,297 last year.

 

Total employee compensationand benefits costs decreased to $390,797 from $972,731 last year, or60 percent. In the year ended December 31, 2007, we incurredstock-based compensation of $316,500 related to the extension of the exerciseperiod of certain stock options and warrants issued pursuant to separationagreements with three former employees. The remaining compensation expensereduction came primarily as a result of the termination of the three employeesin early 2007 and reduced stock option expense, as certain options granted inprior years became fully expensed in 2007. General and administrative expenses in 2008 also included $1,100,000related to technology licensing from Artann under the Artann LicensingAgreement, with $600,000 to be paid in cash and $500,000 to be paid in commonstock.  Fees for legal services in theyear ended December 31, 2008 increased $93,016, or 78 percent,compared to last year, due to legal fees associated with our negotiations withArtann, one-time costs of our reverse stock split, the filing of ourRegistration Statement on Form S-8 and other SEC filings and patentrelated legal expenses. Fees accrued or paid to outside directors increased to$70,717 for the year ended December 31, 2008 compared to $25,417 lastyear, due primarily to a one-time stock grant to the directors in recognitionof their efforts in our repositioning and financing since the beginning of2007.

 

Research and developmentcosts in the year ended December 31, 2008 were $597,755.  This represents an increase of $454,127, or316 percent, compared to the $143,628 recognized as research anddevelopment expense during the year ended December 31, 2007.  The 2008 research and development expenseamount included $250,000 of expense related to Artann’s achievement of thefirst project milestone under the Artann Development agreement, additionalresearch and development expenses totaling $50,000 related to work performed byArtann under our development agreement, and the expensing of our $300,000acquisition of certain intellectual property and know-how from Profile. Fiscal2007 expenses included a $35,000 payment and the issuance of warrants valued at$72,000 to Artann pursuant to a cooperation agreement signed in April 2007and $24,407 of research costs related to a prostate visioning system project.

 

*InterestExpense.*  Total interest expense for the year ended December 31,2008 was $1,910,037, an increase of $597,817 or 46 percent, compared to $1,312,220last year. The increased interest expense can be attributed to the issuance of$1,900,000 of convertible notes in our 2007 and 2008 private placements,$299,250 of convertible notes in our September 2008 unit put offering, and$262,500 of convertible notes related to our April 2008 acquisition ofintellectual property from Profile. Amortization of the original issue discount attributable to shares ofcommon stock issued, warrants issued and beneficial conversion features relatedto these notes resulted in $1,055,453 of recorded interest expense in the yearended December 31, 2008 compared to $446,359 in the year ended December 31,2007.  Amortization of debt issuancecosts related to the notes issued and outstanding during the years ended December 31,2008 and 2007 was $421,564 and $506,639, respectively.  Interest expense based on stated interestrates was $433,020 and $359,222 during the years ended December 31, 2008and 2007, respectively.

 

*DebtExtinguishment Cost.*  Our total debt extinguishment cost for theyear ended December 31, 2008 was $123,785, a decrease of 64 percent,compared to $343,454 last year. Our debt extinguishment cost resulted primarilyfrom the cost of warrants issued in connection with the amendment of certainshort term loans to defer their maturity dates. The year-to-year decrease was aresult of the repayment of a significant portion of these outstanding shortterm loans in late 2007 and early 2008.

 

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*Year ended December 31, 2007 compared to theyear ended December 31, 2006:*

 

*OperatingExpenses/Operating Loss.*  Our operating expenses equal our operatingloss because we have no revenue. A 21 percent decrease in our operatingexpenses for the year ended December 31, 2007 compared to the prior year,from $1,842,169 to $1,448,902, was directly related to our efforts torestructure the Company, with an emphasis on minimizing costs and conservingcash while repositioning the Company and raising capital to fund development.In late 2006, our former CEO retired. In the first quarter of 2007, twoadditional executive level positions were eliminated. These moves resulted in areduction of salaries, payroll taxes and benefits from $935,705 during the yearended December 31, 2006 to $423,347 in 2007, a savings of $512,358 or55 percent. Offsetting this was a 41 percent increase in stock-basedcompensation, from $389,034 to $549,384 in those same periods related to theextension of exercise periods of certain options and warrants of the departingexecutives pursuant to termination agreements. In December we moved ourheadquarters into a smaller facility, resulting in a reduction of rent expensefrom $47,519 in 2006 to $21,286 in 2007, saving $26,233 or 55 percent.

 

Research and developmentcosts for the year ended December 31, 2007 were $143,628, a decrease of$102,491, or 42 percent, compared to 2006. The 2007 research anddevelopment costs included the issuance of warrants valued at $72,000 and cashpayments of $45,000 to Artann pursuant to a cooperation agreement signed in April 2007and $24,407 of research costs related to a prostate visioning system project.Research and development costs in 2006 consisted of contracted development workon our ProUroScan System and a subsequently abandoned prostate visioning systemproject.

 

*InterestExpense.*  Interest expense for the year ended December 31,2007 was $1,312,220 compared to $1,089,762 in 2006, an increase of $222,458 or20 percent. The majority of our recorded interest expense represents thecost of warrants issued in conjunction with debt issuances and the cost ofcertain convertible features of debt issuances. $952,998of the 2007 interest expenseand $802,475 of the 2006 interest expense related to the cost of warrants andconvertible debt features. The increased interest expense is the result of anincrease in the average amount of debt outstanding over the course of 2007compared to 2006 used to fund operations.

 

*Debt Extinguishment Cost.*  Debtextinguishment costs for the year ended December 31, 2007 was $353,454,compared to $27,922 in 2006. These expenses represent primarily the cost ofwarrants issued in connection with the amendment of certain short term loansmade to defer their maturity dates in late 2006 and early 2007, and theissuance of stock and warrants pursuant to the refinancing of $600,000 of debtwith the Smith Trust in October 2007.

 

***Liquidity and Capital Resources***

 

*Assets; Property Acquisitions and Dispositions*

 

Our primary assets arepatents and patent applications, which are the foundation for our proposedproduct offerings. These assets secure $1,600,000 of senior bank notes anda note issued to an investor in the amount of $600,000 and, as a result, arenot available to secure other senior debt financing.

 

We anticipate purchasingapproximately $400,000 of tooling molds and other capital for production,computer equipment, software and general office furniture and equipment duringthe remainder of 2009. We do not anticipate selling any significant assets inthe near term.

 

*Purchase of Patents*

 

On April 3, 2008, wepurchased certain previously-licensed patents, patent applications, andknow-how (the “Profile Assets”) associated with imaging technology from ProfileL.L.C., a Delaware limited liability company 

 

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(“Profile”), pursuant to an asset purchase agreement. The purchaseprice of the Profile Assets was $300,000, of which $150,000 was paid in cashand $150,000 was financed under a secured promissory note (the “Profile Note”).

 

*Recent Financings*

 

Between December 2007and July 2008, we raised a total of $2,000,000 (including conversion of$175,000 of existing debt) from the sale of convertible promissory notes andwarrants in four private placements.

 

In connection with thepurchase of the Profile Assets, on April 3, 2008 we borrowed an aggregateof $112,500 pursuant to three convertible promissory notes each in the amountof $37,500. Payment in full of the promissory notes and the interest accruedthereon at an annual rate of 10% became due on December 31, 2008. In January 2009, following the closingof the 2009 Public Offering, we repaid $45,500 of the notes, and $29,500 of thenotes were converted into common stock at $0.70 per share (based on 70 percentof the 2009 Public Offering price).  On March 19,2009, the remaining $37,500 promissory note and accrued interest thereon, dueto Mr. James Davis, was refinanced along with another $150,000 promissorynote due to Mr. Davis (see below).

 

On September 16, 2008,we received funding commitments to purchase $325,000 of units in accordance withthe terms of a unit put agreement (the “Unit Put Agreement”) (such fundingcommitments, the “Unit Put Arrangements”). Between September 2008 and December 2008, we raised $315,000from the sale of convertible promissory notes and warrants pursuant to the UnitPut Arrangements.

 

On September 25, 2008,we borrowed $150,000 pursuant to a promissory note issued in favor of Mr. Davis.As consideration for providing the loan, we issued an immediately exercisable,five-year warrant to purchase 100,000 shares of our common stock at $1.50 pershare to Mr. Davis. The proceeds of the loan were used to retire the$150,000 principal amount of the Profile Note.**** Payment in full of the promissory notes andthe interest accrued thereon at an annual rate of 10 percent was due sevendays after the closing date of the 2009 Public Offering.  On March 19, 2009, Mr. Davis agreedto refinance the $150,000 debt (and $7,291 of interest accrued thereon) alongwith a $37,500 note (and $3,646 of accrued interest thereon), another $2,632payable to Mr. Davis, and $15,293 of expenses paid by Mr. Davis onour behalf.  Mr. Davis also agreedto loan to us an additional $64,638 to pay for our exhibition of the ProUroScansystem at the annual American Urology Association meeting, the retention of aninvestor relations firm and the initiation of a clinical advisory board.  He also agreed to have certain websitemaintenance services performed for us. Pursuant to the refinancing and the other arrangements, we issued a$281,000 unsecured convertible promissory note to Mr. Davis.  The promissory note matures on March 19,2010, bears no interest, and is convertible into our common stock at $0.55 pershare at the option of Mr. Davis.

 

On January 12, 2009, weclosed on the 2009 Public Offering.  Weexpect that the $1,880,000 net proceeds of that offering will be sufficient tofund our cash obligations under the Artann Development Agreement and the ArtannLicense Agreement and to finance our operating expenses up to receipt of FDA510(k) clearance, as described in “Current Operations” above, and toretire certain short-term liabilities. However, if our product developmentefforts experience significant unforeseen delays, we may not have sufficientfunds to complete these objectives, and will require additional financing. Wedo not expect the funds from the 2009 Public Offering to be sufficient for usto initiate any significant market launch or scale-up manufacturingcapabilities. In addition, we need funding beyond the net proceeds of the 2009Public Offering to pay, for example, up to $1,000,000 of future payments toArtann related to their achievement of FDA 510(k) clearancemilestones.

 

The closing of the 2009Public Offering triggered the automatic conversion of certain debt instrumentsinto equity, as follows:

 

·                  $733,334 convertible debentures together with$143,815 of interest accrued thereon converted into 292,384 shares of ourcommon stock.

 

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·                  $1,900,000 of convertible notes issued in the2007 and 2008 private placements together with $177,882 of interest accruedthereon converted into 3,058,381 Units.

 

·                  $299,250 of convertible notes issued pursuantto the Unit Put Arrangement together with $9,563 of interest accrued thereonconverted into 441,165 shares of our common stock.

 

*Current Financing Plans*

 

As a result of the closing on the 2009 Public Offering and thesubsequent conversion of convertible notes into Units, we have 6,108,381redeemable warrants outstanding.  Thesewarrants have an exercise price of $1.30 per share, which we may redeem oncethe last sale price of our common stock equals or exceeds $1.82 per share for aperiod of ten consecutive trading days. If this event were to occur, we intend to exercise our right to redeemthe warrants, which will allow all holders of warrants a period of 30 days toexercise their warrants.  If all suchwarrant holders exercise their warrants, we could realize up to approximately$7.9 million, depending on the number of shares actually exercised pursuant tosuch a redemption.  There can be noassurance that we will be able to redeem the warrants, or of how much would berealized if such a redemption were made.

 

During the first half of 2009, we plan to identify a distributionpartner to market our products (see Item 1, “***Marketing and Distribution”***).  We expect such a distribution partner toprovide significant financial support in the form of licensing fees, loans,equity investment or a combination of these. In addition to financial support, a successful collaboration with such apartner would allow us to gain access to down stream marketing, manufacturing,and sales support.  There can be noassurance that a distribution partner can be successfully identified andengaged during the first half of 2009, or at all.

 

In March 2009, werenewed $1.2 million of the secured debt to mature on March 28, 2010, andtemporarily paid down $400,000 of the secured debt.  We intend to re-borrow the $400,000 secureddebt before the end of May, 2009 upon the establishment of a satisfactoryguaranty of the debt with the lender.

 

We also have other shortterm liabilities, consisting of the Davis convertible promissory note describeabove, accounts payable and accrued expenses, exceeding $1,575,000  We expect to pay for these obligations fromthe proceeds of the exercise of the Unit warrants and license fees from apotential distribution partner. If we are unable to exercise the warrants orreceive financial support from a distribution partner, we will pursue one ormore additional rounds of funding in 2009 and 2010 to provide the workingcapital needed to fund a significant commercial launch into the urology market.If additional funds are raised by the issuance of convertible debt or equitysecurities, or by the exercise of outstanding warrants, then existingshareholders will experience dilution in their ownership interest. Ifadditional funds are raised by the issuance of debt or certain equity instruments,we may become subject to certain operational limitations, and such securitiesmay have rights senior to those of our existing holders of common stock.

 

If adequate funds are notavailable through these initiatives on a timely basis, or are not available onacceptable terms, we may be unable to fund expansion, or to develop or enhanceour products. If we are forced to slow our development programs, or put them onhold, it would delay regulatory clearances or approvals needed, and thus delaymarket entry for our products. Ultimately, if no additional financing isobtained beyond what has been secured to date, we likely would be forced tocease operations. There can be no assurance we will be successful in raisingsuch funds.

 

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**Off-Balance Sheet Arrangements**

 

Not applicable.

 

**Going Concern**

 

We have incurred operatinglosses, accumulated deficit and negative cash flows from operations sinceinception. As of December 31, 2008, we had an accumulated shareholders’deficit of approximately $7.3 million. These factors, among others, raisesubstantial doubt about our ability to continue as a going concern. Our consolidatedfinancial statements included in this Annual Report on Form 10-K do notinclude any adjustments related to recoverability and classification of assetcarrying amounts or the amount and classification of liabilities that mightresult should we be unable to continue as a going concern.

 

**Critical Accounting Policies**

 

Our critical accountingpolicies are policies which have a high impact on the reporting of ourfinancial condition and results, and require significant judgments andestimates. Our critical accounting policies relate to (a) the valuation ofstock-based compensation awarded to employees, directors, loan guarantors andconsultants and (b) the accounting for debt with beneficial conversionfeatures.

 

Valuation of Stock-Based Compensation

 

Effective as of August 17, 1999(inception), we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123“Accounting for Stock-Based Compensation”**(“SFAS 123”)**and on January 1, 2006adopted SFAS No. 123 (revised 2004) “**Share-Based Payment”**(“SFAS 123R”), whichrequires the measurement and recognition of compensation expense for allshare-based payment awards made to employees and directors including employeestock options based on fair values. Our determination of fair value ofshare-based payment awards is based on the date of grant using anoption-pricing model which incorporates a number of highly complex andsubjective variables. These variables include, but are not limited to, theexpected volatility of our stock price and estimates regarding projectedemployee stock option exercise behaviors and forfeitures. We recognize theexpense related to the fair value of the award straight-line over the vestingperiod.

 

Debt with Beneficial Conversion Features

 

The beneficial conversionfeatures of the promissory notes were valued using the Black-Scholes pricingmodel. The resulting original issue discount is amortized over the life of thepromissory notes using the straight-line method, which approximates the interestmethod.

 

**ITEM 7A:****QUANTITATIVE ANDQUALITATTIVE DISCLOSURES ABOUT MARKET RISK**

 

Not applicable.

** **

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**ITEM8:  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

The following financial statements areincluded:

 
| Report of Independent Registered Public Accounting  Firm       | F-2    |
|----------------------------------------------------------------|--------|
| Audited Financial  Statements:                                 |   |
| Consolidated  Balance Sheets                                   | F-3    |
| Consolidated Statements of Operations                          | F-4    |
| Consolidated Statement of Shareholders’ Equity  (Deficit) | F-5    |
| Consolidated Statements of Cash Flows                          | F-12   |
| Notes to Consolidated Financial Statements                     | F-14   |

 

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Shareholders,Audit Committee and Board of Directors

ProUroCare Medical Inc.

Eden Prairie, MN

 

We have audited theaccompanying consolidated balance sheets of ProUroCare Medical Inc. (adevelopment stage company) as of December 31, 2008 and 2007, and therelated consolidated statements of operations, shareholders’ equity (deficit)and cash flows for the years then ended and the period from August 17,1999 (inception) to December 31, 2008. These consolidated financial statements are the responsibility of theCompany’s management.  Our responsibilityis to express an opinion on these consolidated financial statements based onour audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the consolidated financial statements are free of materialmisstatement.  The Company is notrequired to have, nor were we engaged to perform, an audit of its internalcontrol over financial reporting.  Ouraudits included consideration of its internal control over financial reportingas a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on the effectivenessof the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement as well as evaluating the overall consolidated financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of ProUroCare Medical Inc. as of December 31,2008 and 2007 and the results of their operations and their cash flows for theyears then ended and the period from August 17, 1999 (inception) to December 31,2008, in conformity with U.S. generally accepted accounting principles.

 

The accompanyingconsolidated financial statements have been prepared assuming that the Companywill continue as a going concern.  Asdiscussed in Note 2 to the consolidated financial statements, the Company hasrecurring operating losses, negative cash flows from operations and requiresadditional working capital to support future operations, which raises substantialdoubt about its ability to continue as a going concern.  Management’s plans in regards to thesematters are also described in Note 2. The consolidated financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.

 

/s/ Virchow,Krause & Company, LLP

 

 

Minneapolis, Minnesota

March 24, 2009

 

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**ProUroCare Medical Inc.**

**(ADevelopment Stage Company)**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                      | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Assets**                                                                                                                      | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Current assets:                                                                                                                 |       |                            |       |                            |       |
| Cash                                                                                                                            |       | $                               | 3,900      |                            | $          | 400,613 |   |
| Restricted cash                                                                                                                 |       | 44,214                          |       | 44,000                          |       |
| Other current  assets                                                                                                           |       | 31,634                          |       | 21,733                          |       |
| Total current  assets                                                                                                           |       | 79,748                          |       | 466,346                         |       |
|                                                                                                                            |       |                            |       |                            |       |
| Equipment and  furniture, net                                                                                                   |       | —                          |       | 605                             |       |
| Deferred  offering expenses                                                                                                     |       | 729,924                         |       | 132,638                         |       |
| Debt issuance  costs, net                                                                                                       |       | 266,882                         |       | 439,321                         |       |
|                                                                                                                            |       | $                               | 1,076,554  |                            | $          | 1,038,910 |   |
| ** **                                                                                                                      |       |                            |       |                            |       |
| **Liabilities and Shareholders’ Deficit**                                                                                  |       |                            |       |                            |       |
| Current  liabilities:                                                                                                           |       |                            |       |                            |       |
| Notes payable,  bank                                                                                                            |       | $                               | 1,600,000  |                            | $          | — |   |
| Notes payable                                                                                                                   |       | 34,425                          |       | 163,143                         |       |
| Notes payable -  related parties                                                                                                |       | 634,000                         |       | 110,450                         |       |
| Convertible  debt, net of original issue discount                                                                               |       | 1,033,484                       |       | —                          |       |
| Convertible debt  - related parties, net of original issue discount                                                             |       | 1,179,913                       |       | —                          |       |
| Accounts payable                                                                                                                |       | 1,203,549                       |       | 484,375                         |       |
| Accrued license  and development fees                                                                                           |       | 1,327,835                       |       | —                          |       |
| Accrued expenses                                                                                                                |       | 937,253                         |       | 801,925                         |       |
| Total current  liabilities                                                                                                      |       | 7,950,459                       |       | 1,559,893                       |       |
|                                                                                                                            |       |                            |       |                            |       |
| Commitments and  contingencies (note 7)                                                                                         |       |                            |       |                            |       |
| Long-term bank  debt                                                                                                            |       | —                          |       | 1,600,000                       |       |
| Long-term note  payable - related parties                                                                                       |       | —                          |       | 600,000                         |       |
| Long-term  convertible debt, net of original issue discount                                                                     |       | 221,199                         |       | 353,934                         |       |
| Long-term  convertible debt - related parties net of original issue discount                                                    |       | 162,759                         |       | 616,666                         |       |
| Total  liabilities                                                                                                              |       | 8,334,417                       |       | 4,730,493                       |       |
| Shareholders’  deficit:                                                                                                    |       |                            |       |                            |       |
| Common stock,  $0.00001 par. Authorized 50,000,000 shares; issued and outstanding 1,811,429  and 1,727,311 shares, respectively |       | 18                              |       | 17                              |       |
| Additional  paid-in capital                                                                                                     |       | 13,677,932                      |       | 12,586,496                      |       |
| Deficit  accumulated during development stage                                                                                   |       | (20,935,813                     | )          | (16,278,096                     | )          |
| Total  shareholders’ deficit                                                                                               |       | (7,257,863                      | )          | (3,691,583                      | )          |
|                                                                                                                            |       | $                               | 1,076,554  |                            | $          | 1,038,910 |   |

 

See accompanying notes to financial statements.

 

F-3

----

Tableof Contents

 

**ProUroCareMedical Inc.**

**(ADevelopment Stage Company)**

**Consolidated Statements of Operations**

 
| ** **                                      | ** ** | ** **            | ** ** | ** **            | ** ** | **Period from**    | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | ** **            | ** ** | ** **            | ** ** | **August 17,**     | ** ** |
| ** **                                      | ** ** | ** **            | ** ** | ** **            | ** ** | **1999**                | ** ** |
| ** **                                      | ** ** | **Year ended**   | ** ** | **Year ended**   | ** ** | **(inception) to** | ** ** |
| ** **                                      | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,**   | ** ** |
| ** **                                      | ** ** | **2008**              | ** ** | **2007**              | ** ** | **2008**                | ** ** |
| Operating  expenses:                            |       |                  |       |                  |       |                    |       |
| Research and  development                       |       | $                     | 597,755    |                  | $          | 143,628                 |       | $ | 5,455,307 |   |
| General and  administrative                     |       | 2,026,677             |       | 1,305,274             |       | 9,831,173               |       |
| Total operating  expenses                       |       | 2,624,432             |       | 1,448,902             |       | 15,286,480              |       |
| Operating loss                                  |       | (2,624,432            | )          | (1,448,902            | )          | (15,286,480             | )          |
| Interest income                                 |       | 537                   |       | 1,278                 |       | 18,295                  |       |
| Interest expense                                |       | (1,001,551            | )          | (872,713              | )          | (3,814,474              | )          |
| Interest expense  - related parties             |       | (908,486              | )          | (439,507              | )          | (1,347,993              | )          |
| Debt  extinguishment expense                    |       | (75,571               | )          | (326,626              | )          | (430,119                | )          |
| Debt  extinguishment expense - related parties  |       | (48,214               | )          | (26,828               | )          | (75,042                 | )          |
| Net loss                                        |       | $                     | (4,657,717 | )                     | $          | (3,113,298              | )          | $ | (20,935,813 | ) |
|                                            |       |                  |       |                  |       |                    |       |
| Net loss per  common share:                     |       |                  |       |                  |       |                    |       |
| Basic and  diluted                              |       | $                     | (2.65      | )                     | $          | (1.98                   | )          | $ | (19.95 | ) |
|                                            |       |                  |       |                  |       |                    |       |
| Weighted average  number of shares outstanding: |       |                  |       |                  |       |                    |       |
| Basic and  diluted                              |       | 1,759,607             |       | 1,572,555             |       | 1,049,158               |       |

 

See accompanying notes to consolidated financialstatements.

 

F-4

----

Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements ofShareholders’ Equity (Deficit)**

 
| ** **                                                                                                                                                     | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **                | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                     | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **                | ** ** |
| ** **                                                                                                                                                     | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**    | ** ** | **Total**                 | ** ** |
| ** **                                                                                                                                                     | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                                     | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** ** |
| **Balance  at inception, August 17, 1999**                                                                                                                | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **             | ** ** | ** **                | ** ** |
| Net loss for the  period from inception to December 31, 1999                                                                                              |       | —                |       | $           | —     |            | $          | —                 |       | $                         | —     |   | $ | — |   |
| **Balance,  December 31, 1999**                                                                                                                           | ** ** | **—**            | ** ** | **—**  | ** ** | **—**      | ** ** | **—**             | ** ** | **—**                | ** ** |
| Net loss for the  year ended December 31, 2000                                                                                                            |       | —                |       | —      |       | —          |       | —                 |       | —                    |       |
| **Balance,  December 31, 2000**                                                                                                                           | ** ** | **—**            | ** ** | **—**  | ** ** | **—**      | ** ** | **—**             | ** ** | **—**                | ** ** |
| Issuance of  common stock to founders at $33.33 per share on March 1, 2001                                                                                |       | 1.0                   |       | —      |       | 20              |       | —                 |       | 20                        |       |
| Cancellation of  founders’ shares, March 6, 2001                                                                                                     |       | (1.0                  | )          | —      |       | (20             | )          | —                 |       | (20                       | )          |
| Recapitalization  and transfer of common stock to Clinical Network, Inc. July 6, 2001                                                                |       | 300,000               |       | 3           |       | (3              | )          | —                 |       | —                    |       |
| Issuance of  common stock to CS Medical Technologies, LLC as consideration for technology  license agreement on July 6, 2001, valued at $1.58 per share   |       | 300,000               |       | 3           |       | 474,997         |       | —                 |       | 475,000                   |       |
| Net loss for the  year ended December 31, 2001                                                                                                            |       | —                |       | —      |       | —          |       | (612,533               | )          | (612,533                  | )          |
| **Balance,  December 31, 2001**                                                                                                                           | ** ** | **600,000**           | ** ** | **6**       | ** ** | **474,994**     | ** ** | **(612,533**           | **)**      | **(137,533**              | **)**      |
| Issuance of  common stock valued at $4.29 per share to Profile LLC for technology license,  January 14, 2002                                              |       | 400,000               |       | 4           |       | 1,713,596       |       | —                 |       | 1,713,600                 |       |
| Issuance of  common stock at $23.33 per share for services rendered, November 14,  2002                                                                   |       | 4,421                 |       | —      |       | 103,166         |       | —                 |       | 103,166                   |       |
| Issuance of  common stock for cash at $23.33 per share on November 22, 2002, net of  costs of $193,386                                                    |       | 45,335                |       | 1           |       | —  864,418 |       | —                 |       | 864,419                   |       |
| Options to  purchase 90,000 shares issued to officers and directors, valued at $4.60 per  share, granted March 19, 2002; portion vested in 2002           |       | —                |       | —      |       | 124,583         |       | —                 |       | 124,583                   |       |
| Options to  purchase 6,000 shares issued to consultants for services rendered, valued at  $4.60 per share, granted March 19, 2002; portion vested in 2002 |       | —                |       | —      |       | 18,400          |       | —                 |       | 18,400                    |       |
| Warrant for  3,000 shares valued at $4.60 per share, issued to a director on  April 19, 2002; portion vested in 2002                                      |       | —                |       | —      |       | 4,025           |       | —                 |       | 4,025                     |       |
| Warrant for 150  shares valued at $3.33 per share issued for services rendered,  November 11, 2002                                                        |       | —                |       | —      |       | 490             |       | —                 |       | 490                       |       |
| Net loss for the  year ended December 31, 2002                                                                                                            |       | —                |       | —      |       | —          |       | (3,613,003             | )          | (3,613,003                | )          |
| **Balance,  December 31, 2002**                                                                                                                           | ** ** | **1,049,756**         | ** ** | **11**      | ** ** | **3,303,672**   | ** ** | **(4,225,536**         | **)**      | **(921,853**              | **)**      |
| Stock issued in  lieu of cash for accounts payable, valued at $23.33 per share,  February 25, 2003                                                        |       | 545                   |       | —      |       | 12,705          |       | —                 |       | 12,705                    |       |
| Warrants for  19,286 shares valued at $3.00 per share, issued to bank line of credit  guarantors, March 1, 2003                                           |       | —                |       | —      |       | 57,858          |       | —                 |       | 57,858                    |       |
| Warrant for  2,143 shares valued at $3.00 per share, issued to director as a bank line of  credit guarantor, March 1, 2003                                |       | —                |       | —      |       | 6,429           |       | —                 |       | 6,429                     |       |
| Warrant for  9,215 shares issued for services rendered, valued at $20.30 per share,  June 30, 2003                                                        |       | —                |       | —      |       | 187,060         |       | —                 |       | 187,060                   |       |
| Warrants for  22,501 shares valued at $3.60 per share, issued to bank line of credit  guarantors, August 5, 2003                                          |       | —                |       | —      |       | 81,003          |       | —                 |       | 81,003                    |       |
| Warrant for  2,143 shares valued at $3.60 per share, issued to director as a bank line of  credit guarantor, August 5, 2003                               |       | —                |       | —      |       | 7,714           |       | —                 |       | 7,714                     |       |
| Warrants for  6,429 shares valued at $3.40 per share, issued to bank line of credit  guarantors, September 11, 2003                                       |       | —                |       | —      |       | 21,858          |       | —                 |       | 21,858                    |       |
| Warrant for  11,789 shares valued at $3.50 per share, issued to bank line of credit  guarantor, December 22, 2003                                         |       | —                |       | —      |       | 41,250          |       | —                 |       | 41,250                    |       |
|                                                                                                                                                                |            |                       |            |             |            |                 |            |                        |            |                           |            |  |  |  |  |

 

F-5

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Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Shareholders’ Equity(Deficit) (Continued)**

 
| ** **                                                                                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **                | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **                | ** ** |
| ** **                                                                                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**    | ** ** | **Total**                 | ** ** |
| ** **                                                                                                                                                                                                                                                                                    | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                                                                                                                                                                    | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** ** |
| Options to  purchase 90,000 shares issued to officers and directors, valued at $4.60 per  share, granted March 19,  2002; portion vested in 2003                                                                                                                                         |       | —                |       | —      |       | 133,400         |       | —                 |       | 133,400                   |       |
| Options to  purchase 6,000 shares issued to consultants for services rendered, valued at $4.60 per share, granted March 19, 2002;  portion vested in 2003                                                                                                                                |       | —                |       | —      |       | 6,900           |       | —                 |       | 6,900                     |       |
| Warrant for  3,000 shares valued at $4.60 per share, issued to a director on April 19, 2002; portion vested in 2003                                                                                                                                                                      |       | —                |       | —      |       | 6,900           |       | —                 |       | 6,900                     |       |
| Net loss for the  year ended December 31, 2003                                                                                                                                                                                                                                           |       | —                |       | —      |       | —          |       | (1,632,457             | )          | (1,632,457                | )          |
| **Balance,  December 31, 2003**                                                                                                                                                                                                                                                          | ** ** | **1,050,301**         | ** ** | **11**      | ** ** | **3,866,749**   | ** ** | **(5,857,993**         | **)**      | **(1,991,233**            | **)**      |
| Options to  purchase 3,000 shares issued to a consultant valued at $6.70 per share, granted  February 1, 2004, portion  vested in 2004                                                                                                                                                   |       | —                |       | —      |       | 10,100          |       | —                 |       | 10,100                    |       |
| Options to  purchase 45,000 shares issued to officer valued at $6.70 per share, granted February 1, 2004; portion vested in 2004                                                                                                                                                         |       | —                |       | —      |       | 84,173          |       | —                 |       | 84,173                    |       |
| Repurchase of  90,000 shares pursuant to the exercise of dissenters’ rights at time of  merger, April 5, 2004 in  connection with $750,000 note payable                                                                                                                             |       | (90,000               | )          | (1          | )          | (749,999        | )          | —                 |       | (750,000                  | )          |
| Issuance of  shares to shareholders of Global Internet Communications, Inc. pursuant  to merger April 5, 2004                                                                                                                                                                       |       | 209,700               |       | 2           |       | (2              | )          | —                 |       | —                    |       |
| Issuance of  common stock for cash at $20.00 per share during 2004, net of costs of  $139,493                                                                                                                                                                                                 |       | 220,500               |       | 2           |       | 4,270,505       |       | —                 |       | 4,270,507                 |       |
| Cost associated  with Global Internet Communications, Inc. reverse merger effective  April 5, 2004                                                                                                                                                                                  |       | —                |       | —      |       | (162,556        | )          | —                 |       | (162,556                  | )          |
| Effect of  anti-dilution and price-protection provisions of warrants issued to loan guarantors in 2003,  triggered by April 5, 2004 closing  of private placement; shares subject to warrants increased by 37,501; exercise price reduced from $23.33 to $16.67  per share (see note 10) |       | —                |       | —      |       | 320,974         |       | —                 |       | 320,974                   |       |
| Issuance of  common stock valued at $20.00 per share for accrued expenses in lieu of cash,  May 21, 2004                                                                                                                                                                                 |       | 3,861                 |       | —      |       | 77,225          |       | —                 |       | 77,225                    |       |
| Warrants for  10,000 shares issued for services rendered valued at $11.50 per share on  July 19, 2004                                                                                                                                                                                    |       | —                |       | —      |       | 114,914         |       | —                 |       | 114,914                   |       |
| Options to  purchase 20,000 shares issued to officer valued at $15.00 per share, granted July 21, 2004; portion vested in 2004                                                                                                                                                           |       | —                |       | —      |       | 41,670          |       | —                 |       | 41,670                    |       |
| Issuance of  common stock valued at $20.00 per share for accrued interest in lieu of cash,  October 12, 2004                                                                                                                                                                             |       | 4,444                 |       | —      |       | 88,882          |       | —                 |       | 88,882                    |       |
| Warrants for  20,000 shares issued for services rendered valued at $8.30 per share on  December 2, 2004                                                                                                                                                                                  |       | —                |       | —      |       | 166,172         |       | —                 |       | 166,172                   |       |
| Options to  purchase 90,000 shares issued to officers and directors, valued at $4.60 per  share, granted March 19,  2002; portion vested in 2004                                                                                                                                         |       | —                |       | —      |       | 82,452          |       | —                 |       | 82,452                    |       |
| Warrant for  3,000 shares valued at $4.60 per share, issued to a director on April 19, 2002; portion vested in 2004                                                                                                                                                                      |       | —                |       | —      |       | 1,150           |       | —                 |       | 1,150                     |       |
| Net loss for the  year ended December 31, 2004                                                                                                                                                                                                                                           |       | —                |       | —      |       | —          |       | (2,318,896             | )          | (2,318,896                | )          |
| **Balance,  December 31, 2004**                                                                                                                                                                                                                                                          | ** ** | **1,398,806**         | ** ** | **14**      | ** ** | **8,212,409**   | ** ** | **(8,176,889**         | **)**      | **35,534**                | ** ** |

