**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-KSB**

 

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

 

**For the fiscal year ended****December 31, 2007**

 

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

 

**Forthe 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.) |
|                                                                                   |       |                |
| **5500 Wayzata Blvd.,  Suite 310, Golden Valley, MN**                             | ** ** | **55416**           |
| (Address of principal executive offices)                                               |       | (Zip Code)          |
|                                                                                   |       |                |
| Registrant’s  telephone number, including area code    **952-476-9093** |

 

 

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

 

Securities registered pursuant to Section 12(b) ofthe Exchange Act:  **None**

 

Securities registered pursuant to Section 12(g) ofthe Act:

**Common Stock, $0.00001 par value**

 

Checkwhether the 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 90days.    **Yes****x****         No****o**

 

Checkif there is no disclosure of delinquent filers in response to Item 405 ofRegulation S-B contained in this form, and no disclosure will be contained, tothe best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-KSBor any amendment to this Form 10-KSB  **o**

 

Indicateby check mark whether the registrant is a shell company (as defined by Rule 12-bof the Exchange Act).    **Yes****o****     No****x**

 

Stateissuer’s revenues for its most recent fiscal year:  **$0**

 

State the aggregatemarket value 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 a specified datewithin the past 60 days.  (See definitionof affiliate in Rule 12b-2 of the Exchange Act.)**                                  $1,984,379as of March 6, 2008**

 

Statethe number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date.

 

**1,727,350 common shares at March 26, 2008**

 

TransitionalSmall Business Issuer Format (check one):   **Yes****o****         No****x**

 

** **

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**INTRODUCTORY CAUTIONARY STATEMENT**

 

*This Annual Report on Form 10-KSBincludes forward-looking statements within the meaning of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”).  These statements are based on management’scurrent beliefs 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-looking statements.We caution you not to put undue reliance on any forward-looking statementsincluded in this document.  See “RiskFactors Associated with our Business, Operations, and Securities.”*

 

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**TABLE OF CONTENTS**

 
| ** **        | ** **                                                                                                                                   | **Page** |
|-------------------|----------------------------------------------------------------------------------------------------------------------------------------------|----------|
|              |                                                                                                                                         |     |
| **PART I**   |                                                                                                                                         |     |
|              |                                                                                                                                         |     |
| ITEM 1:           | DESCRIPTION OF BUSINESS                                                                                                                      | 1        |
|              |                                                                                                                                         |     |
|              | RISK FACTORS                                                                                                                                 | 22       |
|              |                                                                                                                                         |     |
| ITEM 2:           | DESCRIPTION OF  PROPERTY                                                                                                                     | 39       |
|              |                                                                                                                                         |     |
| ITEM 3:           | LEGAL PROCEEDINGS                                                                                                                            | 39       |
|              |                                                                                                                                         |     |
| ITEM 4:           | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                         | 39       |
|              |                                                                                                                                         |     |
| **PART II**  |                                                                                                                                         |     |
|              |                                                                                                                                         |     |
| ITEM 5:           | MARKET FOR  COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                                                                                    | 40       |
|              |                                                                                                                                         |     |
| ITEM 6:           | MANAGEMENT’S  DISCUSSION AND ANALYSIS OR PLAN OF OPERATION                                                                              | 41       |
|              |                                                                                                                                         |     |
| ITEM 7:           | FINANCIAL STATEMENTS                                                                                                                         | F-1      |
|              |                                                                                                                                         |     |
| ITEM 8:           | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES                                                       | 44       |
|              |                                                                                                                                         |     |
| ITEM 8A:          | CONTROLS AND  PROCEDURES                                                                                                                     | 44       |
|              |                                                                                                                                         |     |
| ITEM 8B:          | OTHER INFORMATION                                                                                                                            | 45       |
|              |                                                                                                                                         |     |
| **PART III** |                                                                                                                                         |     |
|              |                                                                                                                                         |     |
| ITEM 9:           | DIRECTORS,  EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE;  COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT | 46       |
|              |                                                                                                                                         |     |
| ITEM 10:          | EXECUTIVE COMPENSATION                                                                                                                       | 47       |
|              |                                                                                                                                         |     |
| ITEM 11:          | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                                             | 51       |
|              |                                                                                                                                         |     |
| ITEM 12:          | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                                                   | 55       |
|              |                                                                                                                                         |     |
| ITEM 13:          | EXHIBITS                                                                                                                                     | 58       |
|              |                                                                                                                                         |     |
| ITEM 14:          | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                                                                      | 62       |
|              |                                                                                                                                         |     |
| **SIGNATURES**    | 63                                                                                                                                           |