 

F-6

----

Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Shareholders’ Equity (Deficit)(Continued)**

 
| ** **                                                                                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **                | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **                | ** ** |
| ** **                                                                                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**    | ** ** | **Total**                 | ** ** |
| ** **                                                                                                                                            | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                            | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** ** |
| Options to  purchase 90,000 shares issued to officers and directors, valued at $4.60 per  share, granted March 19,  2002; portion vested in 2005 |       | —                |       | —      |       | 5,734           |       | —                 |       | 5,734                     |       |
| Options to  purchase 45,000 shares issued to officer valued at $6.70 per share, granted  February 1, 2004; portion vested in 2005                |       | —                |       | —      |       | 111,108         |       | —                 |       | 111,108                   |       |
| Options to  purchase 20,000 shares issued to officer valued at $15.00 per share, granted  July 21, 2004; portion vested in 2005                  |       | —                |       | —      |       | 100,008         |       | —                 |       | 100,008                   |       |
| Options to  purchase 15,000 shares issued to officer valued at $16.20 per share, granted  January 3, 2005; portion vested in 2005                |       | —                |       | —      |       | 74,256          |       | —                 |       | 74,256                    |       |
| Options to  purchase 15,000 shares issued to officer valued at $6.70 per share, granted  September 6, 2005; portion vested in 2005               |       | —                |       | —      |       | 6,625           |       | —                 |       | 6,625                     |       |
| Issuance of  common stock for services rendered at $10.20 per share on May 13, 2005                                                              |       | 5,000                 |       | —      |       | 51,000          |       | —                 |       | 51,000                    |       |
| Issuance of  common stock for cash at $7.60 per share on June 15, 2005                                                                           |       | 6,579                 |       | —      |       | 50,001          |       | —                 |       | 50,001                    |       |
| Issuance of  common stock for deferred offering costs at $7.10 per share on  September 1, 2005                                                   |       | 2,500                 |       | —      |       | 17,750          |       | —                 |       | 17,750                    |       |
| Issuance of  common stock in lieu of cash for accrued expenses at $8.90 per share on  December 31, 2005                                          |       | 4,541                 |       | —      |       | 40,418          |       | —                 |       | 40,418                    |       |
| Warrants for  2,500 shares valued at $6.30 per share, issued to bank loan guarantor,  September 14, 2005                                         |       | —                |       | —      |       | 15,750          |       | —                 |       | 15,750                    |       |
| Warrants for  2,500 shares valued at $5.30 per share, issued in connection with notes  payable on September 21, 2005                             |       | —                |       | —      |       | 13,250          |       | —                 |       | 13,250                    |       |
| Warrants for  20,000 shares valued at $4.80 per share, issued to bank loan guarantors,  October 19, 2005                                         |       | —                |       | —      |       | 106,000         |       | —                 |       | 106,000                   |       |
| Net loss for the  year ended December 31, 2005                                                                                                   |       | —                |       | —      |       | —          |       | (2,028,056             | )          | (2,028,056                | )          |
| **Balance,  December 31, 2005**                                                                                                                  | ** ** | **1,417,426**         | ** ** | **14**      | ** ** | **8,804,309**   | ** ** | **(10,204,945**        | **)**      | **(1,400,622**            | **)**      |
| Options to  purchase 45,000 shares issued to officer valued at $6.70 per share, granted  February 1, 2004; portion vested in 2006                |       | —                |       | —      |       | 101,008         |       | —                 |       | 101,008                   |       |
| Options to  purchase 20,000 shares issued to officer valued at $15.00 per share, granted  July 21, 2004; portion vested in 2006                  |       | —                |       | —      |       | 100,008         |       | —                 |       | 100,008                   |       |
| Options to  purchase 15,000 shares issued to officer valued at $16.20 per share, granted  January 3, 2005; portion vested in 2006                |       | —                |       | —      |       | 81,006          |       | —                 |       | 81,006                    |       |
| Options to  purchase 15,000 shares issued to officer valued at $6.70 per share, granted  September 6, 2005; portion vested in 2006               |       | —                |       | —      |       | 8,834           |       | —                 |       | 8,834                     |       |
| Options to  purchase 17,500 shares issued to officers and an employee valued at $5.60 per  share, granted March 1, 2006; portion vested in 2006  |       | —                |       | —      |       | 48,215          |       | —                 |       | 48,215                    |       |

 

F-7

----

Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Shareholders’ Equity (Deficit)(Continued)**

 
| ** **                                                                                                                                                                                                                       | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **                | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                                                       | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **                | ** ** |
| ** **                                                                                                                                                                                                                       | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**    | ** ** | **Total**                 | ** ** |
| ** **                                                                                                                                                                                                                       | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                                                                                                       | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** ** |
| Options to  purchase 3,000 shares issued to a director valued at $5.90 per share, granted  May 30, 2006; portion vested in 2006                                                                                             |       | —                |       | —      |       | 5,163           |       | —                 |       | 5,163                     |       |
| Original issue  discount on convertible debt issued on February 16, 2006                                                                                                                                                    |       | —                |       | —      |       | 400,000         |       | —                 |       | 400,000                   |       |
| Warrants for  5,000 shares valued at $4.60 per share, issued in connection with notes  payable on January 25, 2006                                                                                                          |       | —                |       | —      |       | 23,000          |       | —                 |       | 23,000                    |       |
| Issuance of  common stock for deferred offering costs at $9.10 per share on  February 22, 2006                                                                                                                              |       | 2,500                 |       | —      |       | 22,750          |       | —                 |       | 22,750                    |       |
| Original issue  discount on convertible debt issued on February 29, 2006                                                                                                                                                    |       | —                |       | —      |       | 333,334         |       | —                 |       | 333,334                   |       |
| Issuance of  common stock for services rendered at $6.40 per share on April 21, 2006                                                                                                                                        |       | 7,000                 |       | —      |       | 44,800          |       | —                 |       | 44,800                    |       |
| Warrants for  3,750 shares valued at $6.80 per share, issued in connection with notes  payable on June 1, 2006                                                                                                              |       | —                |       | —      |       | 25,500          |       | —                 |       | 25,500                    |       |
| Warrants for 375  shares valued at $5.40 per share, issued in connection with notes payable on July 21,  2006                                                                                                               |       | —                |       | —      |       | 2,025           |       | —                 |       | 2,025                     |       |
| Warrants for 500  shares valued at $4.60 per share, issued in connection with notes payable on August 30,  2006                                                                                                             |       | —                |       | —      |       | 2,300           |       | —                 |       | 2,300                     |       |
| Issuance of  common stock for cash at $4.30 per share on September 7, 2006                                                                                                                                                  |       | 11,628                |       | —      |       | 50,000          |       | —                 |       | 50,000                    |       |
| Issuance of  common stock for services rendered at $6.30 per share on September 8,  2006                                                                                                                                    |       | 1,415                 |       | —      |       | 8,938           |       | —                 |       | 8,938                     |       |
| Warrants for  5,000 shares valued at $4.50 per share, issued in connection with notes  payable on November 30, 2006                                                                                                         |       | —                |       | —      |       | 22,500          |       | —                 |       | 22,500                    |       |
| Warrants for  5,171 shares valued at $5.40 per share, accrued for issuance in connection  with a note payable as of December 31, 2006                                                                                       |       | —                |       | —      |       | 27,922          |       | —                 |       | 27,922                    |       |
| Net loss for the  year ended December 31, 2006                                                                                                                                                                              |       | —                |       | —      |       | —          |       | (2,959,853             | )          | (2,959,853                | )          |
| **Balance,  December 31, 2006**                                                                                                                                                                                             | ** ** | **1,439,969**         | ** ** | **14**      | ** ** | **10,111,612**  | ** ** | **(13,164,798**        | **)**      | **(3,053,172**            | **)**      |
| Options to  purchase 45,000 shares issued to officer valued at $6.70 per share, granted  February 1, 2004; portion vested in 2007                                                                                           |       | —                |       | —      |       | 16,811          |       | —                 |       | 16,811                    |       |
| Options to  purchase 20,000 shares issued to officer valued at $15.00 per share, granted  July 21, 2004; portion vested in 2007                                                                                             |       | —                |       | —      |       | 58,314          |       | —                 |       | 58,314                    |       |
| Warrants for  5,000 shares valued at $4.50 per share, issued in connection with debt  extinguishment on January 3, 2007                                                                                                     |       | —                |       | —      |       | 22,500          |       | —                 |       | 22,500                    |       |
| Options to  purchase 15,000 shares issued to officer valued at $16.20 per share, granted  January 3, 2005; portion vested in 2007                                                                                           |       | —                |       | —      |       | 81,007          |       | —                 |       | 81,007                    |       |
| Options to  purchase 17,500 shares issued to officers and an employee valued at $5.60 per  share, granted March 1, 2006; portion vested in 2007                                                                             |       | —                |       | —      |       | 33,245          |       | —                 |       | 33,245                    |       |
| Issuance of  investment units consisting of common stock and warrants for 62,500 shares  issued for cash at $4.00 per share on January 18, January 23,  February 28 and May 1, 2007, net of costs of $52,388 |       | 125,000               |       | 2           |       | 447,610         |       | —                 |       | 447,612                   |       |

 

F-8

----

Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Shareholders’ Equity (Deficit)(Continued)**

 
| ** **                                                                                                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **                | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **                | ** ** |
| ** **                                                                                                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**    | ** ** | **Total**                 | ** ** |
| ** **                                                                                                                                                            | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                                            | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** ** |
| Options to purchase 20,000 shares issued to officer valued  at $3.40 per share, granted February 1, 2007; portion vested in 2007                                 |       | —                |       | —      |       | 32,857          |       | —                 |       | 32,857                    |       |
| Warrants for 5,000 shares valued at $3.60 per share,  issued in connection with debt extinguishment on February 1, 2007                                          |       | —                |       | —      |       | 18,000          |       | —                 |       | 18,000                    |       |
| Issuance of common stock in lieu of cash for a loan  from a director at $4.10 per share on February 9, 2007                                                      |       | 1,707                 |       | —      |       | 7,000           |       | —                 |       | 7,000                     |       |
| Modification of warrant term of warrant to purchase  30,000 shares pursuant to separation agreement of employee dated March 15,  2007, valued at $3.20 per share |       | —                |       | —      |       | 96,000          |       | —                 |       | 96,000                    |       |
| Issuance of common stock in lieu of cash for accrued  expenses at $4.00 per share on March 21, 2007                                                              |       | 12,478                |       | —      |       | 49,911          |       | —                 |       | 49,911                    |       |
| Warrants for 6,240 shares issued pursuant to  amendment of convertible debt valued at $4.30 per share on March 21,  2007                                         |       | —                |       | —      |       | 26,829          |       | —                 |       | 26,829                    |       |
| Issuance of common stock for accounts payable $5.00  per share on April 2, 2007                                                                                  |       | 4,141                 |       | —      |       | 20,704          |       | —                 |       | 20,704                    |       |
| Warrants for 20,000 shares issued for services  rendered valued  at $3.60 per share on April 16, 2007                                                            |       |                  |       |        |       | 72,000          |       | —                 |       | 72,000                    |       |
| Modification of option term to purchase 45,000 shares  pursuant to separation agreement of officer dated May 11, 2007, valued  at $2.30 per share                |       | —                |       | —      |       | 103,500         |       | —                 |       | 103,500                   |       |
| Modification of option term to purchase 45,000 shares  pursuant to separation agreement of officer dated May 11, 2007, valued  at $2.60 per share                |       | —                |       | —      |       | 117,000         |       | —                 |       | 117,000                   |       |
| Options to purchase 3,000 shares issued to a  director valued at $5.90 per share, granted May 30, 2006; portion vested  in 2007                                  |       | —                |       | —      |       | 8,850           |       | —                 |       | 8,850                     |       |
| Options to purchase 3,000 shares issued to a  director valued at $2.40 per share, granted June 14, 2007; portion  vested in 2007                                 |       | —                |       | —      |       | 1,800           |       | —                 |       | 1,800                     |       |
| Issuance of common stock in lieu of cash for  director’s fees at $3.00 per share on September 10, 2007                                                      |       | 20,694                |       | —      |       | 62,082          |       | —                 |       | 62,082                    |       |
| Issuance of common stock in lieu of cash for loans  from directors at $3.00 per share on September 10, 2007                                                      |       | 1,100                 |       | —      |       | 3,300           |       | —                 |       | 3,300                     |       |
| Issuance of common stock as debt issuance cost at  $2.00 per share on November 7, 2007                                                                           |       | 33,333                |       | —      |       | 66,666          |       | —                 |       | 66,666                    |       |
| Warrants for 6,050 shares valued at $2.80 per share,  issued in connection with notes payable on December 27, 2007                                               |       | —                |       | —      |       | 16,940          |       | —                 |       | 16,940                    |       |
| Warrants for 5,800 shares valued at $1.70 per share,  issued in connection with notes payable on December 27, 2007                                               |       | —                |       | —      |       | 9,860           |       | —                 |       | 9,860                     |       |
| Warrants for 700 shares valued at $2.20 per share,  issued in connection with notes payable on December 27, 2007                                                 |       | —                |       | —      |       | 1,540           |       | —                 |       | 1,540                     |       |
| Original issue discount on convertible debt issued on  December 27, 2007                                                                                         |       | —                |       | —      |       | 595,666         |       | —                 |       | 595,666                   |       |
| Original issue discount attributable to warrants for  240,000 shares issued on December 27, 2007                                                                 |       | —                |       | —      |       | 88,576          |       | —                 |       | 88,576                    |       |
| Issuance of common stock as compensation for loan guarantees  at $1.00 per share on December 28, 2007                                                            |       | 88,889                |       | 1           |       | 88,888          |       | —                 |       | 88,889                    |       |
| Warrants for 15,400 shares valued at $4.00 per  share, accrued for issuance in addition to interest on a note payable as of  December 31, 2007                   |       | —                |       | —      |       | 61,600          |       | —                 |       | 61,600                    |       |

 

F-9

----

Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Shareholders’ Equity (Deficit)(Continued)**

 
| ** **                                                                                                                                                                                           | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **                | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **                | ** ** |
| ** **                                                                                                                                                                                           | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**    | ** ** | **Total**                 | ** ** |
| ** **                                                                                                                                                                                           | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                                                                           | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** ** |
| Warrants for 51,010 shares valued at $3.60 per  share, accrued for issuance in connection with debt extinguishment as of  December 31, 2007                                                     |       | —                |       | —      |       | 183,637         |       | —                 |       | 183,637                   |       |
| Warrants for  15,221 shares valued at $5.40 per share, accrued for issuance in connection  with debt extinguishment as of December 31, 2007                                                     |       | —                |       | —      |       | 82,191          |       | —                 |       | 82,191                    |       |
| Net loss for the  year ended December 31, 2007                                                                                                                                                  |       | —                |       | —      |       | —          |       | (3,113,298             | )          | (3,113,298                | )          |
| **Balance,  December 31, 2007**                                                                                                                                                                 | ** ** | **1,727,311**         | ** ** | **17**      | ** ** | **12,586,496**  | ** ** | **(16,278,096**        | **)**      | **(3,691,583**            | **)**      |
| Original issue  discount on convertible debt issued between Jan 4, 2008 and July 30,  2008                                                                                                      |       | —                |       | —      |       | 350,873         |       | —                 |       | 350,873                   |       |
| Warrants for  160,000 shares valued at $0.47 to $1.10 per share issued in connection with  convertible debt between Jan 4, 2008 and July 30, 2008                                               |       | —                |       | —      |       | 65,160          |       | —                 |       | 65,160                    |       |
| Warrants for  14,500 shares valued at $1.00 per share issued to former employee pursuant to  a termination agreement on January 4, 2008                                                         |       | —                |       | —      |       | 14,500          |       | —                 |       | 14,500                    |       |
| Warrants for  52,357 shares valued at $3.60 per share, connection with debt extinguishment  on January 16, 2008; portion expensed in 2008                                                       |       | —                |       | —      |       | 4,848           |       | —                 |       | 4,848                     |       |
| Rounding of  common stock due to reverse stock split on February 14, 2008                                                                                                                       |       | 39                    |       | —      |       | —          |       | —                 |       | —                    |       |
| Warrants for  75,000 shares valued at $0.92 per share, issued in connection with notes  payable on April 3, 2008                                                                                |       | —                |       | —      |       | 42,768          |       | —                 |       | 42,768                    |       |
| Options to  purchase 20,000 shares issued to officers valued at $0.79 per share, granted  July 11, 2008                                                                                         |       | —                |       | —      |       | 15,800          |       | —                 |       | 15,800                    |       |
| Cancellation of  an officer’s options to purchase 20,000 shares valued at $0.27 per share on  July 11, 2008                                                                                |       | —                |       | —      |       | (5,400          | )          | —                 |       | (5,400                    | )          |
| Cancellation of  an officer’s options to purchase 15,000 shares valued at $0.31 per share on  July 11, 2008                                                                                |       | —                |       | —      |       | (4,650          | )          | —                 |       | (4,650                    | )          |
| Options to  purchase 3,000 shares issued to directors valued at $0.71 per share, granted  July 11, 2008                                                                                         |       | —                |       | —      |       | 2,130           |       | —                 |       | 2,130                     |       |
| Issuance of  common stock valued at $1.00 per share in lieu of cash for directors’ fees on  July 11, 2008                                                                                  |       | 59,634                |       | 1           |       | 59,633          |       | —                 |       | 59,634                    |       |
| Extension of  note payable modified with a conversion feature added and recorded as debt  extinguishment on September 12, 2008                                                                  |       | —                |       | —      |       | 48,214          |       | —                 |       | 48,214                    |       |
| Original issue  discount on convertible debt issued between September 16, 2008 and  December 11, 2008                                                                                      |       | —                |       | —      |       | 145,743         |       | —                 |       | 145,743                   |       |
| Warrants for  95,500 shares valued at $0.89 to $1.31 per share issued in connection with  convertible debt between September 16, 2008 and December 11, 2008                                |       | —                |       | —      |       | 75,819          |       | —                 |       | 75,819                    |       |
| Original issue  discount attributable to warrants for 100,000 shares valued at $0.47 per  share, issued on September 25, 2008                                                                   |       | —                |       | —      |       | 46,604          |       | —                 |       | 46,604                    |       |
| Warrants for  31,817 shares valued at $5.40 per share, issued on September 30, 2008 in  connection with debt extinguishment expensed and accrued from previous years;  portion expensed in 2008 |       | —                |       | —      |       | 61,700          |       | —                 |       | 61,700                    |       |
| Warrants for  3,000 shares valued at $1.32 per share, issued in connection with debt  extinguishment on October 24, 2008                                                                        |       | —                |       | —      |       | 3,960           |       | —                 |       | 3,960                     |       |
| Issuance of  common stock as compensation for loan guarantees at $1.00 per share on  October 31, 2008                                                                                           |       | 17,778                |       | —      |       | 17,778          |       | —                 |       | 17,778                    |       |
| Warrants for  44,445 shares valued at $0.77 per share issued as compensation for loan  guarantees on October 31, 2008                                                                           |       | —                |       | —      |       | 34,223          |       | —                 |       | 34,223                    |       |

 

F-10

----

Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Shareholders’ Equity (Deficit)(Continued)**

 
| ** **                                                                                                                                           | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **                | ** **      |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|-----------------|
| ** **                                                                                                                                           | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **                | ** **      |
| ** **                                                                                                                                           | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**    | ** ** | **Total**                 | ** **      |
| ** **                                                                                                                                           | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                           | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** **      |
| Issuance of  common stock valued at $1.00 per share for debt issuance cost on  October 31, 2008                                                 |       |  

6,667         |       | —      |       | 6,667           |       | —                 |       | 6,667                     |            |
| Warrants for  16,667 shares valued at $0.77 per share issued as debt issuance costs on  October 31, 2008                                        |       | —                |       | —      |       | 12,834          |       | —                 |       | 12,834                    |            |
| Warrants for  3,836 shares valued at $1.32 per share, accrued for issuance in connection  with debt extinguishment as of December 31, 2006      |       | —                |       | —      |       | 5,063           |       | —                 |       | 5,063                     |            |
| Options to  purchase 17,500 shares issued to officers and an employee valued at $5.60 per  share, granted March 1, 2006; portion vested in 2008 |       | —                |       | —      |       | 9,663           |       | —                 |       | 9,663                     |            |
| Options to  purchase 3,000 shares issued to a director valued at $5.90 per share, granted  May 30, 2006; portion vested in 2008                 |       | —                |       | —      |       | 3,687           |       | —                 |       | 3,687                     |            |
| Options to  purchase 3,000 shares issued to a director valued at $2.40 per share, granted  June 14, 2007; portion vested in 2008                |       | —                |       | —      |       | 3,600           |       | —                 |       | 3,600                     |            |
| Options to  purchase 5,000 shares issued to officer valued at $3.40 per share, granted  February 1, 2007; portion vested in 2008                |       | —                |       | —      |       | 8,869           |       | —                 |       | 8,869                     |            |
| Options to  purchase 15,000 shares issued to officer valued at $16.20 per share, granted  January 3, 2005; portion vested in 2008               |       | —                |       | —      |       | 6,731           |       | —                 |       | 6,731                     |            |
| Options to  purchase 85,000 shares issued to officers valued at $0.85 per share, granted  July 11, 2008; portion expensed in 2008               |       | —                |       | —      |       | 12,042          |       | —                 |       | 12,042                    |            |
| Reversal of  expense associated with performance-based option of an officer that did not  vest                                                       |       | —                |       | —      |       | (7,727          | )          | —                 |       | (7,727                    | )               |
| Warrants for  12,576 shares valued at $4.00 per share, accrued for issuance in addition to  interest on a note payable; portion expensed in 2008     |       | —                |       | —      |       | 50,304          |       | —                 |       | 50,304                    |            |
| Net loss for the  year ended December 31, 2008                                                                                                  |       | —                |       | —      |       | —          |       | (4,657,717             | )          | (4,657,717                | )               |
| **Balance,  December 31, 2008**                                                                                                                 | ** ** | **1,811,429**         | ** ** | **$**       | **18**     | ** **      | **$**      | **13,677,932**         | ** ** | **$**                     | **(20,935,813** | **)** | **$** | **(7,257,863** | **)** |
|                                                                                                                                                      |            |                       |            |             |            |                 |            |                        |            |                           |                 |  |  |  |  |

 

See accompanying notes toconsolidated financial statements.

 

F-11

----

Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Cash Flows**

 
| ** **                                                                                                              | ** ** | **Year Ended  December 31,** | ** ** | **Year Ended  December 31,** | ** ** | **Period from August  17, 1999 (inception) to** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2008**                               | ** ** | **2007**                               | ** ** | **December 31, 2008**                                          | ** ** |
| Cash flows from  operating activities:                                                                                  |       |                                   |       |                                   |       |                                                                     |       |
| Net loss                                                                                                                |       | $                                      | (4,657,717 | )                                      | $          | (3,113,298                                                               | )          | $ | (20,935,813 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                                            |       |                                   |       |                                   |       |                                                                     |       |
| Depreciation and  amortization                                                                                          |       | 605                                    |       | 3,134                                  |       | 20,797                                                                   |       |
| Gain on sale of  furniture and equipment                                                                                |       | —                                 |       | —                                 |       | (2,200                                                                   | )          |
| Stock-based  compensation                                                                                               |       | 59,245                                 |       | 549,384                                |       | 1,764,347                                                                |       |
| Common stock  issued for services rendered                                                                              |       | 50,467                                 |       | —                                 |       | 207,371                                                                  |       |
| Common stock  issued for debt guarantees                                                                                |       | 17,778                                 |       | 88,889                                 |       | 106,667                                                                  |       |
| Common stock  issued for debt issuance cost                                                                             |       | 6,667                                  |       | —                                 |       | 6,667                                                                    |       |
| Notes payable  issued for intangibles expensed as research and development                                              |       | 150,000                                |       | —                                 |       | 150,000                                                                  |       |
| Warrants issued  for services                                                                                           |       | —                                 |       | 72,000                                 |       | 540,636                                                                  |       |
| Warrants issued  for debt guarantees                                                                                    |       | 34,223                                 |       | —                                 |       | 355,197                                                                  |       |
| Warrants issued  for debt extinguishment                                                                                |       | 75,571                                 |       | 283,829                                |       | 359,400                                                                  |       |
| Warrants issued  for debt extinguishment-related parties                                                                |       | —                                 |       | 26,828                                 |       | 26,828                                                                   |       |
| Warrants issued  for debt issuance cost                                                                                 |       | 12,834                                 |       | —                                 |       | 12,834                                                                   |       |
| Amortization of  note payable-original issue discount                                                                   |       | —                                 |       | 23,162                                 |       | 152,247                                                                  |       |
| Amortization of  note payable-related parties original issue discount                                                   |       | 50,304                                 |       | 89,940                                 |       | 140,244                                                                  |       |
| Amortization of  convertible debt-original issue discount                                                               |       | 428,430                                |       | 272                                    |       | 638,685                                                                  |       |
| Amortization of  convertible debt-related parties original issue discount                                               |       | 505,217                                |       | 244,587                                |       | 749,804                                                                  |       |
| Amortization of  debt issuance costs                                                                                    |       | 421,564                                |       | 506,639                                |       | 1,705,733                                                                |       |
| Bargain  conversion option added to note payable- related parties for debt  extinguishment                              |       | 48,214                                 |       | —                                 |       | 48,214                                                                   |       |
| Write-off debt  issuance cost for debt extinguishment                                                                   |       | —                                 |       | 42,797                                 |       | 42,797                                                                   |       |
| Write-off of  deferred offering cost                                                                                    |       | —                                 |       | —                                 |       | 59,696                                                                   |       |
| License rights  expensed as research and development, paid by issuance of common stock to CS  Medical Technologies, LLC |       | —                                 |       | —                                 |       | 475,000                                                                  |       |
| License rights  expensed as research and development, paid by issuance of common stock to  Profile, LLC                 |       | —                                 |       | —                                 |       | 1,713,600                                                                |       |
| Changes in  operating assets and liabilities:                                                                           |       |                                   |       |                                   |       |                                                                     |       |
| Deposits                                                                                                                |       | —                                 |       | —                                 |       | (189,554                                                                 | )          |
| Other current  assets                                                                                                   |       | 44,603                                 |       | 36,311                                 |       | 133,892                                                                  |       |
| Accounts payable                                                                                                        |       | 199,379                                |       | (46,520                                | )          | 929,834                                                                  |       |
| Accrued  development expense                                                                                            |       | 1,327,835                              |       | —                                 |       | 1,327,835                                                                |       |
| Other accrued  expenses                                                                                                 |       | 129,808                                |       | 229,042                                |       | 1,139,796                                                                |       |
| Net cash used in  operating activities                                                                                  |       | (1,094,973                             | )          | (963,004                               | )          | (8,319,446                                                               | )          |
| Cash flows from  investing activities:                                                                                  |       |                                   |       |                                   |       |                                                                     |       |
| Purchases of  equipment and furniture                                                                                   |       | —                                 |       | —                                 |       | (20,797                                                                  | )          |
| Deposit into a  restricted cash account                                                                                 |       | (214                                   | )          | (44,000                                | )          | (44,214                                                                  | )          |
| Net cash used in  investing activities                                                                                  |       | (214                                   | )          | (44,000                                | )          | (65,011                                                                  | )          |
|                                                                                                                         |            |                                        |            |                                        |            |                                                                          |            |  |  |  |

 

F-12

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Tableof Contents

 

**ProUroCare Medical Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Cash Flows (Continued)**

 
| ** **                                                                                                                                                                               | ** ** | **Year Ended  December 31,** | ** ** | **Year Ended  December 31,** | ** ** | **Period from August  17, 1999 (inception) to** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **2008**                               | ** ** | **2007**                               | ** ** | **December 31, 2008**                                          | ** ** |
| Cash flows from  financing activities:                                                                                                                                                   |       |                                   |       |                                   |       |                                                                     |       |
| Proceeds of note  payable, bank                                                                                                                                                          |       | —                                 |       | —                                 |       | 500,000                                                                  |       |
| Payments of note  payable, bank                                                                                                                                                          |       | —                                 |       | —                                 |       | (500,000                                                                 | )          |
| Proceeds of  notes payable                                                                                                                                                               |       | —                                 |       | —                                 |       | 340,500                                                                  |       |
| Payment of notes  payable                                                                                                                                                                |       | (333,222                               | )          | (54,442                                | )          | (1,370,518                                                               | )          |
| Proceeds of  notes payable - related parties                                                                                                                                             |       | 112,500                                |       | 432,150                                |       | 560,100                                                                  |       |
| Payments of  notes payable - related parties                                                                                                                                             |       | (76,450                                | )          | (126,850                               | )          | (203,300                                                                 | )          |
| Proceeds from  long-term notes payable and bank debt                                                                                                                                     |       | 923,337                                |       | 684,000                                |       | 3,807,337                                                                |       |
| Proceeds from  long-term notes payable, related parties                                                                                                                                  |       | 254,500                                |       | 866,000                                |       | 1,120,500                                                                |       |
| Payments on  long-term bank debt                                                                                                                                                         |       | —                                 |       | (600,000                               | )          | (600,000                                                                 | )          |
| Proceeds from  warrants                                                                                                                                                                  |       | 54,500                                 |       | 50,000                                 |       | 104,500                                                                  |       |
| Payments for  debt issuance costs                                                                                                                                                        |       | (148,211                               | )          | (293,260                               | )          | (673,437                                                                 | )          |
| Payment for  rescission of common stock                                                                                                                                                  |       | —                                 |       | —                                 |       | (100,000                                                                 | )          |
| Payments for  deferred offering expenses                                                                                                                                                 |       | (88,480                                | )          | —                                 |       | (117,307                                                                 | )          |
| Cost of reverse  merger                                                                                                                                                                  |       | —                                 |       | —                                 |       | (162,556                                                                 | )          |
| Net proceeds  from issuance of common stock                                                                                                                                              |       | —                                 |       | 447,612                                |       | 5,682,538                                                                |       |
| Net cash  provided by financing activities                                                                                                                                               |       | 698,474                                |       | 1,405,210                              |       | 8,388,357                                                                |       |
| Net increase (decrease)  in cash                                                                                                                                                         |       | (396,713                               | )          | 398,206                                |       | 3,900                                                                    |       |
| Cash, beginning  of the period                                                                                                                                                           |       | 400,613                                |       | 2,407                                  |       | —                                                                   |       |
| Cash, end of the  period                                                                                                                                                                 |       | $                                      | 3,900      |                                   | $          | 400,613                                                                  |       | $ | 3,900 |   |
|                                                                                                                                                                                     |       |                                   |       |                                   |       |                                                                     |       |
| Supplemental  cash flow information:                                                                                                                                                     |       |                                   |       |                                   |       |                                                                     |       |
| Cash paid for  interest                                                                                                                                                                  |       | $                                      | 123,073    |                                   | $          | 235,355                                                                  |       | $ | 716,409 |   |
| Non-cash  investing and financing activities:                                                                                                                                            |       |                                   |       |                                   |       |                                                                     |       |
| Deferred  offering costs included in accounts payable                                                                                                                                    |       | 461,456                                |       | 109,988                                |       | 571,444                                                                  |       |
| Deferred  offering costs included in accrued expenses                                                                                                                                    |       | 47,350                                 |       | 22,650                                 |       | 70,000                                                                   |       |
| Debt issuance  costs included in accounts payable                                                                                                                                        |       | 58,339                                 |       | 55,817                                 |       | 114,156                                                                  |       |
| Warrants issued  pursuant to notes payable                                                                                                                                               |       | 139,677                                |       | 112,440                                |       | 463,864                                                                  |       |
| Warrants issued  for debt issuance costs                                                                                                                                                 |       | 55,409                                 |       | —                                 |       | 298,021                                                                  |       |
| Prepaid expenses  financed by note payable                                                                                                                                               |       | 54,504                                 |       | 42,585                                 |       | 165,526                                                                  |       |
| Convertible debt  issued in lieu of cash for accrued expenses                                                                                                                            |       | 31,413                                 |       | —                                 |       | 31,413                                                                   |       |
| Common stock  issued in lieu of cash for accrued expenses                                                                                                                                |       | 9,167                                  |       | 111,993                                |       | 238,803                                                                  |       |
| Common stock  issued for debt issuance cost                                                                                                                                              |       | 6,667                                  |       | 66,666                                 |       | 164,834                                                                  |       |
| Warrants issued  in lieu of cash for accrued expenses                                                                                                                                    |       | 1,250                                  |       | —                                 |       | 1,250                                                                    |       |
| Conversion of  notes payable, related parties into convertible debentures                                                                                                                |       | —                                 |       | 200,000                                |       | 200,000                                                                  |       |
| Common stock  issued in lieu of cash for accounts payable                                                                                                                                |       | —                                 |       | 20,704                                 |       | 122,291                                                                  |       |
| Common stock  issued in lieu of cash for notes payable-related parties                                                                                                                   |       | —                                 |       | 10,300                                 |       | 10,300                                                                   |       |
| Convertible debt  issued as debt issuance costs related to guarantee of long-term debt  (recorded as a beneficial conversion in additional paid-in capital) applied  to accounts payable |       | —                                 |       | —                                 |       | 733,334                                                                  |       |
| Issuance of note  payable for redemption of common stock                                                                                                                                 |       | —                                 |       | —                                 |       | 650,000                                                                  |       |
| Conversion of  accounts payable to note payable                                                                                                                                          |       | —                                 |       | —                                 |       | 241,613                                                                  |       |
| Deposits applied  to note payable and accrued interest                                                                                                                                   |       | —                                 |       | —                                 |       | 142,696                                                                  |       |
| Deposits applied  to accounts payable                                                                                                                                                    |       | —                                 |       | —                                 |       | 45,782                                                                   |       |
| Assumption of  liabilities in the Profile, LLC transaction                                                                                                                               |       | —                                 |       | —                                 |       | 25,000                                                                   |       |
| Proceeds from  sale of furniture and equipment                                                                                                                                           |       | —                                 |       | —                                 |       | 2,200                                                                    |       |
| Deposits applied  to accrued expenses                                                                                                                                                    |       | —                                 |       | —                                 |       | 1,076                                                                    |       |

 

See accompanying notes to financial statements.

 

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**ProUroCare Medical Inc.**

**A DevelopmentStage Company**

**Notes to ConsolidatedFinancial Statements**

** **

**December 31, 2008and 2007 and the period from**

**August 17, 1999(inception) to December 31, 2008**

 

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

 

***(a)***                     Description of Business, DevelopmentStage Activities, and Basis of Presentation

 

ProUroCare Medical Inc. (“ProUroCare,” the “Company,”“we” or “us”) is a development stage company engaged in the business ofdeveloping for market innovative products for the detection andcharacterization of male urological prostate disease.  The primary focus of the Company is currentlythe ProUroScanTM prostate imaging system, designed for use asan aid to the physician in visualizing and documenting tissue abnormalities inthe prostate that have been previously detected by a digital rectal exam.  The Company’s developmental activities,conducted by its wholly owned operating subsidiary ProUroCare Inc. (“PUC”),have included the acquisition of several technology licenses, the purchase ofintellectual property, the development of a strategic business plan and asenior management team, product development and fund raising activities.

 

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

 

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

 

On December 27, 2007, the Company’s shareholdersapproved a one-for-ten reverse split of the Company’s common stock without a corresponding reduction in thenumber of authorized shares of the Company capital stock (the “Reverse Split”).  The Reverse Split became effective on February 14,2008.  The exercise price and the numberof shares of common stock issuable under the Company’s outstanding convertibledebentures, options and warrants were proportionately adjusted to reflect theReverse Split for all periods presented.

 

OnJanuary 12, 2009, the Company closed a public offering of 3,050,000 unitsat $1.00 per unit (the “2009 Public Offering”)(see Note 14).  Each unit sold (the “2009 Units”) consistedof one share of common stock and one redeemable warrant to purchase one shareof common stock at an exercise price of $1.30 per share.

 

The accompanying consolidated financial statementsinclude the accounts of the Company and its wholly owned subsidiary, PUC.  Significant inter-company accounts andtransactions have been eliminated in consolidation.

 

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***(b)***                     Restatement of Share Data

*** ***

All share data has been restated to give effect tothe Reverse Split.

 

At the effective time of the Merger, all 350,100shares of common stock of PUC that were outstanding immediately prior to theMerger and held by PUC shareholders were cancelled, with one share ofProUroCare common stock issued to Global. Simultaneously, the non-dissenting shareholders of PUC received an aggregateof 960,300 shares of common stock of Global in exchange for their aggregate of320,100 shares of PUC.  The share data inthis paragraph has been restated to give effect to the Reverse Split, as notedabove.

 

All share data has been restated to give effect tothe Merger under which each PUC share was converted into three shares ofGlobal.

 

***(c)***                      Accounting Estimates

*** ***

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of expensesduring the reporting periods. The Company’s significant estimates include thedetermination of the fair value of its common stock and stock-basedcompensation awarded to employees, directors, loan guarantors and consultantsand the accounting for debt with beneficial conversion features. Actual resultscould differ from those estimates.

 

*Valuation of Stock-Based Compensation. *Effective as of August 17, 1999 (inception), the Company adoptedStatement of Financial Accounting Standards (“SFAS”) No. 123 “Accountingfor Stock-Based Compensation”**(“SFAS 123”)**and on January 1, 2006 adopted SFAS No. 123(revised 2004) “**Share-BasedPayment”**(“SFAS 123R”), which requires the measurementand recognition of compensation expense for all share-based payment awards madeto employees and directors including employee stock options based on fairvalues.  The Company’s determination offair value of share-based payment awards is based on the date of grant using anoption-pricing model which incorporates a number of highly complex andsubjective variables.  These variablesinclude, but are not limited to, the Company’s expected stock price volatilityand estimates regarding projected employee stock option exercise behaviors andforfeitures.  The Company recognizes theexpense related to the fair value of the award straight-line over the vestingperiod.

 

*Debt with Beneficial Conversion Features*.  Thebeneficial conversion features of the promissory notes were valued using theBlack-Scholes pricing model, which is considered the Company’s equivalent tothe fair value of the conversion. The resulting original issue discount isamortized over the life of the promissory notes (generally no more that 24months) using the straight-line method, which approximates the interest method.

 

***(d)***                     Net Loss Per Common Share

*** ***

Basicand diluted loss per common share is computed by dividing net loss by theweighted-average number of common shares outstanding for the reportingperiod.  These calculations reflect theeffects of the Company’s Reverse Split (see Note 1(a)).  Dilutive common-equivalent shares have notbeen included in the computation of diluted net loss per share because theirinclusion would be antidilutive. Antidilutive common equivalent shares issuable based on future exerciseof stock options or warrants could potentially dilute basic loss per 

 

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commonshare in subsequent years.  All optionsand warrants outstanding were antidilutive for the years ended December 31,2008 and 2007 and the period from August 17, 1999 (inception) to December 31,2008 due to the Company’s net losses. 1,603,994 and 1,167,686 shares of common stock issuable under our stockoptions, warrants, convertible debt and contingent shares and warrants issuableunder agreements with loan guarantors were excluded from the computation ofdiluted net loss per common share for the years ended December 31, 2008and 2007, respectively.  Also excluded werethe undetermined number of shares issuable pursuant to the convertible notesand warrants issued in connection with our private placements, unit putarrangements and certain convertible notes, whose terms of conversion werebased on the price of the equity securities offered in the Company’santicipated public offering, as described and defined in Note 14.  The number of such shares was determined onthe January 7, 2009 effective date of the 2009 Public Offering to be6,937,177 and 3,432,622 shares as of December 31, 2008 and 2007,respectively.

 

***(e)***                      Comparative Figures

*** ***

Certain comparative figureshave been reclassified to conform to the financial statement presentationadopted in the current year, including the reclassification of transactionswith related parties.

 

***(f)***                        Cash

*** ***

The Company maintains itscash in high quality financial institutions. The balances, at times, may exceed federally insured limits.

 

***(g)***                     Equipment and Furniture

*** ***

Equipment and furniture arestated at cost and depreciated using the straight-line method over theestimated useful lives ranging from three to seven years. Maintenance, repairs,and minor renewals are expensed as incurred.

 

***(h)***                     License Agreements

*** ***

The costs associated with acquisition of licensesfor technology are recognized at the fair value of stock and cash used asconsideration.

 

Costs of acquiring technology which has noalternative future uses are expensed immediately as research and developmentexpense.

 

***(i)***                        Impairment of Long-lived Assets andLong-lived Assets to be Disposed Of

*** ***

The Company reviews long-lived assets and certainidentifiable intangibles for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to future undiscounted net cashflows expected to be generated by the asset. If such assets are considered tobe impaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the assets exceeds the fair value of the assets. Assetsto be disposed of are reported at the lower of the carrying amount or fairvalue less costs to sell.

 

During the years ended December 31, 2008 and2007, and the period from August 17, 1999 (inception) to December 31,2008, the Company did not record any impairment charges.

 

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***(j)***                        Stock-Based Compensation

 

Effective August 17, 1999, the Company adoptedthe fair value recognition provisions of Financial Accounting Standards Board (“FASB”)SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), torecord option and warrant issuances, including stock-based employeecompensation.  The Company’s policy is togrant stock options at fair value at the date of grant, and to record theexpense at fair value as required by SFAS 123, using the Black-Scholes pricingmodel.

 

Effective January 1,2006, the Company adopted SFAS 123R, that focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions.  This statementreplaced SFAS 123, and supersedes Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees.” SFAS 123R requires all companies to expense the fair value of employeestock options and similar awards, which has been the Company’s policy todate.  Stock-based employee andnon-employee compensation cost related to stock options and warrants was$59,245, $621,384, and $2,304,983 for the years ended December 31, 2008and 2007, and the period from August 17, 1999 (inception) to December 31,2008, respectively, or $0.03, $0.40, and $2.19 on a per share basis.  The Company estimates the amount of futurestock-based compensation expense related to currently outstanding options to beapproximately $30,600, $24,000 and $12,000 for the years ending December 31,2009, 2010, and 2011, respectively.  TheCompany recognizes the expense related to the fair value of the awardstraight-line over the vesting period.

 

The Black-Scholes option-pricing model was developedfor use in estimating the fair value of traded options that have no vestingrestrictions and are fully transferable. In addition, option pricing modelsrequire the input of highly subjective assumptions. Because the Company’semployee and consultant stock options have characteristics significantlydifferent from those of traded options, and because changes in the subjectiveinput assumptions can materially affect the fair value estimate, the existingmodels may not necessarily provide a reliable single measure of the fair valueof the Company’s employee stock options.

 

Indetermining the compensation cost of the options granted during the years endedDecember 31, 2008 and 2007, as specified by SFAS 123R, the fair value ofeach option grant has been estimated on the date of grant using the BlackScholes pricing model and the weighted average assumptions used in thesecalculations are summarized as follows:

 
| ** **                        | ** ** | **For the years ended  December 31,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                                  | ** ** | **2007** | ** ** |
| Risk-free  Interest Rate          |       | 3.13                                                      | %          | 4.90 | % |
| Expected Life of  Options Granted |       | 4.3years                                                  | (1)        | 4.0 years | (1) |
| Expected  Volatility              |       | 131.2                                                     | %          | 133.4 | % |
| Expected  Dividend Yield          |       | 0                                                         |       | 0 |   |
|                                   |            |                                                           |            |  |  |  |

 

----

(1)Calculated as the average of the vesting periods and the contractualterm of the options.

 

The expected life of theoptions is determined using a simplified method, computed as the average of theoption vesting periods and the contractual term of the option.  For performance-based options that vest uponthe occurrence of an event, the Company uses an estimate of when the event willoccur as the vesting period used in the Black-Scholes calculation for eachoption grant.  Because of the limitedtrading history of the Company’s stock, the expected volatility is based on asimple average of weekly price data since the date of the Merger on April 5,2004.  Management expects and estimatesthat substantially all employee stock options will vest, and therefore theforfeiture rate used was zero.  The 

 

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risk-free rates for theexpected terms of the stock options and awards are based on the U.S. Treasuryyield curve in effect at the time of grants.

 

***(k)***                     Warrants

 

In accordance with Emerging Issues Task Force (“EITF”)Issue No. 96-18, “Accounting for Equity Instruments that are Issued toOther than Employees for Acquiring, or in Conjunction with Selling, Goods andServices” and EITF Issue No. 98-5, “Accounting for Convertible Securitieswith Beneficial Conversion Features or Contingently Adjustable ConversionRatios” (“EITF 98-5”), the Company has elected to utilize the fair-value methodof accounting for warrants issued to non-employees as consideration for goodsor services received, including warrants issued to lenders and guarantors ofCompany debt (see Notes 9, 10 and 11). The weighted-average fair value of the warrants granted during the yearsended December 31, 2008 and 2007 was $1.37 and $3.80, respectively, andsuch warrants are immediately vested and exercisable on the date of grant.

 

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

 
| ** **                           | ** ** | **For the years ended  December 31,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                                  | ** ** | **2007** | ** ** |
| Risk-free  Interest Rate             |       | 3.23                                                      | %          | 4.68 | % |
| Expected Life of  Warrants Issued(1) |       | 5.0 years                                                 |       | 4.9 years |   |
| Expected  Volatility                 |       | 129.5                                                     | %          | 135.0 | % |
| Expected  Dividend Yield             |       | 0                                                         |       | 0 |   |

 

----

(1)The contractual term of the warrants.

 

The expected volatility isbased on weekly price data since the date of the Merger on April 5,2004.  Based on the lack of history tocalculate a forfeiture rate, the Company has not adjusted the calculated valueof the warrants.  The risk-free rates for the expected terms ofthe stock warrants are based on the U.S. Treasury yield curve in effect at thetime of grants.

 

***(l)***                        Financial Instruments

 

The carrying amount for all financial instruments approximates fair value. The carrying amounts for cash, notes payable, accounts payable and accrued liabilities approximate fair value because of the short maturity of these instruments. The carrying amounts for long-term debt, and other obligations approximates fair value as the interest rates and terms are substantially similar to rates and terms which could be obtained currently for similar instruments.

 

***(m)***                  Research and Development

 

Expenditures for researchand product development costs, including certain upfront license fees fortechnologies under development, are expensed as incurred.

 

***(n)***                     Debt Issuance Costs

 

Debt issuance costs areamortized over the term of the related debt as interest expense using thestraight-line method, which approximates the interest method.

 

The costs related to theCompany’s $2.2 million Crown Bank promissory notes issued in February 2006were recorded as debt issuance cost, and were amortized over the approximatelytwo-year term of the notes using the straight-line method until October 14,2007.  At that time, $600,000 of thenotes were 

 

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retired, and approximately$42,800 of debt issuance cost related to that portion of the notes was expensedas debt extinguishment expense.  The debtissuance cost associated with the remaining Crown Bank notes were amortized asinterest expense until December 28, 2007, when the notes were modified toextend the maturity date of the notes to February 28, 2009.  The Company evaluated this modification inaccordance with EITF Issue No. 96-19 “Debtor’s Accounting for aModification or Exchange of Debt Instruments” “EITF (6-19”).  The changein the agreement did not qualify as an extinguishment of debt; therefore, debtissuance cost from the old debt is carried forward.  The remaining$39,370 of unamortized debt issuance cost, together with $12,000 of bank feesassociated with the extension, is being amortized over the new term of thenotes as interest expense.

 

On October 15, 2007,the Company borrowed $600,000 pursuant to a promissory note issued to thePhillips W. Smith Family Trust (the “Smith Trust”) that matured on February 28,2009.  In consideration for this loan, onNovember 7, 2007 the Company agreed to issue 33,333 shares of its commonstock to the Smith Trust.  The $66,666value of this consideration was recorded as debt issuance cost and is beingamortized over the term of the loan.

 

On December 27, 2007,the Company held its first closing on a private placement of investment unitsconsisting of convertible debentures and warrants (the “2007 Private Placement”)(see Note 11(b)).  Direct costs of theoffering totaling $337,077, including underwriting fees, legal and accountingexpenses, and printing costs were recorded as a debt issuance cost asset.

** **

**During the year ended December 31,2008, the Company incurred additional debt issuance costs related to a secondclosing on the 2007 Private Placement, the closings on**an aggregate of $720,000 of units consisting of unsecured,subordinated, convertible promissory notes and common stock purchase warrantsin additional private placements (the“2008 Private Placements”) (see Note 11(b))and the closing on a $315,000 unit put financing facility (see Note 11(c)).  Included in this debt issuancecost was the issuance of warrants to acquire 32,500 shares of our common stockvalued at $42,575 related to the origination of the unit put financing facility(see Note 12(f)).

** **

**Debt issuance costs aresummarized as follows:**

 
| ** **                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
| Debt issuance  costs, gross |       | $        | 701,238    |     | $          | 452,113 |   |
| Less  amortization          |       | (434,356 | )          | (12,792  | )          |
|                        |       |     |       |     |       |
| Debt issuance  costs, net   |       | $        | 266,882    |     | $          | 439,321 |   |

 

Amortizationexpense related to debt issuance costs was $421,564, $506,639, and $1,705,733for the years ended December 31, 2008 and 2007 and the period from August 17,1999 (inception) to December 31, 2008, respectively.  The unamortized debt issuance cost as of December 31,2008 will either be amortized in 2009 or expensed as interest expense upon theautomatic conversion of the related debt into the Company’s equity securitiesupon the effective date of the 2009 Public Offering (see Note 14).

 

***(o)***                     Deferred Offering Costs

 

The legal, accounting,printing and certain other expenses directly related to the 2009 PublicOffering that became effective on January 7, 2009 were recorded as adeferred offering cost asset as of December 31, 2008 and 2007.  The deferred offering costs were recorded asa cost of the offering and a reduction of additional paid-in capital upon itsclosing on January 12, 2009.

 

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***(p)***                     Restricted Cash

 

Pursuant to the renewal of the Crown Bank promissorynotes (see Note 10), the Company agreed to deposit with Crown Bank four monthsworth of future interest payments due under the notes.    The funds on deposit are not available tothe Company for any purpose other than for debt service on the Crown Bankpromissory notes.  On March 19,2009, pursuant to the renewal of a Crown Bank promissory note, this restrictionwas removed (see Note 14).

 

***(q)***                     Income Taxes

 

The Company utilizes theliability method of accounting for income taxes. Under this method, deferredtax assets and liabilities are recognized for the expected future taxconsequences attributable to temporary differences between the financialstatement and income tax reporting bases of assets and liabilities. Deferredtax assets are reduced by a valuation allowance to the extent that realizationis not assured.

 

***(r)***                       Recently Issued Accounting Pronouncements

 

During May, 2008, FASBissued SFAS 162, “The Hierarchy of Generally accepted Accounting Principles (“SFAS162”).  SFAS 162 identifies the sourcesof accounting principles and the framework for selecting principles that are inconformity with generally accepted accounting principles in the United Statesof America.  SFAS 162 became effective duringNovember 2008.  The adoption of SFAS162 did not have a material effect on the Company’s results of operations,financial position or cash flows.

 

**(2)**                     Going Concern; Management’s Plan to FundWorking Capital Needs

 

TheCompany incurred net losses of $4,657,717, $3,113,298 and $20,935,813 andnegative cash flows from operating activities of $1,094,973, $963,004, and$8,319,446 for the years ended December 31, 2008 and 2007 and for thecumulative period from August 17, 1999 (inception) to December 31,2008, respectively. From July 2001 through January 2002, the Companyentered into several license arrangements to develop the licensed technologiesinto diagnostic equipment and treatments for enlarged prostates and other maleurological conditions. Since January 2002, the Company’s efforts to developthe licensed technologies have been significantly delayed at times due to alack of sufficient capital resources. The Company anticipates materiallyincreasing its expenditures for technology development activities and buildingthe Company’s infrastructure over the near term. Implementation of the Company’sbusiness plan is dependent upon the successful transition of its productdevelopment program into a viable product with market penetration andprofitability and obtaining sufficient capital to fund these developmentalactivities.

 

Managementbelieves that the Company has sufficient funds to complete clinicals of itsProUroScan System, submit a premarket notification application to FDA andobtain FDA clearance of a 510(k) for a basic mapping and data maintenancelabeling claim.  However, the Companydoes not currently have sufficient funds to make a significant commerciallaunch into the urology market. As of February 28, 2009, the Company hadapproximately $774,000 cash on hand and current liabilities of approximately$3.5 million, including $2.2 million of secured debt that was due on thatdate.  In March 2009, the Companyrenewed $1.8 million of the secured debt to mature on March 28, 2010, andtemporarily paid down $400,000 of the secured debt.  The Company intends to re-borrow the $400,000secured debt before the end of May, 2009 upon the establishment of asatisfactory guaranty of the debt with the lender. Management believes thatover the next 12 months the Company will need approximately $8 million ofworking capital to fund operations through FDA clearance and subsequentcommercial launch.

 

As a result of the closing on the 2009 Public Offering and thesubsequent conversion of convertible notes into the Company’s equity Units,there are 6,108,381 redeemable warrants outstanding.  These warrants have an exercise price of$1.30 per share, which the Company may redeem once the last sale price of ourcommon stock equals or exceeds $1.82 per share for a period of ten consecutivetrading days.  If this event were tooccur, the Company 

 

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intends to exercise its right to redeem the warrants, which will allowall holders of warrants a period of 30 days to exercise their warrants. If allsuch warrant holders exercise their warrants, the Company could realize up toapproximately $7.9 million, depending on the number of shares actuallyexercised pursuant to such a redemption. There can be no assurance that the Company will be able to redeem thewarrants, or of how much would be realized if such a redemption were made.

 

During the first half of 2009, the Company plans to identify adistribution partner to market its products. The Company expects such a distribution partner to provide significantfinancial support in the form of licensing fees, loans, equity investment or acombination of these.  In addition tofinancial support, a successful collaboration with such a partner would allowaccess to down stream marketing, manufacturing, and sales support.  There can be no assurance that a distributionpartner can be successfully identified and engaged during the first half of2009, or at all.

 

Ifthe Company is unable to obtain sufficient funding through the exercise of thewarrants or from financial support from a distribution partner, it will pursueone or more additional rounds of funding in 2009 and 2010 to provide theworking capital needed to fund a significant commercial launch into the urologymarket.  If additional funds are raisedby the issuance of convertible debt or equity securities, or by the exercise ofoutstanding warrants, then existing shareholders will experience dilution intheir ownership interest. If additional funds are raised by the issuance ofdebt or certain equity instruments, the Company may become subject to certainoperational limitations, and such securities may have rights senior to those ofits existing holders of common stock.

 

Ifadequate funds are not available through these initiatives on a timely basis,or are not available on acceptable terms, the Company may be unable to fundexpansion, or to develop or enhance our products. If the Company is forced toslow our development programs, or put them on hold, it would delay regulatoryclearances or approvals needed, and thus delay market entry for its products.Ultimately, if no additional financing is obtained beyond what has been securedto date, the Company likely would be forced to cease operations. There can beno assurance the Company will be successful in raising such funds.

** **

** **(3)                  Equipment and Furniture

 

Equipment and furnitureconsisted of the following at December 31:

 
| ** **                     | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Computer  equipment            |       | $        | 11,563     |     | $          | 11,563 |   |
| Furniture                      |       | 4,279    |       | 4,279    |       |
|                           |       | 15,842   |       | 15,842   |       |
| Less accumulated  depreciation |       | (15,842  | )          | (15,237  | )          |
|                           |       | $        | 0          |     | $          | 605 |   |

 

Depreciation expense was $605, $3,134, and $20,797for the years ended December 31, 2008 and 2007 and the period from August 17,1999 (inception) to December 31, 2008, respectively.

 

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**(4)**                     Accrued Expenses

 

Accrued expenses consistedof the following at December 31:

 
| ** **                                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Accrued interest                                   |       | $        | 169,985    |     | $          | 69,134 |   |
| Accrued  compensation, benefits, and related taxes |       | 350,836  |       | 535,537  |       |
| Accrued  interest-related party                    |       | 263,522  |       | 87,088   |       |
| Public offering  costs                             |       | 70,000   |       | 22,650   |       |
| Audit fees                                         |       | 47,000   |       | 21,250   |       |
| Directors’ fees                               |       | 20,249   |       | 9,166    |       |
| Consulting fees                                    |       | 15,000   |       | 15,000   |       |
| Other                                              |       | 662      |       | —   |       |
| Contracted  development                            |       | —   |       | 35,000   |       |
| Legal fees                                         |       | —   |       | 7,100    |       |
|                                               |       | $        | 937,253    |     | $          | 801,925 |   |

** **

**(5)**                     Agreements with Artann Laboratories Inc.

 

TheCompany has developed its ProUroScan System under contracts with ArtannLaboratories, Inc. (“Artann”), a scientific technology company based inTrenton, New Jersey, that is focused on early-stage technology development.

*** ***

***Artann 2004 Development Agreement***

 

In July 2004, the Company entered into adevelopment agreement with Artann and Dr. Armen Sarvazyan under whichArtann and Dr. Sarvazyan developed two working, pre-clinical ProUroScanTM systems. These systems were delivered to the Company in late November 2004.  The Company paid Artann $180,000 for thisdevelopment work, which was expensed as research and development cost duringthe year ended December 31, 2004.

*** ***

***Artann 2004 Research andDevelopment Agreement***

 

In July 2004, the Company entered into aresearch and development agreement with Artann (the “Research and DevelopmentAgreement”) for the further development of the ProUroScanTM system. Under this agreement, Artann was a research and development partner tothe Company, supporting the further development of the ProUroScanTM system. For its role, Artann received a payment of $50,000 and warrants for thepurchase of 10,000 shares of the Company’s common stock upon the execution ofthe agreement, and $110,000 and warrants for the purchase of 20,000 shares ofthe Company’s common stock following the shipment of the ProUroScanTM pre-clinical systems in accordance with thedevelopment agreement in December 2004. The warrants were fully vested,five-year warrants at a per share exercise price of $20.00 per sharevalue.  The total value of these warrantscomputed using the Black-Scholes pricing model was $281,086.  All payments and the value of the warrantswere recorded as research and development expense in the year ended December 31,2004.

*** ***

***Artann 2007 Cooperation Agreement***

 

On April 16, 2007, the Company entered into a cooperationagreement with Artann (the “Cooperation Agreement”) in which the parties agreedto terminate the existing Research and Development agreement and to use theirbest efforts to finalize a new development agreement within a reasonable periodof time.  The 

 

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CooperationAgreement released each party from all undischarged obligations and liabilitiesunder that agreement.

 

Underthe terms of the Cooperation Agreement, the Company paid $60,000 in feesoriginally due to Artann under the Research and Development Agreement, relatedto submission of two patents and associated patent attorney fees.  Further, the Company issued to Artannfive-year warrants (immediately exercisable) to acquire 20,000 shares of itscommon stock at $4.10 per share, thus fulfilling another obligation under theResearch and Development Agreement.  Thewarrants were valued at $72,000 by the Black-Scholes pricing model and wererecorded as research and development expense. The Company also agreed to pay Artann $35,000 as a first payment forwork already completed under the proposed development agreement.  This payment was made on January 16,2008.

*** ***

***Artann 2008 License Agreement***

 

On July 25, 2008, the Company entered into twoagreements with Artann.  Under the firstagreement, the “License Agreement,” Artann granted to the Company an exclusive,worldwide, sublicensable license to certain patent applications, trade secretsand technology to make, use and market certain mechanical imaging products inthe diagnosis or treatment of urologic disorders of the prostate, kidney orliver field of use.  Artann also agreedto transfer possession of five fully functional prostate imaging systems to theCompany and grant the Company full access to all relevant documentationthereto.  The License Agreement becameeffective on December 23, 2008.  Asconsideration, the Company agreed to pay, on the effective date of theagreement, an upfront cash license fee of $600,000 and shares of the Company’scommon stock valued at $500,000.  Thetotal $1,100,000 license fee was recorded as a general and administrativeexpense in the year ended December 31, 2008.  In addition, the Company agreed to pay Artanna royalty equal to four percent of the first $30 million of net cumulativesales of licensed products, three percent of the next $70 million of netcumulative sales and two percent of net cumulative sales over $100million.  Further, the Company will payArtann a technology royalty of one percent of net sales on prostate imagingsystem products throughDecember 31, 2016.  The combined royalties are subject to aminimum annual royalty equal to $50,000 per year for each of the first twoyears after clearance from the Food and Drug Administration (“FDA”) forcommercial sale and $100,000 per year for each year thereafter untiltermination or expiration of the License Agreement.  The Company also agreed to grant Artann a non-exclusivefully paid up, sublicensable, royalty-free and worldwide license for Artann to make, use or sell anymechanical imaging system for the diagnosis or treatment of disorders of thefemale human breast.  The LicenseAgreement will terminate upon the expiration of all royalty obligations, byfailure of either party to cure a breach of the agreement within a 60-day cureperiod, if the Company fails to make a payment to Artann and such failure isnot cured within a 30-day cure period or should one of the parties becomeinsolvent, go into liquidation or receivership or otherwise lose legal controlof its business.