 

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** **

**PART I**

 

**ITEM1:  DESCRIPTION OF BUSINESS**

 

**Historyof Company; Overview**

** **

See “RISK FACTORS ASSOCIATEDWITH OUR BUSINESS, OPERATIONS AND SECURITIES”, page 22.

 

***Overview***

 

Weare a development stage company engaged in the business of developing formarket innovative products for the detection and characterization of maleurological prostate disease.  Our primaryfocus is currently the ProUroScanTM prostate imaging system.  ProUroCare Inc. (“PUC”) was incorporated in1999 as a Minnesota corporation.  In July 2001,the first activities of PUC were to obtain license rights to certain electricalimpedance tomography (“EIT”) and directed microwave technologies in theurological field of use.  In January 2002,we licensed the rights to certain advanced prostate mechanical imagingtechnology, and became engaged in the business of developing this technologyfor assessing the size, shape and volume of the prostate.  In 2004, through a reverse merger transactionwith Global Internet Communications (“Global”), a Nevada corporation, PUCbecame the wholly owned and sole operating subsidiary of Global, which was thenrenamed ProUroCare Medical Inc.

 

Ourinitial product is the ProUroScanTM system, a mechanical imagingsystem that enables physicians to identify and characterize the existence ofabnormal prostate tissue, and monitor changes in prostate tissue overtime.  During the next 12 months,assuming our financing efforts are successful (see “**ITEM 6: MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION**”), we expect to prepare theProUroScanTM system for clinical trials, obtain FDA clearance on abasic mapping and data maintenance labelingclaim, and prepare to launch our product into the market, although there can beno assurance that we will be successful in meeting these milestones.  We are currently exploring potentialmarketing relationships with medical device companies that are interested inmarketing products in the prostate cancer detection market.   Weexpect such a relationship would provide both financial support and access todown stream marketing, manufacturing and sales capabilities.

 

TheProUroScanTM system has been developed by us under developmentcontracts with Artann Laboratories Inc. (“Artann”) a scientific technologycompany focused on early-stage technology development.  In September 2006, Artann was awarded a$3 million Small Business Innovation Research Phase II Competitive Renewalgrant from the National Cancer Institute to help advance the development andapplication for clearance of our ProUroScanTM system by the U.S.Food and Drug Administration (“FDA”).  Itis our intent to work with Artann under this grant to finalize our currentsystem for clinical trials, and to expand our working relationship with Artannto include their participation in the development and licensing of futuregenerations of the ProUroScanTM system.  Weare currently in active negotiations with Artann to enter into a developmentand licensing agreement that willprovide the foundation for future development of the ProUroScanTM system.

 

***Market Focus - Prostate Disease***

 

Our products are focused on prostate disease in menover 40 years of age. There are two segments of the market that are of interestto the Company:

 

·                  early detection, characterization and monitoring of prostate cancer, and

 

·                  improving the ability of physicians to assess the effectiveness of existing treatments for Benign Prostatic Hyperplasia (“BPH”), also known as enlarged prostate.

 

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It is estimated that nearly 186,320 men will bediagnosed with and over 28,660 men will die from prostate cancer in 2007.  We believe that the percentage of men withmoderate to severe symptoms from prostate disease (BPH or prostate cancer) whoseek screening, diagnosis and treatment will increase in the future as a resultof increased awareness of prostate related diseases and the development ofquantitative diagnostic systems (such as our ProUroScanTM system).In addition, the number of potential patients will increase as a result of anaging population and the increased awareness and standard of living in manyother countries around the world.