*** ***

***Artann 2008 Development Agreement***

 

Under the second Artann agreement, the “Developmentand Commercialization Agreement,” the parties intend to collaborate together to develop,commercialize and market prostate mechanical imaging systems.  Artann will conduct and complete allpre-clinical activities and testing on the prostate imaging system, conduct clinicaltrials, prepare and submit FDA regulatory submissions and provide hardware andsoftware development, refinement and debugging services to ready the prostateimaging system for commercial sale.  Forthese development services, the Company will make cash milestone payments to Artann of $250,000 upon initiation of an FDAapproved clinical study, $250,000 upon completion of that FDA approved clinicalstudy and submission of an FDA regulatory approval application on the prostateimaging system and $750,000 upon FDA clearance to allow the prostate imagingsystem to be commercially sold in the United States.  As of the December 23, 2008 effectivedate of the Development and Commercialization Agreement, the FDA approvedclinical study milestone had been initiated, and the Company has expensed$250,000 on the consolidated statement of operations.  In addition, the Company will issue toArtann shares of common 

 

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stockof the Company having a value of $1 million upon completion of the FDA approved clinical study and submission of anFDA regulatory approval application on the prostate imaging system and, as asuccess bonus, the Company will issue to Artann shares of its commonstock having a value of $1 million uponFDA clearance.  The success bonus will bereduced by ten percent for each month that FDA clearance is delayed following15 months from the effective date of the Development and CommercializationAgreement.  The Company will also pay a monthlyretainer fee for technical advice and training by Artann personnel.  The monthly fee retainer shall be $30,000 permonth for each of the first nine months following the effective date of the Development and Commercialization Agreementand $15,000 per month for the next 12 months.

 

Additionally,Artann will supply to the Company such quantities of the prostate imagingsystem as is reasonably required for pre-commercial testing, evaluation,marketing and clinical study and to facilitate the transfer of commercialproduction to a third party.  Artann alsoagrees to use best reasonable efforts to provide a limited number of commercialsystems, if requested by the Company. The pre-commercial and commercial systems will be sold to the Company atprices yet to be determined.  QualifiedArtann personnel shall provide manufacture and scale-up services to the Companyor a third party manufacturer designated by the Company to facilitate thecommercial manufacture of the prostate imaging systems at a cost of $1,200 perday per individual for such services.

 

The initial term of the Development andCommercialization Agreement is for three years and may thereafter be renewed for additional oneyear terms upon mutual agreement of the parties.  The Developmentand Commercialization Agreement may also terminate if the Company fails to make a payment toArtann and such failure is not cured within a 60-day cure period or should oneof the parties become insolvent, go into liquidation or receivership orotherwise lose legal control of its business.

*** ***

***Accrued License and Development Fees***

 

As of December 31,2008, accrued license and development fees consisted of the following amountsdue to Artann under the License and Development and CommercializationAgreements:

 
| ** **                                                                              | ** ** | **Amount   accrued** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------|------------|
| Upfront license  fee payable in cash                                                    |       | $                         | 600,000    |   |
| Upfront license  fee payable in equity                                                  |       | 500,000                   |       |
| First milestone  cash payment due under the Development and Commercialization Agreement |       | 250,000                   |       |
| Less: Advances                                                                          |       | (22,165                   | )          |
| Accrued license  and development fees at December 31, 2008                         |       | $                         | 1,327,835  |   |

 

**(6)**                     License Agreements

*** ***

***(a)***                     Profile LLC

 

InJanuary 2002, Profile granted the Company an exclusive license forprostate imaging systems in exchange for 323,077 shares of the Company’s commonstock and the assumption of $25,000 of Profile net liabilities. On March 22,2002, in exchange for eliminating certain covenants of the license agreement,the Company issued to Profile an additional 76,923 shares of its commonstock.  The 400,000 shares of commonstock were valued at $1,713,600.  Theaggregated stock and cash consideration for the Profile license was $1,738,600,which was expensed as research and development.

 

OnApril 3, 2008, the Company purchased certain patents, patent applicationsand know-how from Profile (the “Profile Assets”) pursuant to an asset purchaseagreement.  The purchase of the Profile 

 

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Assetseffectively terminated the license agreement. The technology encompassed by the Profile Assets provides the basis forthe ProUroScanTM system, the Company’s initial productcurrently in the final stages of development. The purchase price of the Profile Assets was $300,000, of which $150,000was paid in cash and $150,000 was financed under the Profile Note (see Note 9).  As indicated by SFAS No. 2, “Accountingfor Research and Development Costs,” regarding costs of intangibles that arepurchased from others for a particular research and development project andthat have no alternative future uses, the entire $300,000 purchase price wasexpensed as research and development expense for the year ended December 31,2008.

*** ***

***(b) ***                  CS Medical

 

InJuly 2001, the Company licensed certain microwave technology from CSMedical.  The worldwide, exclusivelicense is limited to the field of use of the treatment of enlarged prostates,prostatitis, prostate cancer and other urological disorders, and terminateswith the expiration of the last patent to expire that is the subject of thelicense and requires defined royalty payments. As consideration for the license, the Company exchanged 300,000 sharesof its common stock valued at $475,000. This consideration was expensed asresearch and development.  Under theterms of the license agreement, royalty payments are to be made quarterly in anamount equal to 0.5 percent of the amount that net sales of the Company’sproducts that incorporate the licensed technology exceed $500,000 in thatquarter.  The Company has no currentplans to develop the licensed technology due to resource limitations.  In the absence of revenues, the Company isnot obligated to make any royalty payments to CS Medical.

*** ***

***(c)***                      RPI Agreement

** **

**In July 2001,the Company entered into a license agreement with Rensselaer PolytechnicInstitute (“RPI”) to allow the Company to use Electrical Impedance Tomography (“EIT”)technology developed and patented by RPI, on a worldwide, exclusive basis forthe diagnosis and treatment of urological conditions. Consideration for thelicense was $50,000, paid in two $25,000 installments, which were expensed asresearch and development in fiscal 2001. On July 27, 2005, the Company andRPI entered into Amendment No. 1 to the RPI license. Subsequently, thelicense become non-exclusive.  TheCompany intends to abandon the EIT technology due to resource limitations.**

** **

** (7)**                  Commitments and Contingencies

*** ***

***(a)***                     Lease

 

EffectiveMarch 1, 2009, the Company began renting approximately 500 square feet ofoffice space on a month-to-month basis at a cost of approximately $550 permonth.  From March 1, 2007 to February 28, 2009, theCompany rented executive offices within the offices of a former Companydirector, Mr. Nazarenko.  Our rentalcost for these offices was approximately $2,129 per month, which is the marketprice for similar office space in Minneapolis, Minnesota.

 

Rent expense for the years ended December 31,2008 and 2007, and the period from August 17, 1999 (inception) to December 31,2008 was $23,062, $21,286 and $256,206, respectively.

*** ***

***(b)***                     Employment Agreements

 

On July 16, 2008, PUCentered into an employment agreement with Richard Carlson, its Chief ExecutiveOfficer.  The agreement provides for aminimum annual salary of $150,000, a cash incentive bonus potential of up to 40percent of Mr. Carlson’s base pay and eligibility to participate in anannual grant of options to purchase shares of common stock, as determined bythe Company’s Board of Directors.  Theagreement provides for severance payments if the Company terminates Mr. Carlsonwithout cause or if Mr. Carlson terminates the agreement for good reasonthat includes nine months of 

 

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base salary plus one monthof base salary for each year of service (up to a maximum of 12 months of basesalary), payment of earned bonuses, continued payment of existing health andlife insurance benefits for a period of nine months and immediate vesting ofall unvested stock options then held by Mr. Carlson.  In addition, within a one-year periodfollowing a “change in control” of the Company, upon termination without cause,unacceptable demotion or reduction in responsibilities or a relocation of morethan 100 miles, Mr. Carlson will receive as severance, nine months of basesalary plus one month of base salary for each year of service (up to a maximumof 12 months of base salary) and immediate vesting of all unvested stockoptions then held by Mr. Carlson. The agreement prohibits Mr. Carlson from directly or indirectlyparticipating in the ownership, management, operation or control of acompetitive business for a period of one year after his employment with theCompany terminates.  The agreement willexpire on December 31, 2009.

 

On July 21, 2007, PUCentered into an employment agreement with its Chief Financial Officer, RichardThon.  The agreement extends through June 30,2009. The agreement provides for a minimum annual salary of $140,000, a cashincentive bonus potential of up to 30 percent of Mr. Thon’s base pay andeligibility to participate in an annual grant of options to purchase shares ofcommon stock, as determined by the Company’s Board of Directors.  The agreement provides for severance paymentsif the Company terminates Mr. Thon without cause or if Mr. Thonterminates the agreement for good reason, including four months of base salaryplus one month of base salary for each year of service (up to a maximum of ninemonths of base salary), payment of earned bonuses, continued payment ofexisting health and life insurance benefits for a period of four months andimmediate vesting of all unvested stock options then held by Mr. Thon.  In addition, within a one-year periodfollowing a “change in control” of the Company, upon termination without cause,unacceptable demotion or reduction in responsibilities or a relocation of morethan 100 miles, Mr. Thon will receive as severance, six months of basesalary plus one month of base salary for each year of service (up to a maximumof 12 months of base salary), and immediate vesting of all unvested stockoptions then held by Mr. Thon.  Theagreement prohibits Mr. Thon from directly or indirectly participating inthe ownership, management, operation or control of a competitive business for aperiod of one year after his employment with the Company terminates.

 

At December 31,2008, approximately $269,000 of our current senior management’s salaries andbonuses had not been paid, and were recorded as an accrued expense.

*** ***

***(c)******                     ******Legal proceedings***

 

The Company is involved in routine legal proceedingsin the conduct of the ordinary course of its business.

** **

**(8)****                    ****Income Taxes**

 

TheCompany has generated net operating loss carryforwards of approximately $5.0million which, if not used, will begin to expire in 2021.  Federal and state tax laws impose significantrestrictions on the utilization of net operating loss carryforwards in theevent of a change in ownership of the Company that constitutes an “ownershipchange,” as defined by Section 382 of the Code.  The Company has analyzed the 2009 PublicOffering along with previous changes and believes that such an ownership changehas not occurred, and that the Company’s use of its net operating losscarryforwards is not subject to such restrictions.

 

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The Company has recorded afull valuation allowance against its deferred tax assets and deferred taxliability due to the uncertainty of realizing the related benefits and costs asfollows:

 
| ** **                                               | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|----------------------------------------------------------|------------|------------|------------|------------|------------|
| Deferred tax  assets                                     |       |       |       |       |       |
| Net operating  loss carryforwards                        |       | $          | 1,916,000  |       | $          | 1,566,000 |   |
| Capitalized  start up costs                              |       | 2,921,000  |       | 2,450,000  |       |
| Expenses paid  with options and warrants                 |       | 724,000    |       | 836,000    |       |
| Capitalized  licenses                                    |       | 893,000    |       | 416,000    |       |
| Other                                                    |       | 164,000    |       | 149,000    |       |
| Deferred tax  liability                                  |       |       |       |       |       |
| Beneficial  conversion feature of convertible debentures |       | (212,000   | )          | (347,000   | )          |
| Less: valuation  allowance                               |       | (6,406,000 | )          | (5,070,000 | )          |
| Net deferred tax  assets                                 |       | $          | 0          |       | $          | 0 |   |

 

Thechange in the valuation allowance was $1,336,000, $795,000 and $6,406,000 forthe years ended December 31, 2008 and 2007 and the period from August 17,1999 (inception) to December 31, 2008, respectively.  In September 2005, the FASB approvedEITF Issue No. 05-8, “Income Tax Consequences of Issuing Convertible Debtwith a Beneficial Conversion Feature” (“EITF 05-8”).  EITF 05-8 provides: (i) that therecognition of a beneficial conversion feature creates a difference betweenbook basis and tax basis of a convertible debt instrument, (ii) that basisdifference is a temporary difference for which a deferred tax liability shouldbe recorded and (iii) the effect of recognizing the deferred tax liabilityshould be charged to equity in accordance with SFAS No. 109 “Accountingfor Income Taxes.”  EITF 05-8 waseffective for financial statements for periods beginning after December 15,2005.  The Company applied EITF 05-8 tothe 2008 and 2007 issuances of convertible debt and the remaining deferred taxliability at December 31, 2008 and 2007 was $212,000 and $347,000,respectively.  Pursuant to EITF 05-8Issue Summary No. 1 dated August 29, 2005, paragraph 15, the Companyoffset the deferred tax liability against the deferred tax valuation allowanceat December 31, 2008 and 2007.

 

Reconciliation between thefederal statutory rate and the effective tax rates for the years ended December 31,2008 and 2007 and the period from August 17, 1999 (inception) to December 31,2008 is as follows:

 
| ** **                           | ** ** | **2008** | ** ** | **2007** | ** ** | **Period from  August 17,  1999  (inception) to  December 31,  2008** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|-------------------------------------------------------------------------------------------|------------|
| Federal  statutory tax rate          |       | (34.0    | )%         | (34.0    | )%         | (34.0                                                                                     | )%         |
| State taxes, net  of federal benefit |       | (4.5     | )          | (4.5     | )          | (4.5                                                                                      | )          |
| Employee  incentive stock options    |       | 0.3      |       | 2.5      |       | 1.9                                                                                       |       |
| Expired warrants  and options        |       | 4.6      |       | 2.6      |       | 1.5                                                                                       |       |
| Capitalized  license fees            |       | —   |       | —   |       | 0.9                                                                                       |       |
| Change in  valuation allowance       |       | 33.6     |       | 33.4     |       | 34.2                                                                                      |       |
| Effective tax  rate                  |       | 0.0      | %          | 0.0      | %          | 0.0                                                                                       | %          |

 

The Company has adopted the policy of classifying interest in interestexpense and penalties in general and administrative expense.

 

The Company had no significant unrecognized tax benefits as of December 31,2008 or December 31, 2007 and, likewise, no significant unrecognized taxbenefits that, if recognized, would affect the effective tax rate.

 

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The Company had no positions for which it deemed that it is reasonablypossible that the total amounts of the unrecognized tax benefit willsignificantly increase or decrease.

 

The tax years that remainsubject to examination by major tax jurisdictions currently are:

 

Federal 2005 - 2007 State of Minnesota 2005 - 2007

** **

** (9)**                  Notes Payable

 

·                  On June 1, 2006, PUC borrowed$75,000 from Mr. Roman Pauly, and in connection therewith issued to Mr. Paulya promissory note to mature on August 30, 2006.  The promissory note and amendments theretobore an interest at the Prime Rate.  On August 24,2006, the promissory note was amended to mature on October 29, 2006.  On January 22, 2007, the Company repaid $25,000of the promissory note.  On March 20,2007, the promissory note was amended for a second time to extend the due dateof the remaining balance until the Company closed on an aggregate of $750,000or more of additional financing following the date of the amendment.  On January 3, 2008 and February 29,2008, the Company repaid $33,000 and $7,650 of the principal of the promissorynote, respectively.  On October 24,2008, the promissory note was further amended to extend the maturity date tothe earlier of the Company’s closing of its anticipated public offering or November 30,2008.  In connection with the promissory note and theamendments thereto, the Company issued several warrants to Mr. Pauly (see Note12(f)).  The note balance outstanding at December 31,2008 and 2007 was $9,350 and $50,000.

 

On January 9, 2009, the Company repaidthe remaining $9,350 principal amount of the Pauly loan and issued a warrant toacquire 4,295 shares of the Company’s common stock as described above (see Note14).

 

·                  On November 30,2006, the Company borrowed $100,000 from Adron Holdings, LLC (“Adron”).  In connection therewith, the Company issuedto Adron an unsecured promissory note that bore an annual interest rate of 60percent and was set to mature on January 2, 2007 (the “Adron Note”).  On each of March 20, 2007 and August 8,2007, the Company amended the Adron Note, resulting in a change of the annualinterest rate to 42 percent, the extension of its due date to September 15,2007 and an agreement to issue to Adron five-year warrants to acquire 167shares at $5.00 per share for each day the principal remained unpaid on andafter March 1, 2007 (see Note 12(f)).  The Company repaid the principal in January,2008.  The note balance outstanding at December 31,2008 and 2007 was $0 and $100,000.

 

·                  OnMay 25, 2007, the Company borrowed $42,585 from a commercial lenderpursuant to an insurance policy financing agreement. The financing agreementcalled for ten monthly installment payments of $4,453 beginning July 1,2007, with an imputed annual interest rate of 9.85 percent.  The proceeds were paid directly to aninsurance company as a prepayment on an insurance policy.  The note was paid in full during 2008.

** **

**·**                  On July 31, 2007, theCompany borrowed for working capital purposes $100,000 from the Smith Trustpursuant to a promissory note.  On January 3,2008, the Company repaid $66,000 of this note. On March 11, 2008, the Company amended thepromissory note with the Smith Trust. Under the terms of the amendment, unpaid principal and interest will bepayable upon the Company’s closing of an aggregate of $500,000 or more offinancing following the date of the amendment. The note bore interest at the Prime Rate (3.25percent and 7.25 percent at December 31, 2008 and 2007, respectively).  In addition,the Company agreed to issue afive-year warrant to the Smith Trust to acquire one share of the Company’scommon stock at $5.00 per share for each $1,000 of principal amount outstandingfor each day the promissory note remained unpaid (see Note 12(f)).  On January 20, 2009, the Company repaidthe Smith 

 

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**Trustpromissory note and issued 28,656 warrants according to the above terms (seeNote 14).  The note balance outstandingat December 31, 2008 and 2007 was $34,000 and $100,000.**

** **

·                  On August 29,October 31 and November 30, 2007, the Company borrowed for working capital needs$50,000, $100,000 and $25,000, respectively, from James Davis pursuant topromissory notes.  Each note boreinterest at the Prime Rate (3.25percent and 7.25 percent at December 31, 2008 and 2007, respectively).  Upon the December 27, 2007 conversion ofthese notes into the convertible debentures of the Company (see Note 11(b)),pursuant to the terms of the promissory note, the Company issued to Mr. Davisa warrant to acquire 12,550 shares of its common stock that was valued at$28,340 using the Black-Scholes pricing model and expensed as interestexpense.  The conversion resulted inthere not being an outstanding balance at December 31, 2007.

** **

**·**                  On October 31, 2007, the Company issued a promissorynote for $600,000 in favor of the Smith Trust effective as of October 15,2007.  The proceeds were used to retire$600,000 of the Crown Bank promissory notes. The promissory note issued to the Smith Trust matures on February 28,2009, bears interest at 1.0 percent over the Prime Rate, but never less than6.50 percent (6.50 percent and 8.25 percent at December 31, 2008 and 2007,respectively), and has a subordinated security interest in all of the Company’sassets.  As consideration to the SmithTrust for making this loan, the Company issued shares of its common stock andwarrants to acquire shares of its common stock (see Note 12(f)).  On March 11, 2008, theCompany amended the promissory note with the Smith Trust.  Under the terms of the first amendment,interest accrued pursuant to the promissory note is payable on the maturitydate, rather than payable monthly.  The note balance outstandingat both December 31, 2008 and 2007 was $600,000.  On March 19, 2009, the Company againamended the promissory note with the Smith Trust to extend the maturity date toMarch 28, 2010 (see Note 14).

 

·                  OnMay 27, 2008, the Company borrowed $43,860 from a commercial lenderpursuant to an insurance policy financing agreement.  The financing agreement calls for ten monthlyinstallment payments of $4,554 beginning July 1, 2008, with an imputedannual interest rate of 8.26 percent. The proceeds were paid directly to aninsurance company as a prepayment on an insurance policy.  On September 16, 2008, the Companyborrowed an additional $10,644 from the same commercial lender pursuant to anincrease in its insurance coverage, resulting in an increase in the remainingmonthly payments of $1,823 beginning November 1, 2008.  The note balance outstanding at December 31,2008 was $25,075.

** **

**·**                  On April 3,2008, the Company purchased the Profile Assets from Profile (see Note6(a)).  $150,000 of the purchase pricewas financed under a secured promissory note issued in favor of Profile (the “ProfileNote”).  Pursuant to the terms of theProfile Note, the principal and interest accrued thereon was to become due andpayable five business days following the close of a public offering of theCompany’s equity securities or August 29, 2008, whichever occurred first(the “Maturity Date”).  Interest accruedat an annual rate of 10 percent prior to the Maturity Date and 18 percentthereafter.  On September 10, 2008,the Company amended the Profile Note such that it became due on September 25,2008.  On September 25, 2008, theCompany repaid the principal amount the Profile Note and the accrued interestthereon.

** **

**·**                  Atvarious times during the years ended December 31, 2008 and 2007, theCompany received short-term, unsecured loans from certain officers anddirectors solely for short-term working capital needs.  These loans were made without any interest orother consideration accruing to the officers and directors, and had no definedterms.  As of December 31, 2008 and2007, the Company had total outstanding borrowings of $0 and $10,450 from onedirector, respectively.

** **

**See Note 13 for information regarding related partytransactions and loans.**

 

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**(10)****             ****Notes Payable - Bank**

 

InFebruary 2006, the Company completed two closings of senior debtfinancing.  Pursuant to the two closings,on February 16, 2006, the Company issued a promissory note to Crown Bankin the amount of $1,200,000 at an interest rate of the Prime Rate plus onepercent**,**but never less than 6.50 percent (6.50 and 8.25 percent at December 31,2008 and 2007, respectively).  On February 28,2006, the Company issued a second promissory note to Crown Bank in the amountof $1,000,000, at an interest rate of the Prime Rate plus one percent (4.25percent and 8.25 percent at December 31, 2008 and 2007,respectively).  The average interest rateof the notes was 6.60 and 9.05 percent for the years ended December 31,2008 and 2007, respectively.  Thepromissory notes were secured by a pledge of all Company assets, including twotechnology licenses that were assigned to Crown Bank, and were guaranteed byBruce Culver, James Davis, William Reiling and the Smith Trust.  In consideration for their guarantees, theCompany issued 10 percent unsecured convertible subordinated debenturestotaling $733,334 to the four guarantors (see Note 11(a)).

 

OnOctober 15, 2007, the Company retired $600,000 of the Crown Bankpromissory notes, and on October 31, 2007, the Company renewed the remainingnotes to mature on February 28, 2009. In connection with the renewal, andas a condition to the effectiveness of the terms and conditions of the renewalof the notes, the Company agreed to deposit into an escrow with Crown Bank fourmonths worth of future interest payments due under the notes.  On December 28, 2007, the Companydeposited $44,000 into Crown Bank as the four months’ interest requirement,thereby making effective the terms of the renewed notes.  The guidance provided by EITF 96-19 indicatesthat a substantial modification of debt terms should be accounted for as anextinguishment of debt.  The presentvalue of the cash flows under the modification of the Crown Bank notes was lessthan 10 percent different from the cash flows of the original agreement.  Accordingly, the extension of the maturitydate of the notes was not deemed to be a substantial modification.

 

Asa condition to the renewal of the notes, Crown Bank required that theguarantors extend their guarantees to cover the longer note terms and increasethe amount each guaranteed.  Asconsideration to Mssrs. Culver, Davis and Reiling for extending theirguarantees through February 28, 2009, the Company issued to each shares ofits common stock and warrants to acquire its common stock (see Note 12(f)).

 

OnMarch 19, 2009, the Company renewed the $1,200,000 Crown Bank note, andtemporarily paid down the $400,000 note (see Note 14).

** **

**(11)****             ****Convertible Debt**

*** ***

***(a)******                    ******Convertible Debentures***

 

As consideration to the guarantors to provide their guarantees for theCrown Bank promissory notes (see Note 10), the Company issued $733,334 ofunsecured convertible 10 percent debentures. All of the debentures mature three years from the date of issue(coincident with the closing dates of the promissory notes as noted above) andare convertible into Company common stock at a price of $3.00 per share.  The face value of the convertible debentureswas recorded as long-term convertible debentures liability for $733,334 (beforethe impact of the calculation of the beneficial conversion feature — see below)with the offset of the cost of the debentures recorded as a debt issuance costasset.  The debt issuance cost asset isbeing amortized as interest expense over the term of the underlying bank notepayable.  The convertible debentures are being treated as debt issuance costbecause they represent the costs directly attributable to the bank promissorynote financing.

 

The embedded conversion feature of the convertible debentures does notmeet all the characteristics of a derivative instrument as described in SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”),and therefore was not separated from the host contract and accounted for as aderivative.  The embedded conversionfeature does not provide for net settlement, the shares to be issued pursuantto the exercise of the conversion feature will be unregistered and, due to thelarge number of shares involved and the thinly traded market for the Company’sshares, cannot 

 

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be readily settled net by a means outside the contract.  The value of the beneficial conversionfeature was computed as the difference between the fair market value of theshares at the transaction dates and the lowest possible conversion price duringthe debenture term ($3.00 per share), multiplied by the number of conversionshares that would be issued at that conversion price (244,445 shares).  The value so computed was in excess of theface value of the convertible debentures issued, and was therefore limited tothe face value of the debentures issued ($733,334).  The beneficial conversion feature wasrecorded as an original issue discount as defined in EITF 98-5 against theconvertible debt liability and is alsobeing amortized as interest expense over the term of the convertibledebentures.  See Note 8 for the deferredincome tax effects of the beneficial conversion feature.

 

On March 21, 2007, theCompany and the four guarantors agreed to amend the debenture agreements. Pursuant to the revised debenture agreements, among other things, theCompany issued a total of 12,478 shares of its Investment Units to the four guarantors in lieu of$49,911 of accrued interest.  Each InvestmentUnit consists of one share of the Company’s common stock and a 3-year warrant(immediately exercisable) to acquire 0.5 shares of the Company’s common stockfor $2.50 ($5.00 per share).  Theguidance provided by EITF 96-19 indicates that a substantial modification ofdebt terms should be accounted for as an extinguishment of debt, as the presentvalue of the cash flows under the March 20, 2007 modification was greaterthan 10 percent different from the present value of the cash flows under theoriginal agreement.  Accordingly, thewarrants issued, valued at $26,829 using the Black-Scholes method, wererecorded as debt extinguishment expense. No other gain or loss was recorded.

** **

**On December 27,2007, the holders of the unsecured convertible 10 percent debentures issued bythe Company agreed to further amend the terms of their debentures to providefor automatic conversion of the principal amount of the debentures and theunpaid interest accrued thereon into shares of the Company’s common stock at$3.00 per share upon the closing of an underwritten public offering by theCompany.  The $733,334 outstandingprincipal amount of the debentures will convert into 244,445 shares of theCompany’s common stock.  As of December 31,2008, $142,604 of unpaid accrued interest related to the debentures wasoutstanding.  Interest will continue toaccrue on the debentures until they are converted or otherwise retired. **The balance outstanding at both December 31, 2008 and2007 was $733,334.

** **

**On January 12,2009, the Company closed on its 2009 Public Offering, which triggered theautomatic conversion of the convertible debentures along with the interestaccrued thereon into shares of the Company’s common stock (see Note 14).**

*** ***

***(b)******                    ******Convertible Notes — 2007 and 2008Private Placements***

** **

**On December 27,2007, the Company closed on the sale of $1,050,000 of units consisting ofunsecured, subordinated, convertible promissory notes (the “2007 Notes”) andcommon stock purchase warrants (the “2007 Warrants”) in the 2007 PrivatePlacement.  Net cash proceeds to theCompany were $712,923, after deducting $337,077 of expenses of the offering(including $105,000 of commissions paid to the placement agent) and excludingfrom the cash proceeds the conversion into units of $25,000 of loans made tothe Company by James Davis and $25,000 of certain loans from the Company’sdirectors.**

** **

**At the closing,the Company issued $997,500 in principal amount of 2007 Notes and 2007 Warrantsto purchase 210,000 shares of common stock. The 2007 Notes bore interest at 10 percent per year and would havematured on June 27, 2009.  As aresult of the 2009 Public Offering, the 2007 Notes converted into the Company’s2009 Units at $0.70 per unit.  The 2007Warrants became exercisable**

 

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**upon theclosing of the 2009 Public Offering and will remain exercisable until December 31,2012 (see Note 12(f)).  The exerciseprice is $0.50 per share.**

** **

**On December 27,2007, the Company also converted $150,000 of existing loans from James Davisinto a note (the “Davis Note”) and warrants similar to those describedabove.  The principal amount of the noteissued to Mr. Davis was $142,500.  Mr. Davisalso received warrants to purchase 30,000 shares of the Company’s commonstock.  The terms of the note andwarrants issued to Mr. Davis are the same as those issued in the 2007 PrivatePlacement, except that his note is converted into the Company’s 2009 Units at$0.50 per unit.  In addition, Mr. Davisagreed that the 2009 Units issued upon conversion of his note and the commonstock issued upon exercise of his warrant will not be transferable for a periodof one year from January 7, 2009.**

 

OnJanuary 4, 2008, the Company closed on the sale of $80,000 of additionalunits as part of the 2007 Private Placement with the same terms as noted above.Net cash proceeds to the Company were $69,600, after deducting $10,400 ofcommissions paid to the placement agent. At closing, the Company issued $76,000in principal amount of 2007 Notes and 2007 Warrants to purchase 16,000 sharesof common stock.

 

OnFebruary 13, February 28, May 2, July 15 and July 30,2008, the Company closed on the 2008 Private Placements, selling an aggregateof $720,000 of investment units. Net cash proceeds to the Company were$539,716, after deducting $180,284 of expenses of the offerings (including$93,600 of commissions paid to the placement agent). Each $10,000 unit consistsof a note in the principal amount of $9,500 (the “2008 Notes”) and a warrant topurchase 2,000 shares of our common stock (the “2008 Warrants”).  In aggregate, theCompany issued $684,000 in principal amount of 2008 Notes and 2008 Warrants topurchase 144,000 shares of common stock. The terms of the 2008 Notes and 2008 Warrants areidentical to the 2007 Notes and 2007 Warrants, respectively, except with regardto the eligible periods of prepayment.

 

The embedded conversionfeatures of the 2007 Notes, the Davis Note and the 2008 Notes do not meet allthe characteristics of a derivative instrument as described in SFAS 133,and therefore were not separated from the host contracts and accounted for as derivatives.The embedded conversion features are indexed to the Company’s common stock, andwould be classified in shareholders’ equity under the guidance of EITF Issue No. 00-19“Accounting for Derivative Financial Instruments Indexed to, and Potentially Settledin, a Company’s Own Stock” (“EITF 00-19”), if they were freestandingderivatives. The embedded conversion feature contains an explicit limit on thenumber of shares to be delivered, the Company has sufficient authorized andunissued shares available to settle the maximum number of shares and thedebenture agreement does not contain a net cash settlement feature. Thebeneficial conversion features of the 2007 Notes, the Davis Note and the 2008Notes, valued at $946,539 using the Black-Scholes pricing model, along with the$153,735 relative fair value of the 2007 Warrants, the Davis Warrants and the2008 Warrants, were recorded as an original issue discount as defined inEITF 98-5 against the convertible debt liability, and are being amortizedas interest expense over the term of the convertible debentures.  $612,689, $417 and $613,106 of the originalissue discount was amortized as interest expense during the years ended December 31,2008 and 2007 and the period from August 17, 1999 (inception) to December 31,2008, respectively.  See Note 8 for thedeferred income tax effects of the beneficial conversion feature.

** **

**The aggregate balance outstanding of the 2007 Notes, theDavis Note and the 2008 Notes at December 31, 2008 and 2007 was $1,900,000and $1,140,000, respectively.  On the January 7, 2009 effective date of the Company’s2009 Public Offering, the 2007 Notes, the Davis Note and the 2008 Notes alongwith the interest accrued thereon automatically converted into units identicalto those sold in the 2009 Public Offering (see Note 14).**

 

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***(c)******                     ******Convertible Notes — Unit PutArrangement***

 

On September 16, 2008, the Companysecured $325,000 of future funding through commitments to purchase units inaccordance with the terms of a unit put agreement (the “Unit Put Agreement,”such future funding commitments, the “Unit Put Arrangements”).  In consideration of each purchaser’s futurefunding commitment, each purchaser received an origination warrant to purchase1,000 shares of the Company’s common stock for each $10,000 unit an investorcommitted to purchase (each, an “Origination Warrant”) (see Note 12(f)).