 

***ProUroScanTM Prostate Mechanical Imaging System***

 

The ProUroScanTM system is a mechanical imaging system that enables physicians to map the prostate to identify and characterize the existence of abnormal prostate tissue, and monitor changes in prostate tissue over time.  The system’s operation is based on measurement of the stress pattern on the rectal wall when the probe is pressed against the prostate.  Temporal and spatial changes in the stress pattern provide information on the elastic structure of the gland and allow two-dimensional reconstruction of prostate anatomy and assessment of prostate mechanical properties.  The data acquired allow the calculation of prostate features such as size, shape and volume.  The prostate image is displayed on a screen that allows physicians to identify the specific location of tissue abnormalities and determine the relative size of the prostate upon completion of the imaging procedure.  In addition to the visual display, results are stored electronically.

 

The ProUroScanTM system consists of arrays of pressuresensors mounted on a probe, a central processing unit containing proprietaryimage construction algorithms, a computer with color monitor and keyboard, acolor printer and single-use disposable sheaths to cover the tip of theprobe.  The ProUroScanTMsystem’s probe is specially designed for the rectal anatomy to minimize patientdiscomfort.  It is ergonomic for theclinician and similar to a traditional DRE for the patient.  The probe utilizes highly sensitive pressuresensors located on the face of the probe head to palpate the prostate.  The probe’s positioning system ensures thatthe person administering the test examines the entire surface of the prostate,and assists prostate image construction.

 

To perform a test, the clinician must first place asingle-use disposable sheath over the probe head and shaft and cover it with alubricant.  The clinician then insertsthe tip of the probe into the patient’s rectum and palpates the prostate.  As the prostate is palpated, a color image ofthe prostate is produced and displayed on the computer monitor, along withindicators of the amount of pressure being applied to help guide theclinician.  Differences in tissuestiffness and elasticity will be depicted in real time on a color monitor.  Total testing time for a healthy prostate is underone minute.

 

Standardizing the procedure using the ProUroScanTMsystem mechanical imaging device should help to minimize the differences inskill levels between physicians in this otherwise subjective procedure.  We expect the system will be more sensitiveand have the ability to detect abnormalities that the normal human fingercannot detect, thereby improving the quality of the diagnostic process.  It should also enable physicians to literallysee the differences in tissue elasticity or stiffness on the color monitor, asopposed to a traditional DRE that relies exclusively on the clinician’s senseof touch.  The system will create a hardcopy of the prostate diagnostic procedure which can be placed into the patient’sfile, and a digital record of the exam that can be stored and used forcomparison to subsequent exams. This is advantageous for physicians andpatients in that it gives them the ability to compare and contrast the patient’sresults from exam to exam, and to get second opinions on the patient’s statusin regards to the diagnosis without an additional exam.  Comparisons of multiple tests over time canalso be done providing longitudinal assessments of the patient’s disease.

 

***Current ProUroScanTM System Status; Future Development***

 

The first generation ProUroScanTM systemwill provide an overall assessment of the prostate resulting in a map or recordof the pressures that are generated from an assessment of the posterior surfaceof the prostate using the current 

 

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sensor probe. Development work is still required in the areas of positioning systemrefinement, software, validation, user interface and sensor production, amongothers, must be completed before the system can be submitted to the FDA for 510(k) clearanceor commercialized.  It is anticipatedthat, once sufficient financing is obtained to undertake such work, anadditional four to five months will be needed to complete the remainingdevelopment tasks leading to the production of clinical study units.  As discussed below, the clinical study unitswill be used to conduct the clinical trials necessary to obtain FDA pre-marketclearance.

 

The ProUroScanTM system prototype has been tested inlaboratory experiments on prostate models and in a pre-clinical study.  The system has been used for more than twoyears and on more than 168 patients at the Robert Wood Johnson Medical Centerin New Brunswick, New Jersey.