 

Each unit consists of a note in the principal amount of $9,500 (the “UnitPut Notes”) and a warrant topurchase 2,000 shares of the Company’s common stock (the “Unit Put Warrants”)(seeNote 12(f)).  The purchase price of the warrant portion ofeach unit was $500.  The Unit Put Notesbore interest at 10 percent per year, were to mature on March 16, 2010and, as a result of the January 12, 2009 closing of 2009 Public Offering,converted into common stock at $0.70 per share.

 

OnSeptember 16, 2008, the Company exercised $162,500 of its put optionsunder the Unit Purchase Agreement, and upon the September 24, 2008 closingthereof, issued Unit Put Notes in the principal amount of $154,375 and 32,500Unit Put Warrants.  On October 17,2008, the Company exercised the remaining $162,500 of its put option under theUnit Put Agreement and on October 28, 2008 and December 11, 2008,closed on $127,500 and $25,000 of this exercise, respectively.  $10,000 of the put option was notclosed.  Pursuant to these closings, theCompany issued Unit Put Notes in the principal amount of $144,875 and 30,500Unit Put Warrants.  Cash proceeds fromall closings were $282,339, while $32,661 of the Unit Put Notes and Warrantswere paid for by the reduction of accrued interest due to one of the investors.  Legal, accounting and other direct costsrelated to the offering totaling $13,002 were recorded as debt issuance costand are being amortized as interest expense over the term of the Unit PutAgreement.

 

Theembedded conversion feature of the Unit Put Notes does not meet all thecharacteristics of a derivative instrument as described in SFAS 133, andtherefore was not separated from the host contracts and accounted for asderivatives.  The embedded conversion featureis indexed to the Company’s common stock and would be classified inshareholders’ equity under the guidance of EITF 00-19 if it was a freestandingderivative.  The embedded conversionfeature contains an explicit limit on the number of shares to be delivered, theCompany has sufficient authorized and unissued shares available to settle themaximum number of shares and the debenture agreement does not contain a netcash settlement feature.  The beneficialconversion features of the Unit Put Notes, valued at $145,743 using theBlack-Scholes pricing model, along with the $17,493 relative fair value of theUnit Put Warrants, were recorded as an original issue discount as defined inEITF 98-5 against the convertible debt liability, and are being amortized asinterest expense over the term of the convertible debentures.  $24,797 of the original issue discount wasamortized as interest expense during the year ended December 31,2008.  See Note 8 for the deferred incometax effect of the beneficial conversion feature.

 

The$299,250 of Unit Put Notes outstanding at December 31, 2008 and theinterest accrued thereon automatically converted into shares of the Company’scommon stock on February 6, 2009 (see Note 14).

*** ***

***(d)****                    **Other Convertible Notes*

** **

**·**                  On April 3, 2008, theCompany borrowed an aggregate of $112,500 pursuant to three promissory notes,each in the amount of $37,500, issued in favor of James Davis, William Reilingand the Smith Trust.  The proceeds fromthe promissory notes were used toward the purchase of the Profile Assets (seeNote 6(a)).  Payment in full of thepromissory notes and the interest accrued thereon at an annual rate of 10percent was due on September 1, 2008. As consideration for providing the 

 

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**loans, the Company issued immediately exercisable,five-year warrants to purchase 25,000 shares of the Company’s common stock at$1.50 per share to each lender.  Thegross proceeds were allocated between the note and the warrants based on therelative fair value at the time of issuance. The $42,769 relative fair value of the warrants was recorded as originalissue discount on the related promissory notes and expensed as interest expenseover the term of the promissory notes.**On September 12,2008, the Company amended the three promissory notes.  Under the terms of the amendments, thematurity date of each $37,500 note was changed from September 1, 2008 tothe earlier of the seven days after the date the Company closed on anunderwritten public offering of equity securities or December 31,2008.  In addition, each note holder wasgiven the option of converting the principal and interest into shares of theCompany’s common stock at price equal to 70 percent of the price of thesecurities sold in that underwritten public offering, in lieu of cash.  EITF Issue No. 06-6 “Debtor’s Accountingfor a Modification (or Exchange) of Convertible Debt Instruments” requires thata modification or exchange of debt instruments be accounted for as debtextinguishment if a substantive conversion option is added to the new ormodified debt instrument.  Under theguidance of EITF Issue No. 05-1 “Accounting for the Conversion of anInstrument That Became Convertible upon the Issuer’s Exercise of a Call Option,”the added conversion option was deemed to be substantive.  Accordingly, the amendments were treated as adebt extinguishment.  No gain or loss wasrecognized.  The $48,214 fair value ofthe beneficial conversion feature was recorded as original issue discount, andwas amortized as debt extinguishment expense over the term of the notes.  The principal balance outstanding at December 31,2008 was $112,500.

** **

**In January 2009, following the closing of the2009 Public Offering, the Company repaid $45,500 of the notes, and $29,500 ofthe notes were converted into common stock at $0.70 per share (see Note14). **On March 19,2009, the remaining $37,500 promissory note, due to Mr. Davis, wasrefinanced along with another $150,000 promissory note due to Mr. Davis(see Note 14).

** **

**·**                  On September 25, 2008, the Company borrowed $150,000 pursuant to aconvertible promissory note issued in favor of James Davis.  The proceeds of the loan were used to retirethe $150,000 principal balance of the Profile Note.  Payment in full of the promissory notes andthe interest accrued thereon at an annual rate of 10 percent was due on theearlier of seven days after the date the Company closed an underwritten publicoffering of equity securities or March 25, 2010.  Under the terms of the promissory note,following the closing of the 2009 Public Offering, Mr. Davis has theoption to convert the principal and accrued interest into shares of the Company’scommon stock at $0.70 per share.  Asconsideration for providing the loan, the Company issued an immediatelyexercisable, five-year warrant to purchase 100,000 shares of the Company’scommon stock at $1.50 per share to Mr. Davis.  The gross proceeds were allocated between thenote, the warrants and the bargain conversion feature of the note based on the relativefair value at the time of issuance.  The$46,604 relative fair value of the warrants was recorded as original issuediscount and is being expensed as interest expense over the term of thepromissory note.  As the holder’s abilityto exercise the conversion feature of the note is contingent upon an eventoutside the control of the holder, the bargain conversion feature valued at$103,396 was not recorded until January 2009 when the contingency wasremoved (see Note 14). The principal balance outstandingat December 31, 2008 was $150,000.

 

Anyunamortized original discount will be expensed upon a conversion of thepromissory note.** **On March 19. 2009, the $150,000 debt(and $6,542 of interest accrued thereon) was refinanced by Mr. Davis (seeNote 14)

** **

**See Note 13 for related partyinformation concerning convertible notes.**

 

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***(e)******                     ******Future maturities of long-term debt***

 

Future maturities oflong-term convertible notes for the years succeeding December 31, 2008 areas follows:

 
| **Year** | ** ** | **Paid in Cash** | ** ** | **Original  Issue  Discount** | ** ** | **Total** | ** ** |
|----------|------------|----------------------------|------------|-------------------------------|------------|-----------|------------|
| 2009     |       | $                          | —     |                          | $          | (197,166  | )          | $ | (197,166 | ) |
| 2010     |       | 615,500                    |       | (34,376                       | )          | 581,124   |       |
| Total    |       | $                          | 615,500    |                          | $          | (231,542  | )          | $ | 383,958 |   |

 

**(12)**              Shareholders’Equity (Deficit)

*** ***

***(a)****                    **Commonstock issued related to formation and licensing activities*

 

The Company issued 300,000shares to Clinical Network Inc. in July 2001. In connection with theCompany’s license agreements with CS Medical and Profile, the Company issued300,000 and 400,000 shares of common stock in 2001 and 2002, respectively.

*** ***

***(b)******                    ******CommonStock and Warrants issued related to 2002 Private Placement***

 

In connection with a privateplacement to accredited investors, the Company issued 45,335 shares of commonstock in 2002.  In addition, the Companyissued warrants to purchase 4,535 shares of common stock to three individualsrelated to services rendered in connection with the private placement.  These warrants expired unexercised.

*** ***

***(c)***                      Common Stock and Warrants issued relatedto Merger and 2004 Private Placement

 

Merger Agreement

 

Prior to the April 5, 2004 Merger (see Note 1(a)), Profile hadnotified the Company of a possible breach of its license agreement with theCompany, and had also dissented from the Merger proposal as the registeredholder of securities beneficially owned by certain shareholders holding, in theaggregate, 30,847 (pre-merger) shares of PUC’s common stock.  Effective on April 4, 2004, the parties reachedan agreement pursuant to which Profile waived any existing defaults under theProfile license agreement, and the Company agreed topurchase 30,000 of the 30,847 (pre-conversion) shares with respect to whichdissenters’ rights were exercised for an aggregate purchase of $750,000.  Of that amount, $100,000 was paid upon theinitial closing of the private placement (described below) and the balance of$650,000 was paid pursuant to the delivery of a promissory note, which was paidin full in October 2004.  Theremaining 847 (pre-conversion) shares with respect to which dissenters’ rightswere originally exercised withdrew their dissents and participated in theMerger.

 

At the effective time of the Merger all 350,100 (pre-conversion) sharesof common stock of PUC that were outstanding immediately prior to the Mergerand held by PUC shareholders were cancelled, with one share of PUC common stockissued to Global.  Simultaneously, theformer shareholders of PUC common stock received an aggregate of 960,300 sharesof common stock of Global, representing approximately 82.1 percent of Global’scommon stock outstanding immediately after the Merger.

 

Global was a non-operating public shell company at the time of theMerger.  Accordingly, the Merger transactionwas recorded as a recapitalization rather than a business combination.  The assets and liabilities resulting from thereverse acquisition were the former PUC assets and liabilities (at historical 

 

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cost) plus a $13,500 accrued Global liability (assumed at historicalcost).  There were no other assets orliabilities on Global’s books at the time of the Merger.  The Company recorded costs associated withthe Merger totaling $162,556 during 2004.

 

2004 Private Placement ofCommon Stock.

 

In connection with the Merger, the Company completed a privateplacement offering of 220,500 shares of common stock pursuant to Rule 506promulgated under the Securities Act. The initial closing occurred on April 5,2004, at which time the Company issued 198,000 shares at $20.00 per share,aggregating to gross proceeds of $3.96 million. Subsequent to April 5, 2004, the Company issued an additional22,500 shares at $20.00 per share, aggregating to gross proceeds of$450,000.  Costs associated with theprivate placement (including the subsequent registration costs) were $139,493.

 

As part of the private placement, the Company engaged a consultant toprovide financial-advisory services. Under terms of the arrangement, the consultant was paid $27,000 and wasissued a warrant for 30,000 shares of common stock upon the first closing ofthe private placement.  The warrant had athree-year term and was exercisable at $20.00 per share.

*** ***

***(d)***                     Private sales of Common Stock

 

·                  On June 15, 2005, the Company sold 6,579 sharesof its common stock to an accredited investor in a non-public offering.  The per share selling price of $7.60 wasbased on the last selling price prior to this sale as reported on theOver-the-Counter Bulletin Board.  Netproceeds received from this placement were $50,000.

 

·                  On September 7, 2006, the Company sold5,814 shares of its common stock to Scott Smith, a director of the Company, and5,814 shares of our common stock to an investor.  The per share selling price of $4.30 wasbased on the last selling price prior to this sale as reported on theOver-the-Counter Bulletin Board.  Netproceeds received from these investments were $50,000.

 

·                  During the year ended December 31, 2007,the Company sold 125,000 of the Company’s Investment Units at a price of $4.00per unit, with total gross proceeds of $500,000.  The Investment Units were sold in tranches of31,250 Units each to four investors on January 18, January 23, February 28and May 1, 2007.  Each InvestmentUnit consists of one share of the Company’s common stock and a 3-year warrant(immediately exercisable) to acquire 0.5 shares of the Company’s common stockfor $2.50 ($5.00 per share).  Costs ofthis sale totaled $52,388.

 

·                  On February 12, 2007, the Company sold1,707 shares of its common stock to Scott Smith, a director of theCompany.  The per share selling price of$4.10 was based on the last selling price prior to this sale as reported on theOver-the-Counter Bulletin Board.  Thesubscription price was paid by the conversion of a $7,000 loan to the Companyfrom Mr. Smith.

 

·                  On March 21,2007, the Company and the four guarantors of the Company’s Crown Bankpromissory notes (see Note 10) agreed to amend the related debenture agreements. Pursuant to the revised debenture agreements, among other things, theCompany issued a total of 12,478 shares of its Investment Units to the four guarantors in lieu of$49,911 of accrued interest.  The6,240 warrants were valued at $26,829 using the Black-Scholes method and wererecorded as debt extinguishment expense.

** **

**·**                  On September 10, 2007, the Company sold a total of1,100 shares of its common stock to Mr. Carlson and Mr. Smith.  The per share selling price of $3.00 wasbased on the last selling price prior to this sale as reported on theOver-the-Counter Bulletin Board.  Thesubscription price was paid by the conversion of a $3,300 of loans to theCompany from Mr. Carlson and Mr. Smith.

 

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***(e)***       Common Stock and Warrants issued for servicesand liabilities

*** ***

·                  In March 2002, theCompany granted a warrant to purchase 3,000 shares of common stock to a formerdirector that was exercisable at $11.33 per share. This warrant expiredunexercised.  An aggregate of $12,075 ofstock-based compensation expense related to this warrant was recognized in theperiod from August 17, 1999 (inception) to December 31, 2008.

 

·                  In November 2002, theCompany granted a warrant to purchase 150 shares of common stock at an exerciseprice of $23.33 per share to a consultant, for services rendered.  This warrant expired unexercised.  An aggregate of $490 of stock-basedcompensation expense related to this warrant was recognized in the period from August 17,1999 (inception) to December 31, 2008.

 

·                  In February 2003, theCompany issued 545 common shares to a consultant, in lieu of $12,705 cash foraccounts payable.

 

·                  In June 2003, under theterms of an agreement with a supplier, the Company issued a warrant to purchase9,215 shares of common stock at an exercise price of $3.33 per share.  This warrant expired unexercised.  The value of $187,060 related to this warrantwas recognized as research and development expense in the year ended December 31,2003.

 

·                  In May 2004, a vendorwas issued 3,861 shares of the Company’s common stock as payment for productdevelopment work valued at $77,225.

 

·                  In July 2004, theCompany entered into a research and development agreement with Artann for thefurther development of the ProUroScanTM system (seeNote 5).  Under this agreement, warrantsfor the purchase of 10,000 shares of the Company’s common stock upon theexecution of the agreement and warrants for the purchase of 20,000 shares ofthe Company’s common stock in December 2004. The warrants were fullyvested, five-year warrants at a per share exercise price of $20.00 per sharevalue.  The total value of these warrantscomputed using the Black-Scholes pricing model was $281,086.  The value of the warrants was recorded asresearch and development expense in the year ended December 31, 2004.

 

·                  In October 2004,another vendor was issued 4,444 shares of the Company’s common stock in lieu of$88,882 cash for accounts payable.

 

·                  On April 11, 2005, the Company entered into aplacement agency agreement with Stonegate Securities Inc. to raise workingcapital for the Company.  Pursuant to theagreement, on May 13, 2005 the Company issued 5,000 shares of the Company’scommon stock to the placement agent.  The5,000 shares were valued at $51,000 using the stock price on the date of grantand were recorded as general and administrative expense during the year ended December 31,2005.

 

**·**                  On December 30, 2005, the Company issued 4,541 sharesof common stock to our current and former directors in satisfaction of accrueddirector’s fees in the amount of $40,418.

** **

**·**                  On April 21, 2006, the Company issued 7,000 shares ofits common stock to Alan Haggerty, our former Vice-President of Engineering,upon his resignation, pursuant to his employment agreement.  The shares were valued at $44,800 based onthe average closing share price during the five days before and after theissuance date, and were recorded as compensation expense during the year ended December 31,2006.

** **

·                  On September 8, 2006, the Companyissued 1,415 shares of its common stock to a vendor, as payment for productdevelopment work valued at $8,938.

 

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·                  On April 2,2007, the Company issued 4,141 shares of its common stock to a vendor, as payment forproduct development work valued at $20,704.

 

·                  On April 16, 2007, the Companyissued to Artann five-year warrants (immediately exercisable) to acquire 20,000 shares of its commonstock at $4.10 per share pursuant to an agreement with Artann (seeNote 5).  The warrants were valued at $72,000 by theBlack-Scholes pricing model and recorded as research and development expenseduring the year ended December 31, 2007.

 

·                  On September 10,2007, the Company issued a total of 20,694 shares of its common stock to itsdirectors Mr. Smith, Mr. Rudelius, Mr. Koenig and formerdirectors as payment for $62,082 of accrued directors’ fees.

 

·                  On January 4,2008, pursuant to a final separation agreement with a former employee of theCompany, the Company issued to the former employee five-year warrants(immediately exercisable) to acquire up to 14,500 shares of the Company’scommon stock at an exercise price of $5.00 per share, and amended a previouslyissued warrant to acquire up to 30,000 shares of the Company’s common stock toprovide for cashless exercise thereof. The warrants, valued at $14,500 using the Black-Scholes pricing model,were recorded as compensation expense during the year ended December 31,2008.

 

·                  On July 11,2008, the Company’s directors received 21,667 of shares of the Company’s commonstock in lieu of cash for $21,667 of unpaid director’s fees accrued through June 30,2008.  The shares were valued at $1.00per share and expensed during the period of service.

 

·                  On July 11,2008, the Company issued a total of37,967 shares of the Company’s common stock to its directors in recognition of extraordinaryamount of time and effort they have spent on the Company’s restructuring andrefocusing efforts since January 2007. The shares were valued at $1.00 per share and expensed on the date ofissuance.

 

***(f)***        Common Stock and Warrants issued pursuant toloans and loan guarantees

*** ***

***Eachwarrant listed below was valued using the Black-Scholes pricing model; however,the recorded value of warrants issued to lenders and guarantors of Company debtis limited to the corresponding amount loaned or guaranteed (see Note 1(k)).***

*** ***

·                  During the year ended December 31, 2003, the Companyissued warrants to purchase a total of 64,287 shares of common stock at $23.33 per share to nine individuals,including 4,286 shares to David Koenig, a Company director, in exchange fortheir guaranteeing a bank line of credit.  An aggregateof $216,112 of debt issuance cost related to these warrants was recorded andamortized over the life of the bank line of credit.  Upon the closing of the Company’s 2004private placement and Merger on April 5, 2004, certain exercise priceprotections and anti-dilution provisions of these warrants becameeffective.  Under the terms of theseprovisions, the holders of these warrants became eligible to purchase a totalof 101,788 shares at $16.67 per share. The additional warrants and revaluation of the existing warrants werevalued at $320,974 using the Black Scholes pricing model, and were recorded asinterest expense at the time of issuance. The warrants expired unexercised.

 

·                  In September 2005,the Company engaged Venture Law Resources, PLLC (“VLR”) to assist with theintroduction of strategic investors to the Company.  Under this agreement, on September 1,2005 and February 22, 2006, the Company issued a total of 5,000 shares ofcommon stock valued at $40,500 on the grant dates to VLR.  Upon the closing of the Company’s Crown Banknotes on February 16, 2006, the $43,000 aggregate value of the shares andinitial retainer were recorded as debt issuance cost and are being amortizedover the term of the notes (see Note 10).

 

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·                  On September 14, 2005, in connectionwith a commercial guaranty of a $100,000 bank loan, the Company issued twofive-year warrants (immediately exercisable) to James Murphy to acquire a totalof 5,000 shares of the Company’s common stock at $5.00 per share.  The warrants, valued at $29,000 using theBlack-Scholes pricing model, were recorded as debt issuance costs and expensedover the term of the loan as interest expense. The Company recorded $29,000 of expense related to the value of thewarrants during the period from August 17, 1999 (inception) to December 31,2008.

 

**·**                  On September 21, 2005, in connection with $100,000loan from Roman Pauly, the Company issued two five-year warrants (immediatelyexercisable) to the lender to acquire a total of 5,000 shares of the Company’scommon stock at $5.00 per share.  Thegross proceeds of $100,000 were allocated between the promissory note and thecommon stock warrants based on the relative fair values of the securities atthe time of issuance. The warrants, valued at $26,500 using the Black-Scholespricing model, were recorded as original issue discount as defined in EITF 98-5and expensed on a straight-line basis over the term of the promissory note asinterest expense.  The Company recorded$0, $12,187 and $26,500 of expense related to the value of the warrants duringthe years ended December 31, 2008 and 2007, and the period from August 17,1999 (inception) to December 31, 2008, respectively.

** **

**·**                  On October 19, 2005, in connection with commercialguaranties of a $300,000 loan from Venture Bank, the Company issued five-yearwarrants (immediately exercisable) to Ron Musich and Adrian Johnson to acquireup to 7,500 shares (15,000 shares in total) of the Company’s common stock at$5.00 per share.  The warrants, valued at$79,500 using the Black-Scholes pricing model, were recorded as debt issuancecosts and expensed over the term of the loan as interest expense.  The Company recorded $79,500 of expenserelated to the value of the warrants during the period from August 17,1999 (inception) to December 31, 2008.

** **

**·**                  On January 25, 2006, in connection with a $23,000loan, the Company issued a five-year warrant (immediately exercisable) to Adronto acquire 5,000 shares of Company common stock at $5.00 per share.    The gross proceeds of $23,000 wereallocated between the promissory note and the common stock warrant based on therelative fair values of the securities at the time of issuance.  The fair value of the warrant estimated atgrant date using the Black-Scholes pricing model exceeded the amount of theloan.  Accordingly, the warrant wasvalued at $23,000 and recorded as original issue discount as defined in EITF98-5.  The Company recorded $23,000 ofexpense related to the value of the warrants during the period from August 17,1999 (inception) to December 31, 2008.

** **

***·***                  On June 1, 2006, the Companyborrowed $75,000 from Roman Pauly, and in connection therewith issued to Mr. Paulya promissory note to mature on August 30, 2006 (see Note9).  Under the terms of the loanagreement, the Company issued a five-year warrant (immediately exercisable)to Mr. Paulyto acquire 3,750 shares of Company common stock at $5.00 per share.  The fair value of the warrant at the grantdate was estimated using the Black-Scholes pricing model to be $25,500 and wasrecorded as original issue discount as defined in EITF 98-5 and subsequentlyexpensed as interest expense over the 90-day term of the loan.

*** ***

***On August 24, 2006 the promissorynote was amended to mature on October 29, 2006 and the Company agreed toissue a five-year warrant to Mr. Pauly to acquire 41.7 shares of theCompany’s common stock at $5.00 per share for each day the promissory note wasoutstanding after August 30, 2006 upon repayment of the promissorynote.  These warrants were valued at$5.40 per share using the Black-Scholes pricing model.  In connection with amendments to thepromissory note, the Company issued to Mr. Pauly 31,817 warrants accruedbetween August 30, 2006 and October 1,***

 

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***2008 along with a warrant to acquire3,000 shares of its common stock and agreed to continue to accrue 41.7 warrantsper day to be issued upon the Company’s repayment of the promissory note.  The warrants issued and accruing on and afterOctober 1, 2008 are five-year warrants with an exercise price of $1.50 pershare, and were valued at $1.32 per share using the Black-Scholes pricingmodel.***

*** ***

***The guidance provided by EITF Issue 96-19indicates that a substantial modification of debt terms should be accounted foras an extinguishment of debt.  Thepresent value of the cash flows under both amendments was greater than 10percent different from the present value of the cash flows under the originalagreement.  Accordingly, the warrantsissued and the accrual of warrants to be issued pursuant to the amended notewere recorded as debt extinguishment expense. The total debt extinguishment expense recorded for the 15,262, 5171 and35,653 warrants accrued for issuance during the years ended December 31,2008 and 2007, and the period from August 17, 1999 (inception) to December 31,2008 was $70,723, $82,191 and $180,836, respectively.***

*** ***

**·**                  On July 21, 2006, in connection with a $7,500 loanfrom Michael Wright, the Company issued a five-year warrant (immediatelyexercisable)**to Mr. Wright to acquire 375shares of Company common stock at $5.00 per share.  The gross proceeds of $7,500 were allocatedbetween the promissory note and the common stock warrant based on the relativefair values of the securities at the time of issuance.  The warrant, valued at $2,025 using theBlack-Scholes pricing model, was recorded as original issue discount as definedin EITF 98-5 and was expensed as interest expense during the year ended December 31,2006.

** **

***·***                  On August 30,2006, in connection with a $10,000 loan from Leslie Pearson, the Company issueda five-year warrant (immediately exercisable) to Ms. Pearson to acquire500 shares of Company common stock at $5.00 per share. The gross proceeds of$10,000 were allocated between the promissory note and the common stock warrantbased on the relative fair values of the securities at the time ofissuance.  The warrant, valued at $2,300using the Black-Scholes pricing model, was recorded as original issue discountas defined in EITF 98-5 and was expensed as interest expense during the yearended December 31, 2006.

*** ***

·                  On November 30, 2006, the Company borrowed$100,000 from Adron, and in connection therewith issued to Adron apromissory note to mature on January 2, 2007 (see Note 9). Pursuant to the terms of the promissory note, the Company issuedfive-year warrants (immediately exercisable) to Adron’s partners to acquire 5,000shares of Company common stock at $5.00 per share.  In addition, pursuant to the terms of thepromissory note, the Company issued an additional five-year warrant(immediately exercisable) to Adron’s partners to acquire 5,000 shares ofCompany common stock at $5.00 per share, when the loan was not repaid on January 2,2007.  The first warrant, valued at$22,500 using the Black-Scholes pricing model, was recorded as original issuediscount as defined in EITF 98-5 and was expensed as interest expense over the term ofthe promissory note.  The secondwarrant, also valued at $22,500, was expensed immediately as interest expensein January 2007.  The Companyrecorded interest expense of $23,162 and $45,000 related to the warrants issuedpursuant to the original agreement during the year ended December 31,2007, and the period from August 17, 1999 (inception) to December 31,2008, respectively.

 

On each of March 20,2007 and August 8, 2007, the Company amended the Adron Note, resulting inan extension of its due dates, the issuance of a third warrant to acquire 5,000shares of Companycommon stock at $5.00 per share on February 1, 2007and an agreement to issue to Adron five-year warrants to acquire 167 shares at$5.00 per share for each day the principal remained unpaid on and after March 1,2007.  The guidance provided by EITF96-19 indicates that a substantial modification of debt terms should beaccounted for as an extinguishment of debt. The present 

 

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value of the cash flowsunder the modifications was greater than 10 percent different from the presentvalue of the cash flows under the existing agreement.  Accordingly, the accrual of warrants to beissued and the warrants issued on February 1, 2007 pursuant to the AdronNote were recorded as debt extinguishment expense.  The Company expensed as debt extinguishmentcost $4,848, $201,637 and $206,485 related to the accrual of 1,347, 51,010 and52,357 warrants to be issued of warrants pursuant to the amended terms of thepromissory note during the years ended December 31, 2008 and 2007, and theperiod from August 17, 1999 (inception) to December 31, 2008,respectively.  On January 16, 2008,the Company repaid the outstanding principal amount of the Adron Note andissued the 52,357 accrued warrants.

 

·                  On March 14, 2007, upon the termination of employment of anemployee, and in consideration for an agreement to defer payment of accruedsalaries until the Company is able to make such payments, the Company agreed toextend by three years the expiration date of 30,000 warrants beneficially heldby the employee.  The modification of thewarrant resulted in the recording of an immediate incremental compensationexpense totaling $96,000, computed as the increase in the fair value of thewarrant as determined under the provisions of SFAS 123R over the fair value sodetermined immediately before the modification.

 

·                  On July 31, 2007, the Company borrowed $100,000for short-term working capital needs pursuant to a promissory note issued tothe Smith Trust (see Note 9). During the years ended December 31, 2008 and 2007, and the periodfrom August 17, 1999 (inception) to December 31, 2008, the Companyaccrued for the issuance of warrants to acquire 12,576, 15,400 and 27,976shares of the Company’s common stock, respectively, and recorded interestexpense of $50,304, $61,600 and $111,904, respectively, related thereto.  On January 20, 2009, the Company repaidthe promissory note and issued 28,656 warrants related to this note (see Note14).

 

·                  On August 29, October 31, and November 30,2007, the Company borrowed for working capital needs $50,000, $100,000 and$25,000, respectively, from James Davis (see Note 9).  Upon the December 27, 2007 conversion ofthese notes into the convertible debentures of the Company (see Note 11(b)),pursuant to the terms of the promissory note the Company issued to Mr. Davis12,550 warrants that were valued at $28,340 using the Black-Scholes pricingmodel, which were expensed as interest expense during the year ended December 31,2007.

 

·                  On October 15, 2007, the Company borrowed$600,000 pursuant to a promissory note issued to the Smith Trust (see Note9).  In consideration for this loan, on November 7,2007 the Company agreed to issue 33,333 shares of its common stock to the SmithTrust.  The $66,666 value of thisconsideration was recorded as debt issuance cost and is being amortized overthe term of the loan using the straight-line method, which approximates theinterest method.  The Company recorded$48,473, $10,358 and $58,831 of interest expense related to the amortization ofthis debt issuance cost during the years ended December 31, 2008 and2007, and the period from August 17, 1999 (inception) to December 31,2008, respectively.  On October 31, 2008, pursuant to theterms of the loan when the loan remained unpaid on that date, the Companyissued to the Smith Trust 6,667 shares of its common stock and a five-yearimmediately exercisable warrant to acquire 16,667 shares of its common stock atan exercise price of $2.00.  The $6,667 valueof the shares issued and the $12,834 value of the warrants was recorded asinterest expense during the year ended December 31, 2008.

 

**·**                  On December 27, 2007, the Company closed on the sale of $1,050,000of units under its 2007 Private Placement (see Note 11(b)).  At the closing, the Company issued 2007Warrants to purchase 210,000 shares of common stock.  On the same day, the Company also converted$150,000 of existing loans from James Davis into similar units, and issuedwarrants to purchase 30,000 shares of the Company’s common stock.  On January 4,2008, the Company closed on the sale of $80,000 

 

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** **

**of additionalunits as part of the 2007 Private Placement with the same terms as notedabove.  At closing, the Company issued2007 Warrants to purchase 16,000 shares of common stock.**

** **

On February 13, February 28,May 2, July 15 and July 30, 2008, the Company closed on anaggregate $720,000 of units under its 2008 Private Placements (see Note11(b)).  Pursuant to these closings, theCompany issued 2008 Warrants to purchase 144,000 shares of common stock.

 

The $153,735 relative fairvalue of the aggregate 400,000 2007 Warrants, Davis Warrants and 2008 Warrantsissued were recorded as an original issue discount as defined in EITF 98-5against the convertible debt liability, and are being amortized as interestexpense over the term of the convertible debentures.

 

**The exerciseprice of the 2007 Warrants, the Davis Warrants, and the 2008 Warrants was setupon the January 7, 2009 effective date of the Company’s 2009 PublicOffering at $0.50 per share (based on 50 percent of the offering price) (seeNote 14).  All of these warrants becameexercisable upon the January 12, 2009 closing of the 2009 Public Offeringand will remain exercisable until December 31, 2012.  Mr. Davis agreed that the equitysecurities issued upon exercise of the Davis Warrant will not be transferableuntil January 7, 2010. The unamortized original issue discount relating tothe warrants was expensed as interest expense upon the January 12, 2009closing of the 2009 Public Offering.**

** **

**·**                  On December 28, 2007, the terms and conditions of the renewedCrown Bank notes became effective (see Note 10).  Pursuant to the terms of the guarantees theCompany issued to the three guarantors of the Crown Bank notes an aggregate of88,889 shares of the Company’s common stock. The $88,889 value of the shares was recorded as interest expense duringthe year ended December 31, 2007.  On October 31,2008, pursuant to the terms of the loan when the loan remained unpaid on thatdate, the Company issued to the three guarantors an aggregate amount of 17,778shares of our common stock and five-year immediately exercisable warrants toacquire an aggregate of 44,445 shares of our common stock at an exercise priceof $2.00 per share.  The $17,778 value ofthe shares issued and the $34,223 value of the warrants was recorded asinterest expense during the year ended December 31, 2008.