 

We believe that the existing technology platform is robust and provides aplatform on which to develop multiple future generation systems.  We believe that a second generation systemmay be capable of identifying the specific 3-dimensional location of lesionsfound in the prostate.  We believe thatthis system may also be able to create a 3-dimensional image of the position ofthe lesions and allow the physician to rotate the image to assist inidentifying the actual position of the lesion in the prostate gland.  We believe that this second generation systemmay provide a more thorough diagnosis of the patient’s condition.  Future generations of the ProUroScanTMsystem may include the capability of guiding biopsies to suspected cancersites, at a lower cost than current ultrasound approaches.

 

***The Role of the ProUroScanTM System***

 

We believe the ProUroScanTM system’sprimary uses will be threefold.  Forpatients with preliminary positive screening results for prostate cancer whoare in the process of confirming their diagnosis, the system will be used toassist in characterizing the suspicious tissue and thereby could help reducethe number of unnecessary biopsies.  Approximately1 million patients are biopsied each year in the United States, but only 25percent of biopsy procedures performed detect the presence of cancer.  For prostate cancer patients who have chosento forgo surgical treatments and are being followed under active surveillance,the system can be used to create a digital map to objectively define andmeasure the progression of the disease over time, providing a means to helpdetermine when aggressive intervention is warranted.  Finally, for patients who have symptoms ofBPH, the system could be used to monitor changes in prostate size before andduring the course of medical treatments, allowing physicians to more quicklyassess the effectiveness of alternative therapeutic approaches.

 

We intend to ultimately position the ProUroScanTMsystem as an “adjunctive” tool to digital rectal examinations (“DRE”) andprostate specific blood antigen (“PSA”) testing.  We believe that the ProUroScanTMsystem will enable a physician to detect abnormalities in the prostate moreaccurately than with his or her finger, and assess areas of the prostate thatthe physician cannot reach with their finger. Unlike PSA, which uses measurements of the level of a certain antigen inthe blood to infer the existence of cancer, the ProUroScanTM systemdirectly measures the physical presence of abnormal tissue.  Using the combined results of DRE, PSA andProUroScanTM system tests, we believe that the urologist will beable to make a better determination of the need for a prostate biopsy.  Furthermore, we believe the color images andthree-dimensional visualization of the prostate provided by the ProUroScanTMsystem will identify specific regions of the prostate that should be the focusof a biopsy procedure, thereby potentially reducing the need for repeatbiopsies.

 

We believe that the ProUroScanTM system is designed to produce a digitalimage of the prostate showing the size and symmetry of the prostate and thelocation of tissue abnormalities within the prostate.  Its ability to digitally store not only thetest results, but all of the individual pressure readings taken during thecourse of the procedure will facilitate a quantitative analysis of theprogression of the disease over time.  Bycomparing the data taken in a baseline examination to subsequent examinationsduring the course of active surveillance, the urologist will gain valuableinformation about changes in the patient’s condition that can influence theirdecision to pursue additional treatment or continue surveillance.

 

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Use of the ProUroScanTM system inpatients diagnosed with BPH will be beneficial in allowing physicians tomonitor changes in the size and volume of the prostate following treatment withdrugs or other tissue reducing technologies. Timely, accurate assessment of prostate volume changes and theeffectiveness of treatment will enable physicians to recommend alternativetreatments sooner than current assessment methods, and thus provide moreimmediate relief to patients. Importantly, the ProUroScanTM system is also capable ofidentifying previously undefined abnormal tissue that may require furtheranalysis to determine if prostate cancer may be present.

 

***Prostate Cancer Screening, Diagnosis and Treatment***

 

The two most common screening tests for identifyingprostate cancer are the DRE and the PSA, which have been used for severalyears, but have often been criticized for their lack of specificity andselectivity.

 

The DRE has traditionally been used by physicians in early detection efforts,despite a lack of evidence from controlled studies showing that the procedurereduces disease specific mortality rates. In a DRE exam, a physician wearing a latex glove inserts a lubricatedfinger into the rectum to palpate the prostate gland to detectabnormalities.  The clinician must relyon his or her experience and sensitivity of touch to estimate the size of theprostate and detect irregularities in shape or hardness.  There is significant subjectivity inherent inthe DRE exam which can be negatively affected by poor examiner training,experience or an ability to interpret the results, as well as other patientrelated limitations including excessive obesity, patient discomfort and unusualanatomical positioning of the prostate.