** **

**·**                  On April 3, 2008, asconsideration to James Davis, William Reiling and the Smith Trust for providingcertain loans to the Company, the Company issued five-year warrants(immediately exercisable) to purchase a total of 75,000 shares of the Company’scommon stock at $1.50 per share (see Note 11(d)).  The gross proceeds were allocated between thenote and the warrants based on the relative fair value at the time ofissuance.  The relative fair value ofwarrants was recorded as original issue discount on the related promissorynotes and was expensed as interest expense over the term of the promissorynotes.  During the year ended December 31,2008, original issue discounts of $42,768 were expensed as interest expense.

** **

·                  On September 16, 2008, pursuant to theCompany’s Unit Put Agreement (see Note 11(c)), the Company issued OriginationWarrants to purchase an aggregate 32,500 shares of our common stock.  Ofthese, 31,500 Origination Warrants became exercisable when the Companyexercised its put options and closed on $315,000 of the Unit Put Arrangement,while 1,000 Origination Warrants were forfeited when an investor failed to meeta $10,000 unit put obligation.  TheOrigination Warrants are exercisable until December 31, 2012 at anexercise price of $1.00 per share.  The Origination Warrants, valued at $42,575using the Black-Scholes pricing model, were recorded as a debt issuance costasset and are being amortized as interest expense over the term of the Unit PutAgreement.  During the year ended December 31,2008, debt issuance cost of $10,891 was recorded as interest expense.

 

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Each unit issued in the Unit Put Agreementincluded a Unit Put warrant (see Note 11(c)).  Thepurchase price of the warrant portion of each unit was $500.  The Unit Put Warrants will remain exercisableuntil December 31, 2012 at an exercise price of $1.00 per share.  On September 16, 2008, the Companyexercised $162,500 of its put options under the Unit Purchase Agreement, andupon the September 24, 2008 closing thereof, issued 32,500 Unit PutWarrants.  On October 17, 2008, theCompany exercised the remaining $162,500 of its put option under the Unit PutAgreement and on October 28, 2008 and December 11, 2008, closed on$127,500 and $25,000 of this exercise, respectively.  Pursuant to these closings, the Companyissued 30,500 Unit Put Warrants.  The$17,493 relative fair value of the Unit Put Warrants was recorded as anoriginal issue discount as defined in EITF 98-5 against the convertible debtliability, and is being amortized as interest expense over the term of theconvertible debentures.

 

Under the terms of the Unit Put Arrangement, the promissory notesissued along with interest accrued thereon automatically converted into sharesof the Company’s common stock on February 6, 2009 (see Note 14).  The unamortized original issue discount andunamortized debt issuance cost was expensed as interest cost upon thisconversion.

 

**·**                  On September 25, 2008, theCompany borrowed $150,000 pursuant to a convertible promissory note issued infavor of James Davis (see Note 11(d)). As consideration for providing the loan, the Company issued animmediately exercisable, five-year warrant to purchase 100,000 shares of theCompany’s common stock at $1.50 per share to Mr. Davis.  The $46,604 relative fair value of thewarrant was recorded as original issue discount and is being expensed asinterest expense over the term of the promissory note.  During the year ended December 31, 2008,original issue discount of $8,280 was expensed as interest expense.  Any unamortizedoriginal issue discount relating to the warrants will be expensed immediatelyin the event that the promissory note is converted into common stock.

** **

**·**                  On March 19, 2009, pursuant to therenewal of its $600,000 Smith Trust promissory note and guaranties receivedrelating to the Company’s renewal of its $1,200,000 Crown Bank promissory note,the Company issued an aggregate 200,001 shares of its common stock as consideration to theSmith Trust, James Davis, and William Reiling, and will issue a further 33,333shares per month for each month the notes remain outstanding after August 31,2009 (see Note 14).

** **

***(g)***       Warrants summary

*** ***

Warrant activity was asfollows for the years ended December 31:

 
| ** **                     | ** ** | **Warrants** | ** ** | **Weighted-Average Exercise  Price** | ** ** |
|--------------------------------|------------|--------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **2008**     | ** ** | **2007**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Outstanding,  January 1   |       | 639,504      |       | 215,949                                   |       | $ | 10.18 |   | $ | 14.61 |   |
| Granted                        |       | 538,297      |       | 432,920                                   |       | 1.66 |   | 4.91 |   |
| Exercised                      |       | —       |       | —                                    |       | — |   | — |   |
| Expired                        |       | (103,787     | )          | (9,365                                    | )          | 16.37 |   | 3.62 |   |
| Outstanding,  December 31 |       | 1,074,014    |       | 639,504                                   |       | $ | 4.45 |   | $ | 10.18 |   |

 

Thefair value of stock warrants is the estimated present value at grant date usingthe Black-Scholes pricing model (see Note 1(k)).   The weighted-average fairvalue of the warrants granted during the years ended December 31, 2008 and2007 was $1.37 and $3.80, respectively. The expense related to warrants issued to lenders anddebt guarantors was $262,305, $423,096 and $1,097,185 for the years ended December 31,2008 and 2007, and the period from August 17, 1999 (inception) to December 31,2008, respectively (excluding warrants issued in connection with the 2007 and2008 Private Placement 

 

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andUnit Put Agreements).  Stock-basedcompensation cost related to warrants issued to the Company’s consultants andsuppliers was $14,500, $168,000 and $651,136 for the years ended December 31,2008 and 2007, and the period from August 17, 1999 (inception) to December 31,2008, respectively.  Stock-basedcompensation cost related to warrants issued to directors (in lieu of stockoptions) was $0, $0 and $12,075 for the years ended December 31, 2008 and2007, and the period from August 17, 1999 (inception) to December 31,2008, respectively.

 

***(h)***                     Stock Options

*** ***

*Stock Option Plans*

 

In April 2002, the Company’s Board of Directorspassed a resolution adopting the ProUroCare Medical Inc. 2002 Stock Plan (the “2002Plan”), reserving 150,000 shares of the Company’s common stock for issuance.

 

In July 2004, the Company’s Board of Directors passed a resolutionadopting the ProUroCare Medical Inc. 2004 Stock Option Plan (the “2004 Plan”),which was approved by the Company’s shareholders in July 2005.  The Company has reserved 150,000 shares ofcommon stock for issuance under the 2004 Plan.

 

The plans permit the Company to grant incentive and nonqualifiedoptions, stock appreciation rights, stock awards, restricted stock awards,performance shares and cash awards to Company employees and independentcontractors.  The exercise price for alloptions granted under the plans shall be determined by the Board of Directors.The term of each stock option and period of exercisability will also be set bythe Board of Directors, but will not exceed a period of ten years and one dayfrom grant date. The agreements also include provisions for anti-dilution ofoptions.

 

*Stock Option Grants*

 

**Each of the options granted below were valued using theBlack-Scholes pricing model (see Note 1(j)) and are being expensed over thevesting period as general and administrative expense.**

** **

·                  In March 2002, the Company granted anaggregate of 90,000 employee stock options to officers and directors that wereexercisable at $11.33 per share.  Theofficers’ options vested ratably over a 36-month period through December 2004,while the directors’ options vested ratably over a 24-month period through April 2004.  An aggregate $342,782 of stock-basedcompensation expense related to these options was recognized in the period fromAugust 17, 1999 (inception) to December 31, 2008.

 

InOctober 2003, an officer resigned from the Company and 15,000 of hisunvested options were forfeited and in October 2004 his remaining 21,000options expired.  In February 2004,a director resigned from the Board of Directors, and 375 of his unvestedoptions were forfeited, and in October 2005 his remaining 2,625 optionsexpired.  Effective May 1, 2007,Maurice Taylor, the Company’s former Chairman and Chief Executive Officer,retired from the Company.  Pursuant to a May 11,2007 agreement to defer payment of his unpaid salary, the Company extended thedate through which Mr. Taylor may exercise 45,000 options (includingoptions gifted to his children) following his separation to April 1,2012.  The Company recorded stock-basedcompensation expense of $103,500 related to the extension of the exercise datein the year ended December 31, 2007.

 

·                  In April 2002, the Company issued anonqualified stock option to a consultant to acquire 3,000 shares of commonstock at $11.33 per share. This option expired unexercised.  At the same time, the Company also issued anonqualified stock option to another consultant to acquire 3,000 shares 

 

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of common stock at $11.33 per share. This option vested ratably over atwo-year period through April 2004. An aggregate of $27,600 of stock-based compensation expense related tothese options was recognized in the period from August 17, 1999(inception) to December 31, 2008.

 

·                  In February 2004, theCompany issued 45,000 employee stock options to Michael Grossman, our formerPresident and Chief operating Officer. These options were valued at $6.70 per share, vested ratably over athree-year period and are exercisable at $20.00 per share.  The Company expensed, $16,811 and $303,000related to these options during the year ended December 31, 2007 and theperiod from August 17, 1999 (inception) to December 31, 2008,respectively.  Pursuant to a May 11,2007 separation agreement, the Company extended the date through which Mr. Grossmanmay exercise 45,000 options (including options gifted to his children)following his separation until February 1, 2012.  The Company recorded stock-based compensationexpense of $117,000 related to the extension of the exercise date in the yearended December 31, 2007.

 

·                  In February 2004, theCompany issued 3,000 nonqualified stock options to a consultant inconsideration of services rendered.  Theoptions were valued at $6.70 per share, and vested as to 1,500 shares uponissuance and as to the remaining 1,500 shares on January 1, 2005.  These options are exercisable at $20.00 pershare through February 2014.  TheCompany expensed $20,200 related to these options during the period from August 17,1999 (inception) to December 31, 2008.

 

·                  In July 2004, theCompany issued 20,000 employee stock options to Mr. Thon in connectionwith his employment agreement.  Theseoptions were valued at $15.00 per share, vested ratably over a three-yearperiod, and are exercisable at $25.00 per share through July 2014.  The Company expensed $58,314 and $300,000related to these options during the year ended December 31, 2007 and theperiod from August 17, 1999 (inception) to December 31, 2008,respectively.  On July 11, 2008, inconnection with the issuance of new options to Mr. Thon (see below), theseoptions were cancelled.

 

**·**                  In January 2005,the Company issued 15,000 stock options to Mr. Carlson, who at the timewas the Company’s Vice President of Marketing and Sales.  The options were valued at $16.20 per share,vest ratably over a three-year period, and are exercisable at $23.50 per sharethrough January 2015.  The Companyexpensed $6,729, $81,006, and $243,000 related to these options during theyears ended December 31, 2008 and 2007 and the period from August 17,1999 (inception) to December 31, 2008, respectively.  On July 11, 2008, in connection with theissuance of new options to Mr. Carlson (see below), these options werecancelled.

** **

**·**                  In September 2005,the Company issued 15,000 stock options exercisable at $6.00 per share to Mr. Haggerty.  The options were valued at $5.30 per shareand expired unexercised.  The Companyexpensed $15,460 related to these options during the period from August 17,1999 (inception) to December 31, 2008.

** **

**·**                  On March 1, 2006, theCompany issued to five of its employees five-year stock options to acquire atotal of up to 20,000 shares of common stock at $7.50 per share.  The options, valued at $5.60 per share, vestupon the Company securing FDA approval of its ProUroScanTM system.  10,000 of these options were awarded toemployees who subsequently left the Company and have been forfeited.  The remaining options are being expensed overthe vesting period (estimated by the Company as forty-one months) as generaland administrative expense.  The Companyexpensed $9,663, $33,245 and $91,184 related to these options during the yearsended December 31, 2008 and 2007, and the period from August 17, 1999(inception) to December 31, 2008, respectively.

 

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·                  On May 30, 2006, theCompany issued 3,000 nonqualified stock options to Mr. Smith, a director,upon his appointment to the Board of Directors. The options were valued at $5.90 per share, and vested over a two yearperiod.  These options are exercisable at$7.00 per share through May 2013. The Company expensed $3,688, $8,850 and $17,700 related to these optionsduring the years ended December 31, 2008 and 2007, and the period from August 17,1999 (inception) to December 31, 2008, respectively.

 

·                  On February 1, 2007,the Company granted to Mr. Carlson, a seven-year option to acquire up to20,000 shares of the Company’s common stock at a price of $5.00 per share.  The options were valued at $3.40 per shareusing the Black-Scholes pricing model and will be expensed over the vestingperiod as general and administrative expense. ** **The options vested as follows:

 

(a)          5,000 shares vested immediately.

 

(b)         5,000shares vest upon the Company’s closing on new equity financing arrangementsaggregating to $3,000,000 or more after February 1, 2007 and prior to December 31,2007.  This objective was not met, andthese options did not vest and were forfeited.

 

(c)          5,000 shares vest if the Company records gross product revenues of$1,000,000 or more in the Company’s 2008 fiscal year.  This objective was not met, and these optionsdid not vest and were forfeited.

 

(d)         5,000shares vested on December 31, 2008.

 

The Company expensed $1,143,$32,857 and $34,000 related to these options during the year ended December 31,2008 and 2007, and the period from August 17, 1999 (inception) to December 31,2008, respectively.

 

·                  On June 14, 2007, the Company issued3,000 nonqualified stock options to Mr. Rudelius, upon his appointment tothe Board of Directors.  The options werevalued at $2.40 per share, and vest ratably over a 24-month period through June 14,2009.  These options are exercisable at$2.90 per share through May 2014. The Company expensed $3,600, $1,800 and $5,400 related to these optionsduring the year ended December 31, 2008 and 2007**,**andthe period from August 17, 1999 (inception) to December 31, 2008,respectively.

 

·                  On July 11, 2008, the Company issuedincentive stock options to acquire 70,000 shares of its common stock to Mr. Carlson.  The options are exercisable for a period ofseven years at an exercise price of $1.00 per share.  Of the options, 10,000 shares vestimmediately and 20,000 shares will vest on July 1 of each of 2009, 2010and 2011.  At the same time, Mr. Carlsonagreed to cancel existing, fully-vested stock options to acquire 15,000 sharesof common stock at an exercise price of $23.50 per share.  SFAS 123R requires that options that arecancelled and reissued simultaneously be accounted for as a modification of theterms of the original option. Accordingly, the incremental compensation cost of the fully vested portionof the newly issued options, valued at $0.79 per share using the Black-Scholespricing model, over the $0.31 per share value of the cancelled options on thecancellation date will be expensed immediately as general and administrativeexpense.  The value of the unvestedportion will be recorded as general and administrative expense over thethree-year vesting period.  The Companyexpensed $11,750 related to these options during the year ended December 31,2008.

 

·                  On July 11, 2008, the Company issuedincentive stock options to acquire 35,000 shares of its common stock to Mr. Thon.  The options are exercisable for a period ofseven years at an exercise price of $1.00 per share.  Of the options, 10,000 shares vest immediatelyand 8,333 shares will vest on July 1 of each of 2009, 2010 and 2011.  At the same time, Mr. Thon agreed tocancel existing, fully-vested stock options to acquire 20,000 shares of commonstock at an exercise price of $25.00 

 

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per share.  SFAS 123R requiresthat options that are cancelled and reissued simultaneously be accounted for asa modification of the terms of the original option.  Accordingly, the incremental compensationcost of the fully vested portion of the newly issued options, valued at $0.79per share using the Black-Scholes pricing model, over the $0.27 per share valueof the cancelled options on the cancellation date will be expensed immediatelyas general and administrative expense. The value of the unvested portion will be recorded as general andadministrative expense over the three-year vesting period.  The Company expensed $6,042 related to theseoption during the year ended December 31, 2008.

 

·                  On August 11, 2008, the Company issued1,000 non-qualified stock options (immediately exercisable) to each of itsthree outside directors, Mr. Koenig, Mr. Smith and Mr. Rudelius,pursuant to its standard annual option award program, upon their re-election tothe Company’s Board of Directors.  Theoptions are exercisable for a period of seven years at an exercise price of$0.90 per share, and were valued at $0.71 per share.  The Company expensed $2,130 related to theseoption during the year ended December 31, 2008.

 

·                  On March 3,2009, the Company granted a total of 215,000 options to its officers anddirectors (See Note 14).

 

***(i)***        Stock options summary

*** ***

Stock option activity was as follows for the yearsended December 31:

 
| ** **                     | ** ** | **Options** | ** ** | **Weighted-Average Exercise  Price** | ** ** |
|--------------------------------|------------|-------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **2008**    | ** ** | **2007**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Outstanding,  January 1   |       | 175,500     |       | 160,417                                   |       | $ | 15.16 |   | $ | 16.17 |   |
| Granted                        |       | 108,000     |       | 23,000                                    |       | 1.00 |   | 4.73 |   |
| Exercised                      |       | —      |       | —                                    |       | — |   | — |   |
| Forfeited                      |       | (50,500     | )          | (7,917                                    | )          | 19.16 |   | 5.37 |   |
| Expired                        |       | —      |       | —                                    |       | — |   | — |   |
| Outstanding,  December 31 |       | 233,000     |       | 175,500                                   |       | $ | 7.73 |   | $ | 15.16 |   |
|                           |       |        |       |                                      |       |   |   |   |   |
| Exercisable,  December 31 |       | 132,250     |       | 152,210                                   |       | $ | 12.20 |   | $ | 16.54 |   |

 

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The following tablesummarizes information about stock options outstanding as of December 31,2008:

 
| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**               | ** ** |
|---------------------------------------------|------------|------------------------------|------------|--------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number of  Options**  | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| $0.90-$7.50                                 |       | 134,000                      |       | $                                          | 1.96       |   | 6.28 |   | 33,250 |   | $ | 2.26 |   |
| $11.33                                      |       | 51,000                       |       | $                                          | 11.33      |   | 3.26 |   | 51,000 |   | $ | 11.33 |   |
| $20.00                                      |       | 48,000                       |       | $                                          | 20.00      |   | 3.21 |   | 48,000 |   | $ | 20.00 |   |
|                                        |       | 233,000                      |       | $                                          | 7.73       |   | 4.99 |   | 132,250 |   | $ | 12.20 |   |

 

The aggregate intrinsic value of the optionsoutstanding and exercisable at December 31, 2008 was $5,700 and $1,450,respectively.  The average fair value ofeach option granted during the years ended December 31, 2008 and 2007, andthe period from August 17, 1999 (inception) to December 31, 2008, asdetermined using the Black-Scholes pricing model (see Note 1(j)) was $0.84,$3.27 and $4.83, respectively.  Thestock-based employee and non-employee compensation cost related to stockoptions was $44,745, $453,384 and $1,641,772 for the years ended December 31,2008 and 2007, and the period from August 17, 1999 (inception) to December 31,2008, respectively.

 

**(13)**              Related Parties

 

The Company considers itsdirectors, executives and beneficial shareholders of more than five percent ofits common stock to be related parties. During the years ended December 31, 2008 and 2007, the followingsignificant transactions were made between the Company and those parties thatwere related parties at the time of each transaction:

 

From March 1, 2007to January 31, 2009, the Company rented executive offices within theoffices of a former Company director, Mr. Alex Nazarenko.  Our rental cost for these offices wasapproximately $2,129 per month, which is the market price for similar officespace in Minneapolis, Minnesota.

 

OnApril 17, 2007, the Company borrowed $75,000 from Mr. Nazarenko.  In consideration, the Company executed anddelivered to Mr. Nazarenko a $75,000 unsecured demand promissorynote.  The note bore interest at anannual rate of the Prime Rate plus one percent, and was repaid on May 8,2007.

 

As consideration to Mr. James Davis, Mr. WilliamReiling, the Smith Trust and Mr. Bruce Culver to provide their guaranteesfor the Crown Bank promissory notes (see Note 10), in 2006 the Company issued$733,334 of unsecured convertible 10 percent debentures. On March 21,2007, the Company and the four guarantors agreed to amend the debentureagreements.  Pursuant to the reviseddebenture agreements, among other things, the Company issued a total of 12,478shares of its Investment Units to the four guarantors in lieu of $49,911 ofaccrued interest.  On December 27, 2007, theholders of the 10 percent unsecured convertible subordinated debentures agreedto further amend the terms of their debentures to provide for automaticconversion of the principal amount of the debentures and the unpaid interestaccrued thereon into shares of the Company’s common stock at $3.00 per share(see Note 11(a)).

 

OnJune 12, 2007, the Company borrowed $10,000 from Mr. Nazarenko.  The loan bore no interest.  On June 25, 2007, the Company borrowedan additional $27,000 from Mr. Nazarenko. In consideration of these two loans, the Company executed and deliveredto Mr. Nazarenko a $37,000 unsecured demand promissory note.  The note bore interest at an annual rate ofthe Prime Rate plus one percent.  Theprincipal amounts of these loans were repaid to Mr. Nazarenko on December 28,2007.

 

 

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OnJuly 3, 2007, the Company borrowed $10,000 from Mr. Nazarenko (seeNote 9) and was repaid in 2007.

 

**On July 31, 2007, theCompany borrowed $100,000 from the Smith Trust (see Note 9).**

 

**On August 29, October 31,and November 30, 2007,**the Company borrowed for working capital needs $50,000,$100,000 and $25,000, respectively, from James Davis pursuant to promissorynotes (see Note 9).

 

**Effective October 15, 2007,the Company borrowed $600,000 from the Smith Trust pursuant to a long-termpromissory note (see Note 9).  Theproceeds were used to retire bank notes payable.**

 

**On September 28, 2007, theCompany borrowed for working capital purposes $15,000 from Mr. Smith and$10,000 from Mr. Rudelius, both directors of the Company** (see Note 9).  Upon the first closing of the2007 Private Placement, these loans were converted into investment units underthat offering (see Note 11(b)).

 

**On December 27,2007, the Company closed on its 2007 Private Placement (see Note 11(b)).  Mr. Davis acquired $225,000 of the unitssold in the 2007 Private Placement, including the conversion into units of$25,000 of loans made to the Company.  Inaddition, the** Company converted $150,000 of existingloans from Mr. Davis into a note (the “Davis Note”) and warrants similarto those sold in the 2007 Private Placement, except that his note was convertible into the type of equity securitiesoffered by the Company in an underwritten public offering at 50 percent of thepublic offering price.  In addition, Mr. Davisagreed that the equity securities issued upon conversion of the Davis Note andthe common stock issued upon exercise of his warrant will not be transferablefor a period of one year beginning on the effective date of the public offeringtriggering conversion of the note.  Onthe same date, Mr. Reiling acquired $50,000 of the units sold in the 2007Private Placement.

 

**On February 28,2008, Mr. Rudelius acquired $10,000 of the units sold in the 2008 PrivatePlacement.**

 

On April 3, 2008, inconnection with the Company’s purchase of the Profile Assets, the Companyborrowed an aggregate of $112,500 pursuant to three promissory notes each inthe amount of $37,500 (see Note 11(d)). The promissory notes were issued infavor of Mr. Davis, Mr. Reiling and the Smith Trust.  On September 12, 2008, these threepromissory notes were amended to extend their due dates to the earlier of sevendays following the close of an underwritten public offering or December 31,2008, and to give the holders an option to convert their notes into shares ofour common stock at a conversion price equal to 70% of the price of the Unitssold in such offering.

 

On September 16, 2008, Mr. Davisagreed to purchase $100,000 of the puts pursuant to the Unit Put Agreement (seeNote 11(d)).  On September 24, 2008,we closed on $50,000 of Mr. Davis’ put commitment, and issued a $47,500convertible note and a warrant to acquire 10,000 shares of our common stock atan exercise price of $1.00 per share. On October 28, 2008, we closed onthe remaining $50,000 of Mr. Davis’ put commitment, and issued a $47,500convertible note and a warrant to acquire 10,000 shares of our common stock atan exercise price of $1.00 per share.

 

On September 25, 2008,we borrowed $150,000 pursuant to a promissory note issued in favor of Mr. Davisand used the proceeds to retire the $150,000 principal amount of the ProfileNote (see Note 11(d)). As consideration for providing the loan, we issued animmediately exercisable, five-year warrant to purchase 100,000 shares of ourcommon stock at $1.50 per share to Mr. Davis.

 

**On March 19, 2009, pursuant to the renewal of its$600,000 Smith Trust promissory note and guaranties received relating to theCompany’s renewal of its $1,200,000 Crown Bank promissory note, the Companyissued an aggregate 200,001 shares of its common stock**as consideration to theSmith Trust, James Davis,

 

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**and WilliamReiling, and will issue a further 33,333 shares per month for each month thenotes remain outstanding after August 31, 2009**(see Note 14).

 

**On March 19,2009, a $37,500 convertible promissory note and a $150,000 convertiblepromissory note due to Mr. Davis were refinanced and combined with otherloans and advances on behalf of the Company from Mr. Davis in a $281,000convertible promissory note (see Note 14).**

** **

**(14)****          ****Subsequent Events**

 

**On January 7,2009, the Company’s 2009 Public Offering was declared effective by the UnitedStates Securities and Exchange Commission, and January 12, 2009 the 2009Public Offering was closed.  In theoffering, the Company sold 3,050,000 units at $1.00 per unit, with each unitconsisting of one share of common stock and one redeemable warrant to purchaseone share of common stock at an exercise price of $1.30 per share resulting innet cash of $1,883,626, after costs of $1,666,374.**

 

**On the January 7, 2009 effective date of theCompany’s 2009 Public Offering, the $1,757,500 aggregate amount of the 2007Notes and the 2008 Notes, along with $162,959 of interest accrued thereon,automatically converted into 2,743,535 units identical to those sold in the2009 Public Offering (based on 70 percent of the offering price, or $0.70 pershare).  On the same date, the $142,500of Davis Note, along with $14,923 of interest accrued thereon, automaticallyconverted into 314,846 units identical to those sold in the 2009 PublicOffering (based on 50 percent of the offering price, or $0.50 per share).**

 

**The exercise price of the 2007 Warrants, the DavisWarrants and the 2008 Warrants was set upon the January 7, 2009 effectivedate of the Company’s 2009 Public Offering at $0.50 per share (based on 50percent of the offering price.  All ofthese warrants became exercisable upon the January 12, 2009 closing of the2009 Public Offering and will remain exercisable until December 31,2012.  Mr. Davis agreed that theequity securities issued upon exercise of the Davis Warrant will not betransferable until January 7, 2010. Unamortized original issue discount relating to the warrants and thebeneficial conversion feature of the notes totaling $387,169 and unamortizeddebt issuance cost of $207,575 was expensed as interest expense upon theconversion.**

 

**Asconsideration to the guarantors to provide their guarantees for the Crown Bankpromissory notes (see Note 10), the Company issued $733,334 of unsecuredconvertible 10 percent debentures (see Note 11(a)).**  On January 12, 2009, the Company closed on its 2009 PublicOffering, which triggered the automatic conversion of the $733,334 convertible debenturesalong with $143,815 interest accrued thereon into 292,384 shares of the Company’scommon stock.

 

On June 1, 2006, theCompany borrowed $75,000 from Roman Pauly pursuant to a promissory note (seeNote 9).  The Company had repaid a totalof $65,650 of the note through December 31, 2008.  In January 2009,following the closing of the 2009 Public Offering, the Company repaidthe remaining $9,350 principal amount of the Pauly loan and issued animmediately exercisable five-year warrant to acquire 4,295 shares of theCompany’s common stock at $1.50 per share pursuant to the terms of the note.

 

OnJuly 31, 2007, the Company borrowed $100,000 from the Smith Trust pursuantto a promissory note.  The Company hadrepaid a total of $66,000 of the note through December 31, 2008.  In January 2009, following the closing of the 2009 Public Offering, the Company repaid the remaining $34,000principal balance and issued to the Smith Trust a five-year, immediatelyexercisable warrant to acquire 28,656 shares of the Company’s common stock at$5.00 per share pursuant to the terms of the note.

 

On February 6, 2009 (30days after the effective dates of the Company’s 2009 Public Offering), the$299,250 outstanding Unit Put Notes (see Note 11(c)) along with the $9,563interest accrued thereon automatically

 

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converted into 441,165shares of the Company’s common stock on February 6, 2009.  The notes and accrued interest converted at70 percent of the 2009 Public Offering price, or $0.70 per share.  Unamortized original issue discount relatingto the warrants and the beneficial conversion feature of the notes totaling$138,440 and unamortized debt issuance cost of $44,686 was expensed as interestexpense upon the conversion.

 

**On April 3, 2008, the Company borrowed $112,500pursuant to three convertible promissory notes (see Note 11(d)).  In January 2009, following the closingof the 2009 Public Offering, the Company repaid $45,500 of the notes, and$29,500 of the notes were converted into common stock at $0.70 per share (basedon 70 percent of the 2009 Public Offering price). **On March 19,2009, the remaining $37,500 promissory note, due to Mr. James Davis, wasrefinanced along with another $150,000 promissory note due to Mr. Davis(see below).

** **

OnSeptember 25, 2008, the Company borrowed $150,000 pursuant to aconvertible promissory note issued in favor of Mr. Davis (see Note11(b)).  The note was convertible uponthe Company’s closing of an underwritten public offering, at 70 percent of thepublic offering price.  As the holder’sability to exercise the conversion feature of the note was contingent upon anevent outside the control of the holder, the bargain conversion feature valuedat $103,396 was not recorded until the January 12, 2009 closing of theCompany’s 2009 Public Offering when the contingency was removed. ** **On March 19, 2009, Mr. Davis agreedto refinance the $150,000 debt (and $7,291 of interest accrued thereon) alongwith the $37,500 note noted above (and ($3,646 of accrued interest thereon),another $2,632 payable to Mr. Davis and $15,293 of expenses paid by Mr. Davison behalf of the Company.  Mr. Davisalso agreed to loan to the Company an additional $64,638 to pay for theexhibition of the ProUroScan system at the annual American Urology Associationmeeting, the retention of an investor relations firm and the initiation of aclinical advisory board.  He also agreedto have certain website maintenance services performed for the Company.Pursuant to the refinancing and the other arrangements, the Company issued a$281,000 unsecured convertible promissory note to Mr. Davis.  The promissory note matures on March 19,2010, bears no interest, and is convertible into our common stock at $0.55 pershare at the option of Mr. Davis.  The guidance provided by EITF Issue 96-19indicates that a substantial modification of debt terms should be accounted foras an extinguishment of debt.  As thepresent value of the cash flows under the new convertible promissory note wasgreater than 10 percent different from the present value of the cash flowsunder the original note, the issuance of the new note will be treated as a debtextinguishment.  Accordingly, the$123,000 value of the bargain conversion option as computed using theBlack-Sholes pricing model will be recorded as original issue discount at theinception of the loan and amortized as debt extinguishment expense over theterm of the note.  Interest imputed onthe new convertible note, using a 6.0 percent assumed interest rate, of $16,000will be recorded as a note discount and amortized as interest expense over theterm of the note.

 

OnMarch 3, 2009, the Company issued non-qualified stock options to acquirean aggregate of 70,000 shares of its common stock to its non-employeedirectors, and incentive options to acquire 45,000 shares of its common stockto Richard Thon.  The options are fullyvested and are exercisable for a period of seven years at an exercise price of$0.85 per share.  The 115,000 optionswill be valued at $0.68 per share using the Black-Scholes pricing model andimmediately expensed as general and administrative expense.