 

Data from community-based studies indicate that the positive predictive value of aDRE in detecting cancer is 15 to 30 percent and varies relatively little withage.  In another Scandinavian study, thepositive predictive value of DRE was found to be only 22 to 29 percent.  According to the Eighth Edition of Campbell’sUrology, a DRE has only fair reproducibility even with experienced examinersand the test misses a substantial proportion of cancers before they becomeadvanced and less amenable to treatment.

 

Another approach for detecting prostate cancer isthe measurement of PSA in serum.  Theprimary value of PSA testing comes from its simplicity, objectivity,reproducibility, its low level of invasiveness and overall cost.  Although PSA is specific to prostate tissue,it is not specific only for prostate cancer. Older men that have benign enlargement of the prostate and acuteprostatitis often have elevated PSA levels. Serum levels of PSA can also be elevated for a period of time aftertransrectal needle biopsy, acute urinary retention and prostate surgery.  Because of the prevalence of these conditionsin men over the age of 50, the specificity of PSA measurements decreases withage.

 

In clinical practice, an elevated PSA level greater than4ng/mL is generally considered an abnormal result.  Values in excess of 4ng/mL increase the oddsof intracapsular tumors by as much as threefold and the odds of extra capsulartumors by threefold to fivefold.  Recentcommunity-based studies show that high PSA values (> than 4ng/mL) have beenseen in about 15 percent of men who are older than 50 years of age.  The probability that a man who is older than50 having prostate cancer if his PSA level is elevated (positive predictivevalue) is approximately 20 to 30 percent. However, the likelihood of cancer depends on the degree of elevation inthe PSA levels.  For levels between 4 and10ng/mL, the positive predictive value is about 20 percent.  This value increases to between 42 percentand 64 percent if the PSA level is greater than 10ng/nL. Despite thesevariances, PSA testing has increased the detection rate of early-stage cancers,which are more curable than late-stage cancers.

 

Most clinicians have adopted the strategy of performing bothtests in combination, which has been shown to increase the combined predictivevalue.  In fact, in a large study ofvolunteers, the combination of DRE and PSA detected 26 percent more cancersthan PSA alone.  However, because of thesignificant risk of prostate cancer, prostate biopsy is recommended for all menwho have DRE abnormalities, regardless of PSA level, because 25 percent of menwith cancer have PSA levels less than 4mg/nL.

 

A patient with a positive DRE or PSA is typically referred to a urologist forfurther diagnosis, who will usually perform a prostate biopsy to obtain tissuesamples for microscopic analysis.  Theprostate is biopsied by a needle that 

 

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is guided by ultrasound into the prostate throughthe rectal wall.  Since the existence andexact location of possible cancerous tissue is not known, the urologist willusually take 10 to 14 samples in a scattered pattern throughout the prostate inan attempt to find the suspect tissue. The tissue samples are then sent to a laboratory for analysis andinterpretation, and the results are reported several days later.  If the results are negative or indeterminate,the urologist may suggest a second biopsy procedure, or that the patientincrease the frequency of future screening examinations.  Approximately 1 million patients are biopsiedeach year in the United States, but only approximately 25 percent of biopsyprocedures performed detect the presence of cancer.

 

The treatment path for patients who test positive forprostate cancer depends on many variables, including age, location andpathology of the cancerous tissue and general health of the patient.  Generally, a younger, otherwise healthypatient will elect to have the prostate removed to eliminate the possibilitythat it might spread beyond the prostate. Older, less healthy patients may elect not to undergo surgery, andinstead monitor the disease closely by semi-annual PSA and DRE exams, andannual biopsies.  This monitoring regimenis commonly referred to as “active surveillance.”  Some patients may elect radiation or drugtreatments, in addition to necessary ongoing active surveillance.  The National Cancer Institute estimates thatapproximately 186,320 men in the United States will be diagnosed with prostatecancer in 2008 and there are approximately 2 million men alive who have ahistory of cancer of the prostate.  Onthis basis, we estimate that the number of men over the last decade that haveelected against prostate removal and thus are undergoing ongoing active surveillanceexceeds one million.

 

***System Development History and Development Partners***

 

The ProUroScanTM system is based on workoriginally performed in the late 1990’s by Artann and ArMed LLC.  In 2002, we licensed the rights to thistechnology, and have worked with Artann and our other technology-based partnerson its development.  Artann is a scientifictechnology company focused on early-stage technology development.

 

Much of the ProUroScanTM system’sdevelopment to date has been accomplished under two development agreementsbetween the Company and Artann. Under the first agreement, the “DevelopmentAgreement,” Artann developed two working, pre-clinical ProUroScanTMsystems.  These development-level systemswere delivered to us in November 2004.

 

Under the second agreement, the “Research andDevelopment Agreement,” Artann was named a research and development partner tothe Company, supporting the further development of the ProUroScanTMsystem and other to-be-determined technologies in the urologic field.  Any intellectual property and know-howresulting from the advancement of the ProUroScanTM system under theResearch and Development Agreement was to be assigned to the Company.

 

In September 2006, Artann was awarded a Small BusinessInnovation Research Phase II Competitive Renewal grant from the National CancerInstitute. The aim of the grant is to help commercialize our ProUroScanTMsystem.  The three-year grant willprovide up to $3 million for development of the ProUroScanTM system,effective September 29, 2006.  It isour intent to work with Artann under this grant, and to expand our workingrelationship with Artann to include their participation in the development andlicensing of future generations of the ProUroScanTM system.

 

On April 16, 2007, we entered into acooperation agreement with Artann in which the parties agreed to terminatetheir existing Research and Development Agreement and to use their best effortsto finalize a new development agreement. The cooperation agreement establishesa platform for joint cooperation in establishing the new development agreement,which will define a process for the joint development of a next generationprostate mechanical imaging system with enhanced functionalities.  The cooperation agreement terminates the Researchand Development Agreement, and releases each party from all undischargedobligations and liabilities under that agreement.  We are currently in active negotiations withArtann to enter into a development and licensing agreement that will provide the foundation for futuredevelopment of the ProUroScanTM system.

 

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We expect to engage a third-party to assist us andArtann in transferring technology from research and development to clinicalstudy status, place design documentation under an FDA compliant quality controlsystem, complete the design documentation required to submit an FDA request forproduct clearance, perform verification and validation testing includingcertification of safety related testing standards and develop quality controlprocesses for transfer to manufacturing.

 

***Key Licensing Activities***

 

Welicense from third parties intellectual properties essential to ourbusiness.  The significant intellectualproperty rights we license related to our ProUroScanTM prostateimaging system, which is the primary focus of our development efforts, includecertain rights from Profile, LLC (“Profile”) that are protected by six U.S.patents (expiring between 2012 and 2021), six foreign patents (expiring in2017) and one foreign patent application.

 

We obtained a license from Profile in 2002 thatprovides for worldwide exclusive rights to its prostate imaging system andrelated patented technology.  The fieldof use for the exclusive license is limited to the diagnosis and treatment ofenlarged prostate, prostatitis, prostate cancer, or other conditions of ordisorders of the prostate, whether healthy or diseased, and any other conditionof urologic disorder which may be diagnosed, imaged, or treated using anydiagnostic or imaging process.  Profile’simaging system was developed by Dr. Armen Sarvazyan, the founder ofArtann, and acquired by Profile after a series of assignments.

 

Artann has filed two additional U.S. patentapplications (filed in May and June of 2005) that build on our basepatents.  These patent applications covera method and device for real-time imaging of the prostate and a method anddual-array transducer probe for real-time mechanical imaging of the prostate.  In our negotiations on a new development andlicensing agreement, Artann has provided us with indications of theirwillingness to grant us exclusive license rights to the two patent applicationsin the field of prostate assessment, as well as related non-patentedtechnology. It is in the interest of Artann and the Company toenter into a mutually beneficial arrangement to use our respective intellectualproperty rights for the development of certain products within the humanprostate assessment field.