 

Alsoon March 3, 2009, the Company granted incentive stock option to acquire anaggregate of 100,000 shares of its common stock to Richard Carlson.  Of the options, 90,000 shares vestimmediately and 10,000 shares will vest on January 2, 2010.  At the same time, Mr. Carlson agreed tocancel existing, unvested stock options to acquire 5,000 shares of common stockat an exercise price of $7.50 per share. SFAS 123R requires that options that are cancelled and reissuedsimultaneously be accounted for as a modification of the terms of the originaloption.  Accordingly, the incrementalcompensation cost of the fully vested portion of the newly issued optionsvalued at $0.68 per share using the Black-Scholes pricing model over the $0.07per share value of the cancelled options on the cancellation date, or $67,850,will be expensed immediately as general and administrative expense.

 

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OnMarch 19, 2009, the Company renewed the $1,200,000 Crown Bank promissorynote, and temporarily paid down the $400,000 Crown Bank promissory note (seeNote 10) pending the Company obtaining a satisfactory guaranty of thatamount.  The renewed note matures on March 28,2010 and bears interest at the Prime Rate plus one percent**,**but neverless than 6.00 percent.  No other noteterms were changed.  The note remainscollateralized by all Company assets and continues to be guaranteed by JamesDavis and William Reiling.

 

OnMarch 19, 2009, the Company amended the $600,000 Smith Trust promissorynote (see Note 9). Under the terms of the amendment, the note’s maturity datewas extended to March 28, 2010, and the interest rate floor was loweredfrom 6.50 percent to 6.00 percent.  Noother terms were changed.

 

**On March 19, 2009, pursuant to the renewal of its$600,000 Smith Trust promissory note and guaranties received relating to theCompany’s renewal of its $1,200,000 Crown Bank promissory note, the Companyissued an aggregate 200,001 shares of its common stock**as consideration to theSmith Trust, James Davis and William Reiling, and will issue a further 33,333shares per month for each month the related notes remain outstanding after August 31,2009.  The guidance provided by EITFIssue 96-19 indicates that a substantial modification of debt terms should beaccounted for as an extinguishment of debt. As the present value of the cash flows under both loan renewals wasgreater than 10 percent different from the present value of the cash flowsunder the original agreements, the renewals of the notes will be treated asdebt extinguishments.  Accordingly, the$100,000 value of the initial 200,001 shares issued will be recorded asoriginal issue discount and expensed as debt extinguishment expense on a straight-linebasis through August 31, 2009. Additional accruals of stock to be issued if the promissory notes remainoutstanding after August 31, 2009 will be expensed each month as debtextinguishment expense.  In addition, the$12,000 loan origination fee will be recorded as original issue discount andexpensed as debt extinguishment expense over the term of the promissory notes.

 

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| **ITEM 9:** | ** ** | **CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|------------|-------------------------------------------------------------------------------------------|

 

None.

 

**ITEM 9A(T):         CONTROLS AND PROCEDURES**

 

***Disclosure Controls and Procedures***

 

We maintain disclosure controls and procedures designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the rules and forms of the Securities andExchange Commission. As of December 31, 2008, the end of the periodcovered by this Annual Report on Form 10-K, we carried out an evaluation,under the supervision and with the participation of management, including ourChief Executive Officer and Chief Financial Officer, of the effectiveness ofthe design and operation of our disclosure controls and procedures pursuant toExchange Act Rule 13a-15. Based upon that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures are effective.

 

***Management’s Annual Report on Internal Control Over Financial Reporting***

 

Thefinancial statements, financial analyses and all other information included inthis Annual Report on Form 10-K were prepared by the Company’s management,which is responsible for establishing and maintaining adequate internal controlover financial reporting.

 

TheCompany’s internal control over financial reporting is designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. The Company’s internal control overfinancial reporting includes those policies and procedures that:

 

·                  pertain to the maintenance of records that,in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company;

 

·                  provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the Company are being made only in accordancewith authorizations of management and directors of the Company; and

 

·                  provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition and use ordisposition of the Company’s assets that could have a material effect on thefinancial statements.

 

Thereare inherent limitations in the effectiveness of any internal control,including the possibility of human error and the circumvention or overriding ofcontrols. Accordingly, even effective internal controls can provide onlyreasonable assurances with respect to financial statement preparation. Further,because of changes in conditions, the effectiveness of internal controls mayvary over time.

 

Managementassessed the design and effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2008. In making this assessment,management used the criteria set forth by the Committee of SponsoringOrganizations of the Treadway Commission in*Internal Control—Integrated Framework*. Based on management’sassessment using this framework, it believes that, as of December 31,2008, the Company’s internal control over financial reporting is effective.

 

ThisAnnual Report on Form 10-K does not include an attestation report of theCompany’s independent registered public accounting firm regarding internalcontrol over financial reporting. Management’s report was not subject to 

 

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attestationby the Company’s independent registered public accounting firm pursuant totemporary rules of the Securities and Exchange Commission that permit theCompany to provide only management’s report in this Annual Report on Form 10-K

 

***Changes in Internal Control Over Financial Reporting***

 

Duringthe quarter ended December 31, 2008, there has been no change in theCompany’s internal control over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 
| **ITEM 9B:** | ** ** | **OTHER INFORMATION** |
|--------------|------------|-----------------------|

 

OnMarch 19, 2009, we renewed our $1,200,000 Crown Bank promissory note.  The renewed note matures on March 28,2010 and bears interest at the Prime Rate plus 1.0 percent**,**but neverless than 6.00 percent.  No other noteterms were changed.  The note remainssecured by all Company assets and continues to be guaranteed by James Davis andWilliam Reiling.  At the same time, wetemporarily paid down the $400,000 Crown Bank promissory note pending ourobtaining a satisfactory guaranty of that amount.  It is our intent to renew the $400,000promissory note within 60 days; however, there can be no assurance that such aguarantee can be provided.  Assuming we are successful in identifyingsuch guarantors, we expect to issue additional consideration to guarantors ofthe $400,000 Crown Bank promissory note upon its renewal.

 

OnMarch 19, 2009, we amended our $600,000 promissory note with the SmithTrust. Under the terms of the amendment, the note’s maturity date was extendedto March 28, 2010, and the interest rate floor was lowered from 6.50percent to 6.00 percent.  No other termswere changed.

 

**On March 19,2009, pursuant to the renewal of the $600,000 Smith Trust promissory note andguaranties received relating to renewal of our $1,200,000 Crown Bank promissorynote, we issued an aggregate 200,001 shares of our common stock**as consideration to theSmith Trust, James Davis and William Reiling, and will issue a further 33,333shares per month for each month the related notes remain outstanding after August 31,2009.

 

**PART III**

 
| **ITEM  10:** | ** ** | **DIRECTORS, EXECUTIVE  OFFICERS AND CORPORATE GOVERNANCE** |
|---------------|------------|-------------------------------------------------------------|

 

***Directors and Executive Officers***

 

The following informationsets forth the names of our executive officers and directors, their ages andtheir present positions with the Company as of March 23, 2009. The directorsserve for a term of one year or until the next annual meeting of theshareholders. Each officer serves at the discretion of the Board of Directors.

 
| **Name**           | ** ** | **Age** | ** ** | **Position**                                |
|--------------------|------------|---------|------------|---------------------------------------------|
| Richard C. Carlson |       | 57      |       | Chief Executive Officer and Acting Chairman |
| Richard B. Thon    |       | 53      |       | Chief Financial Officer                     |
| David F. Koenig    |       | 68      |       | Director                                    |
| Robert J. Rudelius |       | 53      |       | Director                                    |
| Scott E. Smith     |       | 53      |       | Director                                    |

 

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**Richard C.Carlson** was electedto our Board of Directors in December 2006 and became Acting Chairman in May 2007.Mr. Carlson was hired as our Vice President of Marketing and Sales in January 2005,and was promoted to Chief Executive Officer in November 2006. Immediatelyprior to joining ProUroCare, Mr. Carlson was a marketing consultant forseveral medical device companies. From 1998 to April 2004, Mr. Carlsonheld several positions with SurModics, Inc. (“SurModics”), a company thatprovides surface modification solutions for medical device and biomedicalapplications. From February 2003 until April 2004, Mr. Carlsonwas the Vice President of Strategic Planning for SurModics, where he structuredthe company’s performance targets, developed market segmentation plans andlong-term strategies. Prior to that, Mr. Carlson served as the VicePresident of Marketing for SurModics, where he was responsible for developingthe marketing and sales organization.

 

**Richard B.Thon** was engaged asour Chief Financial Officer on a part-time consulting basis from 2002 until July 2004,when he became employed by the Company in that position on a full-time basis.From 2001 to 2004, Mr. Thon was also the part-time Chief Financial Officerof CHdiagnostics, LLC, a marketer of blood glucose diagnostic supplies.

 

**David F.Koenig** served as adirector of our predecessor company, ProUroCare, Inc. (“PUC”), from 1999until April 2004, when he became a director of the Company as a result ofthe Merger. From 1996 to 2005, Mr. Koenig was the Executive Vice Presidentand Chief Operating Officer of Solar Plastics, Inc., a manufacturer ofcustom rotationally molded plastic parts. Mr. Koenig is Chairman of theCompensation Committee and a member of the Audit and Nominating and GovernanceCommittees.

 

**Robert J.Rudelius** was electedto the Company’s Board of Directors in June 2007. Since 2003, Mr. Rudeliushas been the Managing Director and CEO of Noble Ventures, LLC, a companyhe founded, providing advising and consulting services to early-stage companiesin the information technology, renewable energy and loyalty marketing fields. Mr. Rudeliusis also the Managing Director and CEO of Noble Logistics, LLC, a holdingcompany he founded in 2002 to create, acquire and grow a variety of businessesin the freight management, logistics and information technology industries. Mr. Rudeliusis the Chairman of the Nomination and Governance Committee and a member of theCompensation Committee.

 

**Scott E.Smith** has been adirector of the Company since 2006. He is employed by F-2 Intelligence Group (“F-2”),a company engaged in providing critical insights to multinational corporationsand private equity clients on a broad range of strategic issues. From 2002 to2004, Mr. Smith served as F-2’s Director of Corporate Accounts, where hewas responsible for selling strategic consulting services primarily to Fortune500 companies. In 2004, Mr. Smith transitioned to and is currently servingas F-2’s Regional Director of Sales for Private Equity, where he sells marketand competitive intelligence consulting services to private equity firms.  Prior to joining F-2, Mr. Smith wasemployed by the accounting firm Arthur Andersen for 23 years and servedthe last 10 years as an audit partner. Mr. Smith is a CertifiedPublic Accountant and a Certified Management Accountant. Mr. Smith isChairman of the Audit Committee.

 

There are no familyrelationships among our executive officers or directors.

 

**Audit Committee**

** **

Our Board of Directors hasestablished a two-member Audit Committee that currently consists of Messrs. Smith,the Chairman, and Koenig.  The Board ofDirectors has adopted a written charter for the Audit Committee, which is availableon our website www. prourocare.com.  TheAudit Committee was formed after the Merger. Prior to the Merger, the Company had no such Audit Committee.

 

The board of directors hasdetermined that both members of the Audit Committee, Mr. Smith and Mr. Koenig,are “audit committee financial experts” as that term is defined in Item 407(d)(5) ofRegulation S-K promulgated under the Exchange Act.  Mr. Smith was an Audit Partner forArthur Andersen and is a Certified Public Accountant and a Certified ManagementAccountant.  Mr. Koenig’s relevantexperience includes his previous service as the Chief 

 

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Financial Officer anddirector of Quadion Corporation, and his past consulting experience, whichinvolved his oversight and supervision of the performance of businessenterprises respecting the preparation, audit and evaluation of financialstatements.  Both members of the AuditCommittee qualify as “independent directors,” as such term is defined in Section 4200(a)(15)of the NASDAQ listing standards. Moreover, the board of directors has determined that each of the AuditCommittee members is able to read and understand fundamental financialstatements and has past employment experience in finance or accounting.

 

**Code of Ethics DisclosureCompliance**

 

On February 15, 2005, our Board ofDirectors adopted a Code of Ethics for Financial Executives, which includes ourCompany’s principal executive officer, principal financial officer, principalaccounting officer or controller, or persons performing similar functions, asrequired by Sections 406 and 407 of the Sarbanes-Oxley Act of 2002.  Our Code of Ethics is available on our websitewww.prourocare.com, and we will provide a copy, without charge, to anyshareholder upon written request to Dick Thon, ProUroCare Medical Inc., 6440Flying Cloud drive, Suite 101, Eden Prairie, MN 55344.

 

**Section 16(a) BeneficialOwnership Reporting Compliance**

 

The rules of the Securities and Exchange Commission require ourdirectors, executive officers and holders of more than 10 percent of our commonstock to file reports of stock ownership and changes in ownership with theSecurities and Exchange Commission. Based on the Section 16 reports filed by our directors andexecutive officers and written representations of our directors and executiveofficers we believe there were no late or inaccurate filings for transactionsoccurring during fiscal 2008, except as follows:

 
| **Name**        | ** ** | **Number of Late  Reports** | ** ** | **Number of  Transactions Reported  Late** |
|-----------------|------------|-----------------------------|------------|--------------------------------------------|
| David Koenig    |       | 1                           |       | 1                                          |
| Robert Rudelius |       | 1                           |       | 1                                          |
| Scott Smith     |       | 1                           |       | 1                                          |
| James Davis     |       | 2                           |       | 2                                          |

 

**ITEM 11:  EXECUTIVE COMPENSATION**

 

***Summary Compensation Table***

 

The following table setsforth the compensation earned for services rendered in all capacities by ourChief Executive Officer and Chief Financial Officer. There were no otherexecutive officers or other individuals who earned more than $100,000 during2008. The individuals named in the table will be hereinafter referred to as the“Named Executive Officers.”

 

**Summary Compensation Table**

 
| **Name and Position**                           | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)** | ** ** | **Option  Awards  ($)(3)** | ** ** | **All Other  Compensation  ($)(4)** | ** ** | **Total  ($)** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|-----------------|------------|----------------|------------|----------------------------|------------|------------------------------------------|------------|----------------|------------|
| Richard  Carlson(1)                                       |       | 2008     |       | $               | 150,000    |           | $          | —                     |       | $                                        | 25,451     |           | $          | 2,103 |   | $ | 177,554 |   |
| Chief Executive Officer  and Acting Chairman of the Board |       | 2007     |       | $               | 150,000    |           | $          | —                     |       | $                                        | 120,898    |           | $          | — |   | $ | 270,898 |   |
| Richard Thon(2)                                           |       | 2008     |       | $               | 136,375    |           | $          | —                     |       | $                                        | 10,873     |           | $          | 4,825 |   | $ | 152,073 |   |
| Chief Financial  Officer                                  |       | 2007     |       | $               | 140,000    |           | $          | —                     |       | $                                        | 65,348     |           | $          | 1,200 |   | $ | 206,548 |   |

 

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| (1)    |   | All compensation Mr. Carlson earned is related  to his duties as an officer. Due to funding limitations, $124,335 of  Mr. Carlson’s salary earned in 2006, 2007 and 2008 was unpaid as of  December 31, 2008. See “Executive Compensation—Employment Agreements”  for the terms of Mr. Carlson’s current employment arrangements with us.                                                                                                                                                                                                |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (2)    |   | Due to funding  limitations, $144,818 of Mr. Thon’s salary and bonus earned in 2006,  2007 and 2008 was unpaid as of December 31, 2008. See “Executive  Compensation—Employment Agreements” for the terms of Mr. Thon’s current  employment arrangements with us.                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (3)    |   | Option awards  are valued in accordance with Statement of Financial Accounting Standards  (“SFAS”) No. 123 (revised 2004), “Share-Based Payment”  (“SFAS 123R”). See Notes 1(j) and 10(h) to the  Consolidated Financial Statements for the fiscal year ended December 31,  2007 and Notes 1(f) and 7(b) to the Consolidated Financial  Statements for the fiscal year ended December 31, 2008 included in Item  8 of this Annual Report on Form 10-K for the material terms of stock  option grants. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (4)    |   | Other  compensation represents insurance premiums paid by us with respect to term  life insurance and long-term care polices for the benefit of the executive.  There is no cash surrender value associated with the policies.                                                                                                                                                                                                                                                                                                                                                        |

 

***Outstanding Equity Awards at December 31,2008***

 

No stock options orstock-appreciation rights were exercised during fiscal year 2008, and nostock-appreciation rights were outstanding at the end of such fiscal year. Thetable below sets forth outstanding but unexercised options of our NamedExecutive Officers as of December 31, 2008.

 

 
| **Name**        | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (# Exercisable)(1)** | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (# Unexercisable)(1)** | ** ** | **Equity Incentive  Plan Awards:  Number of  Securities  Underlying  Unexercised  Unearned  Options  (#)** | ** ** | **Option  Exercise  Price** | ** ** | **Option Expiration  Date** | ** **            |
|-----------------|------------|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|-----------------------|
| Richard Carlson |       | —                                                                                    |       | —                                                                                      |       | 5,000                                                                                                                     | (2)        | $                           | 7.50       |                        | March 1, 2011    |   |
|            |       | 10,000                                                                                    |       | —                                                                                      |       |                                                                                                                      |       | $                           | 5.00       |                        | February 1, 2017 |   |
|            |       | 10,000                                                                                    |       | 60,000                                                                                      | (3)        |                                                                                                                      |       | $                           | 1.00       |                        | July 11, 2015    |   |
| Richard Thon    |       | —                                                                                    |       | —                                                                                      |       | 5,000                                                                                                                     | (2)        | $                           | 7.50       |                        | March 1, 2011    |   |
|            |       | 3,000                                                                                     |       | —                                                                                      |       | —                                                                                                                    |       | $                           | 11.33      |                        | April 18, 2012   |   |
|            |       | 10,000                                                                                    |       | 25,000                                                                                      | (4)        | —                                                                                                                    |       | $                           | 1.00       |                        | July 11, 2015    |   |

 

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| (1)    |   | See  Notes 1(j) and 12(h) to the Consolidated Financial Statements  for the fiscal year ended December 31, 2008 included in Item 8 in this  Annual Report on Form 10-K for the material terms of stock option  grants.                                                                                                                                                                                                                                                                                                    |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (2)    |   | Equity Incentive  Plan Awards vest upon the Company securing FDA approval of its ProUroScan  System.                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (3)    |   | On July 11,  2008, the Company issued incentive stock options to acquire 70,000 shares of  its common stock to Mr. Carlson. The options are exercisable for a  period of seven years at an exercise price of $1.00 per share. Of the  options, 10,000 shares vest immediately and 20,000 shares will vest on  July 1 of each of 2009, 2010 and 2011. At the same time,  Mr. Carlson agreed to cancel existing, fully-vested stock options to  acquire 15,000 shares of common stock at an exercise price of $23.50 per  share. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (4)    |   | On July 11,  2008, the Company issued incentive stock options to acquire 35,000 shares of  its common stock to Mr. Thon. The options are exercisable for a period  of seven years at an exercise price of $1.00 per share. Of the options,  10,000 shares vest immediately and 8,333 shares will vest on July 1 of  each 2009, 2010 and 2011. At the same time, Mr. Thon agreed to cancel  existing, fully-vested stock options to acquire 20,000 shares of common stock  at an exercise price of $25.00 per share.            |

 

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***Director Compensation***

 

Effective July 1, 2008,our Board of Directors established a policy that each of our non-employeedirectors receives an annual cash payment of $10,000 for annual services to theCompany, that the chairpersons of our Compensation, Audit and Nominating andGovernance committees receive an additional annual payment of $2,500 and thateach committee member receive an annual payment of $1,000 per committee. Inaddition, we have also agreed to grant to all non-employee directors a one-timenon-qualified stock option upon election or appointment to the Board ofDirectors to purchase 3,000 shares of our common stock at fair market value and,additionally, to grant options to purchase 1,000 shares of our common stock ata fair market value to each director upon their annual re-election to theBoard. These director options vest ratably over two years of service.

 

Prior to July 1, 2008,each of our non-employee directors received an annual cash payment of $5,000for services to the Company and the chairpersons of our Compensation, Audit andNominating and Governance committees received an additional annual payment of$2,500. All non-employee directors were granted a one-time non-qualified stockoption upon appointment to the Board of Directors to purchase 3,000 shares ofour common stock at fair market value. These director options vested ratablyover two years of service. The options granted to Mr. Nazarenko and Mr. Koenighave a ten-year term, and to Mr. Smith and Mr. Rudelius have aseven-year term.

 

All directors shall bereimbursed for travel and other out-of-pocket expenses incurred in connectionwith attendance at meetings of the Board of Directors and its committees.

 

The table below sets forthdirector compensation earned during 2008:

 
| **Name**                | ** ** | **Fees Earned  or Paid in  Cash  ($)** | ** ** | **Stock  Awards(5)  ($)** | ** ** | **Option  Awards(6)  ($)** | ** ** | **Total  ($)** | ** ** |
|-------------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|----------------------------|------------|----------------|------------|
| David Koenig(1)         |       | $                                                     | 7,250      |                      | $          | 13,750                     |       | $              | 710        |   | $ | 21,710 |   |
| Alexander  Nazarenko(2) |       | $                                                     | —     |                      | $          | 9,842                      |       | —         |       | $ | 9,842 |   |
| Scott Smith(3)          |       | $                                                     | 6,250      |                      | $          | 13,750                     |       | $              | 4,398      |   | $ | 24,398 |   |
| Robert  Rudelius(4)     |       | $                                                     | 6,750      |                      | $          | 13,125                     |       | $              | 4,310      |   | $ | 24,185 |   |

 

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| (1)    |   | Chairman of the  Compensation Committee as of March 14, 2008. Prior to March 14,  2008, Mr. Koenig was Chairman of the Nominating and Governance  Committee.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (2)    |   | Mr. Nazarenko  resigned from the Board of Directors on March 11, 2008.  Mr. Nazarenko served as Chairman of the Compensation Committee until  that time.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (3)    |   | Chairman of the  Audit Committee.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (4)    |   | Chairman of the  Nominating and Governance Committee as of March 14, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (5)    |   | On July 11,  2008, we issued a total of 12,500 shares of our common stock to our directors  in lieu of cash as payment of directors’ fees earned in 2008. In addition, a  total of 37,967 shares of our common stock were issued to our directors in  recognition of the extraordinary amount of time and effort they have put  forth on the Company’s restructuring and refocusing efforts since January 1,  2007. Finally, 9,167 shares of common stock were issued to our directors in  lieu of cash as payment for directors’ fees earned in 2007 (not included in  the 2008 compensation). The dollar amount included in this column is the  amount recognized for financial statement reporting purposes with respect to  the fiscal year ended December 31, 2008 in accordance with SFAS 123R. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (6)    |   | Each outside  director held options to acquire 4,000 shares at December 31, 2008.  Options awarded during the fiscal year are valued in accordance with  SFAS 123R. See Notes 1(j) and 12(h) to the Consolidated  Financial Statements for the fiscal year ended December 31, 2008  included in Item 8 of this Annual Report on Form 10-K for the material  terms of stock option grants.                                                                                                                                                                                                                                                                                                                                                                                                        |

 

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***Employment Agreements***

 

On July 16, 2008, weentered into an employment agreement with Mr. Carlson, our Chief ExecutiveOfficer. The agreement provides for a minimum annual salary of $150,000, a cashincentive bonus potential of up to 40 percent of Mr. Carlson’s basepay, and eligibility to participate in an annual grant of options to purchaseshares of common stock, as determined by our board of directors. The agreementprovides for severance payments if we terminate Mr. Carlson without causeor if Mr. Carlson terminates the agreement for good reason that includessix months of base salary plus one month of base salary for each year ofservice (up to a maximum of 12 months of base salary), payment of earnedbonuses, continued payment of existing health and life insurance benefits for aperiod of six months and immediate vesting of all unvested stock options thenheld by Mr. Carlson. In addition, within a one-year period following a “changein control” of the Company, upon termination without cause, unacceptabledemotion or reduction in responsibilities or a relocation of more than 100miles, Mr. Carlson will receive as severance, six months of base salaryplus one month of base salary for each year of service (up to a maximum of12 months of base salary), and immediate vesting of all unvested stockoptions then held by Mr. Carlson. The agreement prohibits Mr. Carlsonfrom directly or indirectly participating in the ownership, management,operation or control of a competitive business for a period of one yearfollowing termination of his employment. The agreement will extend through December 31,2009.

 

On July 21, 2007, weentered into an employment agreement with our Chief Financial Officer, RichardThon. The agreement extends through June 30, 2009. The agreement providesfor a minimum annual salary of $140,000, a cash incentive bonus potential of upto 30 percent of Mr. Thon’s base pay and eligibility to participatein an annual grant of options to purchase shares of common stock, as determinedby our Board of Directors. The agreement provides for severance payments if weterminate Mr. Thon without cause or if Mr. Thon terminates theagreement for good reason, including four months of base salary plus one monthof base salary for each year of service (up to a maximum of nine months of basesalary), payment of earned bonuses, continued payment of existing health andlife insurance benefits for a period of four months and immediate vesting ofall unvested stock options then held by Mr. Thon. In addition, within aone-year period following a “change in control” of the Company, upontermination without cause, unacceptable demotion or reduction inresponsibilities, or a relocation of more than 100 miles, Mr. Thon willreceive as severance, nine months of base salary plus one month of base salaryfor each year of service (up to a maximum of 12 months of base salary),and immediate vesting of all unvested stock options then held by Mr. Thon.The agreement prohibits Mr. Thon from directly or indirectly participatingin the ownership, management, operation or control of a competitive businessfor a period of one year following termination of his employment

 

From June 2006 through December 2007,the Company deferred payment of the majority of our remaining executive team’scompensation. We expect to pay a portion of the balance of the deferredcompensation out of the proceeds of the 2009 Public Offering, and intend to paythe balance during the course of 2009 as funding allows. As of December 31,2008, approximately $269,000 of our remaining executive team’s compensation hadnot been paid, and was recorded as an accrued liability.

 
| **ITEM 12:** | ** ** | **SECURITY OWNERSHIP OF  CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS** |
|--------------|------------|-----------------------------------------------------------------------------------------------------|

 

The following table sets forth certain informationregarding beneficial ownership of our common stock as of March 23, 2009, by (i) eachperson known by us to be the beneficial owner of more than five percent of theoutstanding common stock, (ii) each director of the Company, (iii) eachexecutive officer of the Company and (iv) all executive officers anddirectors as a group.

 

The number of shares beneficially owned is determined underrules promulgated by the SEC and the information is not necessarilyindicative of beneficial ownership for any other purpose.  The definition of beneficial ownership forproxy 

 

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statement purposes includes shares over which a person hassole or shared voting power or dispositive power, whether or not a person hasany economic interest in the shares. The definition also includes shares that aperson has a right to acquire currently or within 60 days of March 23, 2009.  Including those shares in the tables doesnot, however, constitute an admission that the named stockholder is a direct orindirect beneficial owner of those shares. Unless otherwise indicated, each person or entity named in the table hassole voting power and investment power (or shares that power with that person’sspouse) with respect to all shares of common stock listed as owned by thatperson or entity.  Unless otherwiseindicated, the address of each of the following persons is 6440 Flying CloudDrive, Suite 101, Eden Prairie, MN 55344.

 
| **Name**                                                | ** ** | **Shares  Beneficially Owned** | ** ** | **Percent of Class** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|
| Richard C.  Carlson(1)                                  |       | 110,850                             |       | 1.2                            |       |
| David F. Koenig(2)                                      |       | 101,502                             |       | 1.1                            |       |
| Robert J.  Rudelius(3)                                  |       | 99,056                              |       | 1.1                            |       |
| Scott E. Smith(4)                                       |       | 163,097                             |       | 1.7                            |       |
| Richard B. Thon(5)                                      |       | 58,000                              |       | *                              |       |
| **All  directors and officers as a group (5 total)(6)** | ** ** | **532,505**                         | ** ** | **5.5**                        | ** ** |
| James Davis (7)(8)                                      |       | 2,955,549                           |       | 26.9                           |       |
| William Reiling(9)(10)                                  |       | 509,985                             |       | 5.4                            |       |

 

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*Less than one percent.

 

(1)   Includes 850 shares held directly and currentlyexercisable options to purchase 110,000 shares of common stock.

 

(2)   Includes 1,875 shares held by ClinicalNetwork Management Corp. and 26,572 shares held by Clinical Network, Inc.with respect to each of which Mr. Koenig is an officer and minorityowner.  Also includes 39,055 shares ofcommon stock held directly and currently exercisable options to purchase up to34,000 shares of common stock.

 

(3)   Includes 45,195 shares held directly,warrants to purchase 29,986 shares of common stock and options to purchase upto 23,875 shares of common stock that are currently exercisable or exercisablewithin 60 days of March 23, 2009.

 

(4)   Includes 86,622 shares held directly,warrants to purchase 52,475 shares of common stock and currently exercisableoptions to purchase up to 24,000 shares of common stock.

 

(5)   Includes currently exercisable directlyheld options to purchase up to 58,000 shares of common stock.

 

(6)   Includes Messrs. Carlson, Koenig,Rudelius, Smith and Thon.

 

(7)   Theaddress of Mr. Davis is 6446 Flying Cloud Drive, Eden Prairie, MN 55344.

 

(8)   Shares beneficially owned includes the following directly held sharesand immediately exercisable warrants and convertible notes: 1,208,468 shares ofcommon stock, $281,000 of convertible notes convertible into 510,909 shares ofcommon stock, and warrants to purchase 989,530 shares of common stock.  Shares beneficially owned also includes the followingshares and immediately exercisable warrants held by Davis &Associates Inc., 401K PSP, of which Mr. Davis has sole votingpower: 74,964 shares of common stock and warrants to purchase 91,014 shares ofcommon stock.  Shares beneficially ownedalso includes the following shares and immediately exercisable warrants held byDavis & Associates Inc., of which Mr. Davis has sole votingpower: 37,482 shares of common stock and warrants to purchase 43,182 shares ofcommon stock.

 

(9)   The address of Mr. Reilingis 200 University Avenue W., Suite 200, St. Paul, MN 55103.

 

(10)Shares beneficially owned includes the following 336,027 directly heldshares and immediately exercisable warrants to purchase 173,958 shares.

 

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**Securities Authorized for Issuance under Equity Compensation Plans asof Last Fiscal Year (December 31, 2008)**

 
| ** **                                                  | ** ** | **Number of Securities to  be Issued Upon Exercise  of Outstanding Options,  Warrants and Rights** | ** ** | **Weighted-Average  Exercise Price of  Outstanding Options,  Warrants and Rights** | ** ** | **Number of Securities  Remaining Available  for Issuance Under  Equity Compensation  Plans (excluding  securities reflected in  column (a))** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                                                                              | ** ** | **(b)**                                                                                                     | ** ** | **(c)**                                                                                                                                                                                          | ** ** |
| Equity compensation  plans approved by stockholders (1)     |       | 233,000                                                                                                                                              |       | $                                                                                                           | 7.73       |                                                                                                                                                                                             | 67,000     |   |
| Equity  compensation plans not approved by stockholders (2) |       | 611,514                                                                                                                                              |       | $                                                                                                           | 3.98       |                                                                                                                                                                                             | —     |   |
| Total                                                       |       | 854,514                                                                                                                                              |       | $                                                                                                           | 5.02       |                                                                                                                                                                                             | 67,000     |   |

 

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(1)       Includes shares of our common stockissuable under options granted under our 2002 and 2004 Plans (as definedbelow).

(2)       Consists of warrants issued to vendors,consultants and lenders and loan guarantors.

 

The Board of Directorsadopted the ProUroCare Inc. 2002 Stock Plan (the “2002 Plan”) and theProUroCare Inc. 2004 Stock Option Plan (and the “2004 Plan”) to provide a meansby which our employees, directors, officers and consultants may be given anopportunity to purchase our stock, to assist in retaining the services of suchpersons, to secure and retain the services of persons capable of filling suchpositions and to provide incentives for such persons to exert maximum effortsfor our success.  Under the 2002 and 2004Plans, we are able to grant incentive and non-qualified options, stockappreciation rights, stock awards, restricted stock awards and performanceshares.  Incentive stock options grantedunder the 2002 Plan and 2004 Plan are intended to qualify as “incentive stockoptions” within the meaning of Section 422 of the Internal Revenue Code of1986, as amended (the “Code”). Non-qualified stock options granted under the 2004 Plan will not qualifyas incentive stock options under the Code. The Compensation Committee of the board of directors determines thevesting provisions of stock-based awards under the 2002 Plan and 2004 Plan on acase-by-case basis.  In accordance withSFAS 123 and SFAS 123R, we have elected to utilize the fair-value method ofaccounting for these options.  Anaggregate of $44,745, $453,384 and $1,626,823 of stock-based compensationrelated to these options was recognized in the years ended December 31,2008, 2007 and the period from August 17, 1999 to December 31, 2008,respectively.

 

***2002 Plan***

** **

In April 2002, PUCadopted the 2002 Stock Plan, pursuant to which PUC granted options to officers,directors, employees and independent contractors.  The Company adopted the 2002 Plan as part ofthe Merger, and on February 15, 2005 our board of directors approved anamendment to the 2002 Stock Plan that provides for the cashless exercise of optionsgranted under the plan, at the discretion of a committee of independentdirectors.  On March 27, 2008, ourboard of directors approved a second amendment to the 2002 Plan that madecertain technical changes to make it compliant with Section 409A of theCode.  Following the amendment, the planwas restated to include the amendment and to reflect the effects of the Mergerand the February 2008 reverse stock split and was renamed as the “Amendedand Restated 2002 Stock Plan.”

 

As of December 31,2008, there were options to purchase 147,000 shares of our common stockoutstanding under the 2002 Plan that are exercisable at prices ranging from$0.90 to $20.00.  All of these optionsare held by Company officers, former officers, consultants and directors.

 

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***2004 Plan***

** **

On July 12, 2005, ourstockholders approved a resolution adopting the 2004 Plan.  On March 27, 2008, our board ofdirectors approved an amendment to the 2004 Plan that made certain technicalchanges to make it compliant with Section 409A of the Code.  Following the amendment, the plan wasrestated to include the amendment and to reflect the effects of the Merger andthe February 2008 reverse stock split and was renamed as the “Amended andRestated 2004 Stock Option Plan.”

 

We have reserved 150,000shares of common stock for issuance under the 2004 Plan.  As of December 31, 2008, there wereoptions to purchase 86,000 shares of our common stock outstanding under the2004 Plan that are exercisable at prices ranging from $1.00 to $7.00 per share.All of these options have been issued to Company officers and directors.

 

**ITEM 13:****        ****CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

Throughout 2008,we rented executive offices within the offices of a former director, Mr. AlexNazarenko.  Our rental cost for theseoffices was approximately $2,129 per month, which is the market price forsimilar office space in Minneapolis, Minnesota.

 

On April 3, 2008, the Company purchased the Profile Assets fromProfile pursuant to an asset purchase agreement.  At the time of the transaction, Profile was a5% beneficial owner of the Company.  Thepurchase price of the Profile Assets was $300,000.

 

On April 3, 2008, in connection with ourpurchase of the Profile Assets, we borrowed an aggregate of $112,500 pursuantto three promissory notes each in the amount of $37,500 (see Note 11(d)). Thepromissory notes were issued in favor of Mr. Davis, Mr. Reiling andthe Smith Trust.  On September 12,2008, these three promissory notes were amended to extend their due dates tothe earlier of seven days following the close of an underwritten publicoffering or December 31, 2008, and to give the holders an option toconvert their notes into shares of our common stock at a conversion price equalto 70% of the price of the Units sold in such offering.

 

OnJuly 11, 2008, our directors received 21,667 of shares of our common stockin lieu of cash for $21,667 of unpaid director’s fees accrued through June 30,2008.

 

OnJuly 11, 2008, we issued a totalof 37,967 shares of our common stock to our directors in recognition of extraordinaryamount of time and effort they have spent on our restructuring and refocusingefforts since January 2007.  Theshares were valued at $1.00 per share and expensed on the date of issuance.

 

On September 16, 2008, Mr. Davisagreed to purchase $100,000 of the puts pursuant to the Unit Put Agreement (seeNote 11(d)).  On September 24, 2008,we closed on $50,000 of Mr. Davis’ put commitment, and issued a $47,500convertible note and a warrant to acquire 10,000 shares of our common stock atan exercise price of $1.00 per share. On October 28, 2008, we closed onthe remaining $50,000 of Mr. Davis’ put commitment, and issued a $47,500convertible note and a warrant to acquire 10,000 shares of our common stock atan exercise price of $1.00 per share.

 

On September 25, 2008, we borrowed$150,000 pursuant to a promissory note issued in favor of Mr. Davis andused the proceeds to retire the $150,000 principal amount of the Profile Note(see Note 11(d)). As consideration for providing the loan, we issued animmediately exercisable, five-year warrant to purchase 100,000 shares of ourcommon stock at $1.50 per share to Mr. Davis.

 

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**Director Independence**

 

Each of Messrs. Koenig,Rudelius and Smith qualifies as an “independent director,” as such term isdefined in Section 4200(a)(15) of the NASDAQ listing standards.  As an executive officer of the Company, Mr. Carlsondoes not qualify as an “independent director.”

 

**ITEM 14: PRINCIPALACCOUNTANT FEES AND SERVICES**

 

**Principal Accountant Fees andServices**

 

Thefollowing is a summary of the fees billed to the Company by Virchow, Krause &Company, LLP (“Virchow Krause”) for professional services rendered for thefiscal years ended December 31, 2008 and 2007, respectively:

 

 
| **Fee Category** | ** ** | **Fiscal 2008 Fees** | ** **  | **Fiscal 2007 Fees** | ** ** |
|-----------------------|------------|--------------------------------|-------------|--------------------------------|------------|
| ** **            | ** ** | ** **                     | ** **  | ** **                     | ** ** |
| Audit Fees            |       | $                              | 82,471      |                           | $          | 77,103 |   |
| Audit-related  Fees   |       | —                         |        | 3,750                          |       |
| Tax Fees              |       | 1,300                          |        | —                         |       |
| All Other Fees        |       | 44,790                         |        | 9,825                          |       |
| Total Fees            | ** ** | **$**                          | **128,561** | ** **                     | **$**      | **90,678** | ** ** |

 

*AuditFees.* These consist of fees billed byour auditors for professional services rendered for the audit of ourconsolidated financial statements and review of the interim consolidatedfinancial statements included in quarterly reports.

 

*Audit-relatedFees.* These consist of fees billed byour auditors for professional services rendered for the review of an SEC comment letter.

 

*TaxFees*. These consist of fees billedby our auditors for professional services for tax compliance, tax adviceand tax planning.

 

*AllOther Fees.* There consist of fees billed by our auditors forprofessional services rendered for the review of private placement memorandumsand registration statement filings on Form S-1 and Form S-8.

 

**PreapprovalPolicies**

 

The policy of our Audit Committee is to review andpreapprove both audit and non-audit services to be provided by the independentauditors (other than with de minimus exceptions permitted by the Sarbanes-OxleyAct of 2002).  This duty may be delegatedto one or more designated members of the Audit Committee with any such approvalreported to the committee at its next regularly scheduled meeting.  Approval of non-audit services shall bedisclosed to investors in periodic reports required by Section 13(a) ofthe Exchange Act.  100 percent of thefees paid to Virchow Krause were pre-approved as aforesaid.

 

No services in connection with appraisal orvaluation services, fairness opinions or contribution-in-kind reports wererendered by Virchow Krause.  Furthermore,no work of Virchow Krause with respect to its services rendered to the Companywas performed by anyone other than Virchow Krause.

 

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**PART IV**

 

**ITEM 15:  EXHIBITS, FINANCIAL STATEMENT SCHEDULES**

** **
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                               |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              |       | Agreement of Merger and Reorganization by and among Global Internet  Communications, Inc., GIC Acquisition Co., and  ProUroCare Inc. dated April 5, 2004 (incorporated by reference to  Exhibit 2.1 to our Current Report on Form 8-K filed April 20,  2004).                                                                                         |
| 2.2              |       | Articles of Merger relating to the merger of  GIC Acquisition Co., then a wholly owned subsidiary of the  registrant with and into ProUroCare Inc., as filed with the Minnesota  Secretary of State on April 5, 2004 (incorporated by reference to  Exhibit 2.2 to our Current Report on Form 8-K filed April 20,  2004).                                  |
| 3.1              |       | Amended and Restated Bylaws of ProUroCare Medical Inc.  (incorporated by reference to Exhibit 3.2 to Annual Report on  Form 10-KSB filed March 31, 2005).                                                                                                                                                                                                                 |
| 4.1              |       | Warrant to acquire 300,000 shares of common stock of ProUroCare  Medical Inc., issued in favor of BINA Enterprises on April 5,  2004 (incorporated by reference to Exhibit 4.2 to Registration Statement  on Form SB-2 filed August 3, 2004).                                                                                                                   |
| 4.2              |       | Form of Warrant to acquire 300,000 shares of common stock of  ProUroCare Medical Inc., issued in favor of Artann  Laboratories, Inc. and Vladimir Drits effective as of July 19, 2004  and December 2, 2004 (incorporated by reference to Exhibit 4.6 to  Registration Statement on Form SB-2/A filed October 1, 2004).                               |
| 4.3              |       | Form of warrants issued to promissory note guarantors and a  lender between September 14 and October 19, 2005 (incorporated by  reference to Exhibit 4.9 to Annual Report on Form 10-KSB filed  March 31, 2006).                                                                                                                                                |
| 4.4              |       | Warrant to acquire 25,000 shares of common stock of ProUroCare  Medical, Inc. issued in favor of Adron Holdings, LLC, dated  January 25, 2006 (incorporated by reference to Exhibit 10.7 to  Current Report on Form 8-K filed January 31, 2006).                                                                                                           |
| 4.5              |       | Security Agreement between Crown Bank and ProUroCare, Inc.,  dated January 11, 2006 and executed February 16, 2006 (incorporated  by reference to Exhibit 4.8 to Current Report on Form 8-K filed  February 23, 2006).                                                                                                                                          |
| 4.6              |       | Security Agreement between Crown Bank and ProUroCare, Inc.,  dated February 28, 2006 (incorporated by reference to Exhibit 4.9  to Current Report on Form 8-K filed March 3, 2006).                                                                                                                                                                                  |
| 4.7              |       | Security Agreement between Crown Bank and ProUroCare  Medical, Inc., dated February 28, 2006 (incorporated by reference  to Exhibit 4.10 to Current Report on Form 8-K filed March 3,  2006).                                                                                                                                                                        |
| 4.8              |       | Warrant to acquire 37,500 shares of common stock of ProUroCare  Medical, Inc. issued in favor of Roman Pauly and Maryjo Pauly, dated  June 1, 2006 (incorporated by reference to Exhibit 10.7 to Current  Report on Form 8-K filed June 6, 2006).                                                                                                               |
| 4.9              |       | Form of warrant to acquire shares of common stock of  ProUroCare Medical, Inc. issued to lenders in connection with a $100,000  promissory note, dated November 29, 2006 and January 3, 2007  (incorporated by reference to Exhibit 4.17 to Annual Report on  Form 10-KSB filed March 30, 2007).                                                      |
| 4.10             |       | Form of warrants to acquire shares of common stock of  ProUroCare Medical Inc. issued in favor of subscribers of the Company’s  $500,000 Investment Unit offering dated January 18 and January 23,  2007 (incorporated by reference to Exhibit 4.18 to Annual Report on  Form 10-KSB filed March 30, 2007).                                      |
| 4.11             |       | Form of revised Convertible Subordinated Debenture issued to William  Reiling, James Davis, Bruce Culver, and the Phillips W. Smith Family  Trust in replacement of Convertible Subordinated Debentures dated  February 17, 2006 and February 28, 2006 (incorporated by reference  to Exhibit 4.23 to Annual Report on Form 10-KSB filed  March 30, 2007). |
| 4.12             |       | Amendment No. 1 to warrant to acquire 300,000 shares of  common stock of ProUroCare Medical Inc., originally issued in favor of  BINA Enterprises on April 5, 2004, dated April 5, 2007  (incorporated by reference to Exhibit 4.14 to Annual Report on  Form 10-KSB filed March 31, 2008).                                                      |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                               |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.13             |       | Form of Amendment No. 1 to Convertible Subordinated  Debentures issued to William Reiling, James Davis, Bruce Culver, and the  Phillips W. Smith Family Trust, dated December 28, 2007  (incorporated by reference to Exhibit 4.15 to Annual Report on  Form 10-KSB filed March 31, 2008). |
| 4.14             |       | Form of warrant issued pursuant to the Company’s 2007 Private  Placement dated December 27, 2007 (incorporated by reference to  Exhibit 4.16 to Annual Report on Form 10-KSB filed March 31,  2008).                                                                                            |
| 4.15             |       | Warrant issued to James Davis dated December 27, 2007  (incorporated by reference to Exhibit 4.17 to Annual Report on  Form 10-KSB filed March 31, 2008).                                                                                                                                                 |
| 4.16             |       | Form of warrant issued pursuant to the Company’s 2008 Private  Placement dated February 13, 2008 (incorporated by reference to  Exhibit 4.18 to Annual Report on Form 10-KSB filed March 31,  2008).                                                                                            |
| 4.17             |       | Form of warrants issued to William Reiling, James Davis and the  Phillips W. Smith Family Trust dated April 3, 2008 (incorporated by  reference to Exhibit 4.1 to Quarterly Report on Form 10-Q filed  May 8, 2008).                                                                            |
| 4.18             |       | Form of Origination Warrant issued pursuant to the Company’s  Unit Put Agreement dated September 16, 2008 (incorporated by reference  to Exhibit 4.22 to Registration Statement on Form S-1 filed  September 19, 2008).                                                                         |
| 4.19             |       | Form of Put Warrant issued pursuant to the Company’s exercise of  its put right pursuant to the Unit Put Agreement dated September 16,  2008 (incorporated by reference to Exhibit 4.23 to Registration  Statement on Form S-1 filed September 19, 2008).                                       |
| 4.20             |       | Warrant issued to James Davis dated September 25, 2008  (incorporated by reference to Exhibit 4.1 to Quarterly Report on  Form 10-Q filed October 23, 2008).                                                                                                                                              |
| 4.21             |       | Form of Warrant issued to James Davis, Bruce Culver,  William S. Reiling and the Smith Family Trust, dated October 31,  2008 (incorporated by reference to Exhibit 4.25 to Amendment No. 1  to Registration Statement on Form S-1 filed November 10, 2008).                                |
| 4.22             |       | Form of Underwriters Warrant Agreement (incorporated by  reference to Exhibit 4.26 to Amendment No. 3 to Registration  Statement on Form S-1 filed December 18, 2008).                                                                                                                               |
| 4.23             |       | Form of Warrant Agreement between ProUroCare Medical Inc. and  Interwest Transfer (incorporated by reference to Exhibit 4.27 to  Amendment No. 3 to Registration Statement on Form S-1 filed  December 18, 2008).                                                                                    |
| 4.24             |       | Specimen Warrant (incorporated by reference to Exhibit 4.28 to  Amendment No. 3 to Registration Statement on Form S-1 filed  December 18, 2008).                                                                                                                                                          |
| 4.25             |       | Form of Unit Certificate (incorporated by reference to  Exhibit 4.29 to Amendment No. 3 to Registration Statement on  Form S-1 filed December 18, 2008).                                                                                                                                             |
| 4.26             |       | Form of Unit Agreement between ProUroCare Medical Inc. and  Interwest Transfer (incorporated by reference to Exhibit 4.30 to  Amendment No. 3 to Registration Statement on Form S-1 filed December 18,  2008).                                                                                       |
| 10.1*            |       | ProUroCare Medical Inc. Amended and Restated 2002 Stock Plan  (incorporated by reference to Exhibit 4.1 to Registration Statement on  Form S-8 filed March 31, 2008).*                                                                                                                                    |
| 10.2*            |       | ProUroCare Medical Inc. Amended and Restated 2004 Stock Option  Plan (incorporated by reference to Exhibit 4.2 to Registration Statement  on Form S-8 filed March 31, 2008).*                                                                                                                             |
| 10.3             |       | Guaranty provided to Crown Bank on behalf of ProUroCare  Medical Inc. dated January 10, 2006 (incorporated by reference to  Exhibit 4.4 to Current Report on Form 8-K filed February 23,  2006).                                                                                                     |
| 10.4             |       | Guaranty provided to Crown Bank on behalf of ProUroCare  Medical Inc. dated February 28, 2006 (incorporated by reference to  Exhibit 4.5 to Current Report on Form 8-K filed March 3,  2006).                                                                                                        |
| 10.5             |       | Promissory Note issued in favor of Crown Bank, dated  February 28, 2006 (incorporated by reference to Exhibit 4.1 to  Current Report on Form 8-K filed March 3, 2006).                                                                                                                                    |
| 10.6             |       | Promissory Note issued in favor of Roman Pauly, dated June 1,  2006 (incorporated by reference to Exhibit 10.1 to Current Report on  Form 8-K filed June 6, 2006).                                                                                                                                        |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7             |       | Amendment #1 to Promissory Note dated June 1, 2006 issued in  favor of Roman Pauly, dated August 24, 2006 (incorporated by reference  to Exhibit 10.3 to Quarterly Report on Form 10-QSB filed  September 18, 2006).                                  |
| 10.8             |       | Promissory Note issued in favor of Adron Holdings, LLC, dated  November 29, 2006, as amended March 21, 2007 (incorporated by  reference to Exhibit 10.37 to Annual Report on Form 10-KSB filed  March 30, 2007).                                 |
| 10.9             |       | Amendment #2 to Promissory Note dated June 1, 2006 issued in  favor of Roman Pauly, dated March 21, 2007 (incorporated by reference to  Exhibit 10.38 to Annual Report on Form 10-KSB filed March 30,  2007).                                         |
| 10.10            |       | Termination and Intent for Cooperation Agreement dated April 16,  2007 by and between ProUroCare Medical Inc. and Artann Laboratories, Inc.  (incorporated by reference to Exhibit 10.4 to Quarterly Report on  Form 10-QSB filed May 15, 2007). |
| 10.11            |       | Promissory Note issued in favor of Alexander Nazarenko, dated  April 17, 2007 (incorporated by reference to Exhibit 10.5 to  Quarterly Report on Form 10-QSB filed May 15, 2007).                                                                          |
| 10.12            |       | Maurice Taylor Agreement to Defer Payment of Accrued Salary dated  May 11, 2007 (incorporated by reference to Exhibit 10.6 to  Quarterly Report on Form 10-QSB filed May 15, 2007).                                                                        |
| 10.13            |       | Michael Grossman Final Separation Agreement dated May 11, 2007  (incorporated by reference to Exhibit 10.7 to Quarterly Report on  Form 10-QSB filed May 15, 2007).                                                                                        |
| 10.14            |       | Promissory Note issued in favor of Alexander Nazarenko, dated  June 25, 2007 (incorporated by reference to Exhibit 10.2 to  Quarterly Report on Form 10-QSB filed August 14, 2007).                                                                        |
| 10.15*           |       | Employment Agreement by and between ProUroCare Inc. and  Richard B. Thon, dated July 21, 2007 (incorporated by reference to  Exhibit 10.3 to Quarterly Report on Form 10-QSB filed August 14,  2007).                                            |
| 10.16            |       | Promissory Note issued in favor of Phillips W. Smith Family  Trust, dated July 31, 2007 (incorporated by reference to  Exhibit 10.4 to Quarterly Report on Form 10-QSB filed  August 14, 2007).                                                       |
| 10.17            |       | Amendment # 2 to Promissory Note issued in favor of Adron  Holdings, LLC on November 29, 2006, dated August 8, 2007  (incorporated by reference to Exhibit 10.5 to Quarterly Report on  Form 10-QSB filed August 14, 2007).                      |
| 10.18            |       | Promissory Note issued in favor of James Davis, dated August 29,  2007 (incorporated by reference to Exhibit 10.4 to Quarterly Report on  Form 10-QSB filed November 14, 2007).                                                                            |
| 10.19            |       | Promissory Note issued in favor of the Phillips W. Smith Family  Trust, executed on October 31, 2007 effective as of October 15,  2007 (incorporated by reference to Exhibit 10.35 to Annual Report on  Form 10-KSB filed March 31, 2008).       |
| 10.20            |       | Security Agreement issued in favor of the Phillips W. Smith  Family Trust, executed on October 31, 2007 effective as of  October 15, 2007 (incorporated by reference to Exhibit 10.36 to  Annual Report on Form 10-KSB filed March 31, 2008).    |
| 10.21            |       | $400,000 Promissory Note issued in favor of Crown Bank, executed  October 31, 2007(incorporated by reference to Exhibit 10.37 to  Annual Report on Form 10-KSB filed March 31, 2008).                                                                      |
| 10.22            |       | $1,200,000 Promissory Note issued in favor of Crown Bank, executed  October 31 2007 (incorporated by reference to Exhibit 10.38 to  Annual Report on Form 10-KSB filed March 31, 2008).                                                                    |
| 10.23            |       | Commercial Loan and Security Agreement with Crown Bank, executed  October 31, 2007 and effective as of December 28, 2007  (incorporated by reference to Exhibit 10.39 to Annual Report on  Form 10-KSB filed March 31, 2008).                         |
| 10.24            |       | Guaranty provided to Crown Bank on behalf of ProUroCare  Medical Inc. by Bruce Culver dated October 10, 2007 (incorporated  by reference to Exhibit 10.40 to Annual Report on Form 10-KSB filed  March 31, 2008).                                     |
| 10.25            |       | Guaranty provided to Crown Bank on behalf of ProUroCare  Medical Inc. by James Davis dated October 10, 2007 (incorporated by  reference to Exhibit 10.41 to Annual Report on Form 10-KSB filed  March 31, 2008).                                      |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                         |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.26            |       | Guaranty provided to Crown Bank on behalf of ProUroCare  Medical Inc. by Phillips W. Smith Family Trust dated October 10,  2007 (incorporated by reference to Exhibit 10.42 to Annual Report on  Form 10-KSB filed March 31, 2008).                                                            |
| 10.27            |       | Promissory Note issued in favor of James Davis, dated  October 31, 2007 (incorporated by reference to Exhibit 10.43 to  Annual Report on Form 10-KSB filed March 31, 2008).                                                                                                                         |
| 10.28            |       | Promissory Note issued in favor of James Davis, dated  November 30, 2007 (incorporated by reference to Exhibit 10.44 to  Annual Report on Form 10-KSB filed March 31, 2008).                                                                                                                        |
| 10.29            |       | Form of Convertible Note issued pursuant to the Company’s 2007  Private Placement dated December 27, 2007 (incorporated by reference to  Exhibit 10.45 to Annual Report on Form 10-KSB filed March 31,  2008).                                                                            |
| 10.30            |       | Convertible Note issued to James Davis dated December 27, 2007  (incorporated by reference to Exhibit 10.46 to Annual Report on  Form 10-KSB filed March 31, 2008).                                                                                                                                 |
| 10.31            |       | Form of Convertible Note issued pursuant to the Company’s 2008  Private Placement dated February 13, 2008 (incorporated by reference to  Exhibit 10.47 to Annual Report on Form 10-KSB filed March 31,  2008).                                                                            |
| 10.32            |       | Amendment #1 to Promissory Note dated July 31, 2007 between  ProUroCare Medical, Inc. and the Phillips W. Smith Family Trust,  Dated March 11, 2008 (incorporated by reference to Exhibit 10.48 to  Annual Report on Form 10-KSB filed March 31, 2008).                              |
| 10.33            |       | Amendment #1 to $600,000 Promissory Note dated October 15, 2007  between ProUroCare Medical, Inc. and the Phillips W. Smith Family  Trust, dated March 11, 2008 (incorporated by reference to  Exhibit 10.49 to Annual Report on Form 10-KSB filed March 31,  2008).                 |
| 10.34            |       | Asset Purchase Agreement by and between ProUroCare Medical Inc.  and Profile, LLC dated April 3, 2008 (incorporated by reference to  Exhibit 10.1 to Quarterly Report on Form 10-Q filed May 8,  2008).                                                                                   |
| 10.35            |       | Security Agreement by and between ProUroCare Medical Inc. and  Profile, LLC dated April 3, 2008 (incorporated by reference to  Exhibit 10.2 to Quarterly Report on Form 10-Q filed May 8,  2008).                                                                                         |
| 10.36            |       | Promissory Note by and between ProUroCare Medical Inc. and  Profile, LLC dated April 3, 2008 (incorporated by reference to  Exhibit 10.3 to Quarterly Report on Form 10-Q filed May 8,  2008).                                                                                            |
| 10.37            |       | Form of Promissory Notes by and between ProUroCare  Medical Inc. and each of William Reiling, James Davis and the  Phillips W. Smith Family Trust dated April 3, 2008 (incorporated by  reference to Exhibit 10.4 to Quarterly Report on Form 10-Q filed May 8,  2008).              |
| 10.38*           |       | Employment Agreement by and between ProUroCare Inc. and Richard  Carlson dated July 16, 2008 (incorporated by reference to  Exhibit 10.1 to Quarterly Report on Form 10-Q filed August 14,  2008).                                                                                             |
| 10.39*           |       | Form of Stock Option Agreement and Notice of Stock Option Grant  for incentive stock options issued to Richard Carlson and Richard Thon on  July 11, 2008 (incorporated by reference to Exhibit 10.4 to  Quarterly Report on Form 10-Q filed August 14, 2008).                                 |
| 10. 40           |       | License Agreement by and between ProUroCare Medical Inc. and  Artann Laboratories Inc. dated July 25, 2008 (incorporated by  reference to Exhibit 10.2 to Quarterly Report on Form 10-Q filed  August 14, 2008).                                                                          |
| 10.41            |       | Development and Commercialization Agreement by and between ProUroCare  Medical Inc. and Artann Laboratories Inc. dated July 25, 2008  (incorporated by reference to Exhibit 10.3 to Quarterly Report on  Form 10-Q filed August 14, 2008).                                                |
| 10.42            |       | Amendment Number 1 to Promissory Note by and between ProUroCare  Medical Inc. and Profile, LLC dated April 3, 2008  (incorporated by reference to Exhibit 10.1 to Current Report on  Form 8-K filed September 16, 2008).                                                             |
| 10.43            |       | Form of Amendment Number 1 to Promissory Notes by and  between ProUroCare Medical Inc. and each of William Reiling, James Davis  and the Phillips W. Smith Family Trust dated April 3, 2008  (incorporated by reference to Exhibit 10.2 on Form 8-K filed  September 16, 2008). |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                        |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.44            |       | Unit Put Agreement dated September 16, 2008 (incorporated by  reference to Exhibit 10.43 to Registration Statement on Form S-1  filed September 19, 2008).                                                                                                                                         |
| 10.45            |       | Form of Unit Put Origination Warrant to be issued to Unit Put  Agreement dated September 16, 2008 (incorporated by reference from  Exhibit 4.23 to Registration Statement on Form S-1 filed  September 19, 2008).                                                                             |
| 10.46            |       | Form of Unit Put Warrant to be issued to Unit Put Agreement dated  September 16, 2008 (incorporated by reference from Exhibit 4.22 to  Registration Statement on Form S-1 filed September 19, 2008).                                                                                          |
| 10.47            |       | Form of Convertible Promissory Note issued pursuant to the  Company’s exercise of its put right pursuant to the Unit Put Agreement dated  September 16, 2008 (incorporated by reference to Exhibit 10.44 to  Registration Statement on Form S-1 filed September 19, 2008).               |
| 10.48            |       | Convertible Promissory Note dated September 25, 2008 issued in  favor of James Davis (incorporated by reference to Exhibit 10.7 to  Quarterly Report on Form 10-Q filed October 23, 2008).                                                                                                         |
| 10.49            |       | Amendment of License Agreement by and between ProUroCare Medical Inc.  and Artann Laboratories, Inc. dated December 19, 2008 (incorporated  by reference to Exhibit 10.46 to Amendment No. 4 to Registration  Statement on Form S-1 filed December 22, 2008).                            |
| 10.50            |       | Amendment to Development and Commercialization Agreement by and  between ProUroCare Medical Inc. and Artann Laboratories, Inc. dated  December 19, 2008 (incorporated by reference to Exhibit 10.46 to  Amendment No. 4 to Registration Statement on Form S-1 filed  December 22, 2008). |
| 10.51            |       | Promissory Note dated March 19, 2009 issued in favor of Crown  Bank (filed herewith).                                                                                                                                                                                                                             |
| 10.52            |       | Financing Agreement by and between ProUroCare Medical Inc. and James  Davis dated March 19, 2009 (filed herewith).                                                                                                                                                                                                     |
| 10.53            |       | Form of Loan Guarantor Compensation Letter Agreement dated  March 19, 2009 (filed herewith).                                                                                                                                                                                                                 |
| 10.54            |       | Letter agreement by and between ProUroCare Medical Inc. and the  Phillips W. Smith Family Trust dated March 19, 2009 (filed herewith).                                                                                                                                                                            |
| 10.55            |       | Amendment #2 to $600,000 Promissory Note dated October 15, 2007  between ProUroCare Medical, Inc. and the Phillips W. Smith Family  Trust, dated March 19, 2009 (filed herewith).                                                                                                                  |
| 10.56            |       | Convertible Promissory Note dated March 19, 2009 issued in favor of  James Davis (filed herewith).                                                                                                                                                                                                                     |
| 21.1             |       | List of Subsidiaries of ProUroCare Medical Inc. (incorporated by  reference to Exhibit 21.1 to Registration Statement on Form SB-2  filed August 3, 2004).                                                                                                                                         |
| 23.1             |       | Consent of Virchow, Krause & Company, LLP (filed  herewith).                                                                                                                                                                                                                                             |
| 24.1             |       | Power of Attorney (included on signature page hereof).                                                                                                                                                                                                                                                            |
| 31.1             |       | Certification of Principal Executive Officer pursuant to  Rule 13a-14(a)/15d-14(a) of the Sarbanes-Oxley Act of 2002 (filed  herewith).                                                                                                                                                                      |
| 31.2             |       | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a)/15d-14(a) of the Sarbanes-Oxley Act of 2002 (filed  herewith).                                                                                                                                                                          |
| 32.1             |       | Certification of Chief Executive Officer and Chief Financial Officer  pursuant to pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                |

 

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*Management contract or compensatory plan.

 

Note:            Inorder that share data agree with the underlying documents, no share data inthis list of Exhibits have been restated to reflect the Company’s one-for-teneffect of the February, 2008 reverse stock split.

 

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**SIGNATURES**

 

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

 

 

ProUroCare Medical, Inc.

 

 
| By:    | /s/ Richard C. Carlson    |   |
|--------|---------------------------|--------|
|   | Richard C. Carlson        |   |
|   | Chief Executive Officer   |   |
|   | Date: March 26, 2009 |   |

 

Pursuant to the requirementsof the Securities Act of 1934, this Annual Report has been signed as of March 26,2009, by the following persons in the capacities indicated.

 

** **
| **Name**               | ** ** | **Title**                                              |
|------------------------|------------|--------------------------------------------------------|
| ** **             | ** ** | ** **                                             |
| /s/ Richard C. Carlson |       | Chief  Executive Officer (Principal Executive Officer) |
| Richard C. Carlson     |       |                                                   |
|                   |       |                                                   |
| /s/ Richard Thon       |       | Chief  Financial Officer (Principal Financial and      |
| Richard Thon           |       | Accounting  Officer)                                   |
|                   |       |                                                   |
| /s/ David Koenig       |       | Director                                               |
| David  Koenig          |       |                                                   |
|                   |       |                                                   |
| /s/ Robert Rudelius    |       | Director                                               |
| Robert Rudelius        |       |                                                   |
|                   |       |                                                   |
| /s/ Scott E. Smith     |       | Director                                               |
| Scott  E. Smith        |       |                                                   |

 

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