 

***Marketing and Distribution***

 

We believe that the cost of establishing a salesforce of sufficient size and capability to effectively rollout the ProUroScanTM system in the U.S. and abroad can be more effectively accomplished byestablishing a distribution relationship with one or more large urology medicaldevice companies.  Establishing such arelationship will not only allow us to quickly and effectively penetrate theurology market, but may also afford us an opportunity for additional financialsupport in the form of licensing fees, equity investment and “in kind” supportfrom other key functional departments of the licensing company.

 

We expect to focus the market rollout of the initialProUroScanTMsystem on urology.  By focusing onurologists, we expect to establish the economic value of the test for patients,physicians and third party payors while demonstrating the system’s clinicalefficacy.  We expect that the initialrollout to urologists will require up to two years and will be the primaryfocus of our marketing and sales efforts during this period of time.

 

We expect to develop and introduce a secondgeneration system, capable of identifying the specific location of suspiciouslesions in the prostate in three dimensions, within two years of our initialmarket rollout.  This system will bepresented as an upgrade to the previous system and effectively differentiate itfrom that first generation system.  Atthat time, we expect to redirect sales of the first generation system into thegeneral practice, family practice and internal medicine market segments toallow for expanded prostate cancer screening by these physicians.  Because of the large size (134,000physicians) and the unique characteristics of the family and practice marketsegments, the company will develop a different product positioningstrategy.  We may seek to establish adistribution relationship 

 

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with a second distributor that operates within thesemarket segments. 

 

In both of these market segments, we believe thatthe ProUroScanTM system will become a key part of a new “standard ofcare” that physicians will follow.  Webelieve that we can be competitive in the prostate-imaging market due to ourpatent position and anticipated ability to deliver high-quality imaging andscreening devices and results.

 

***Regulatory Issues***

 

We are currently in the process of developing aseries of labeling basic mapping and data maintenance claims limited to thesystem’s ability to produce a surface map or a record of tissue elasticity measurementstaken from a prostate to aid in documenting the size, shape and volume of theprostate.  We believe that this reflectsthe current needs of the market and the capabilities of the ProUroScanTMsystem.  We are attempting to create aregulatory strategy that will enable us to begin marketing a basic system andthen expand the labeling claims to incorporate more sophisticated features andfunctionalities as they are developed and validated in clinical studies.  This approach is intended to minimize thetime it will take to obtain initial FDA clearance and allow us to begincommercializing an operational system sooner. Having systems in place will also be important in assessing futureenhancements while physicians are using the cleared device in actual clinicalpractice.

 

In addition to the FDA submission, we expect to satisfyrequirements for a Conformité Européene (“CE”) mark, a mark displayedprominently on products indicating compliance with the regulatory directives ofthe European Union.  The CE mark isrequired to market medical products within the European Union.  We will utilize the services of a notifiedbody such as Technischen Überwachungsvereine or Technical InspectionsOrganizations (“TÜV”), a German company that specializes in assessingconformity with the regulatory directives of the European Union, an assessmentthat will be a prerequisite to CE marking of the products.  It is believed the CE mark conformityassessment process will be similar in duration to the FDA 510(k) process,or approximately six months.

 

***Continuing Revenue Stream; Third-Party Reimbursement***

 

In the U.S. and elsewhere, health care providersthat use the ProUroScanTM 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 thesystem.  Consequently, sales of theProUroScanTM system depend in part on the availability of coverageand reimbursement from third-party payors. The manner in which reimbursement is sought and obtained varies basedupon the type of payor involved and the setting in which the procedure isfurnished.  In general, third-partypayors will provide coverage and reimbursement for medically reasonable andnecessary procedures and tests.  Mostpayors, however, will not pay separately for capital equipment, such as theProUroScanTM 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 determining payment rates, third-partypayors increasingly are scrutinizing the amount charged for medicalprocedures.  The services provided inconjunction with the ProUroScanTM system may not be reimbursed bythird-party payors at rates sufficient to allow us to sell our products on acompetitive and profitable basis.

 

In addition, in many foreign markets, including the countries in theEuropean Union, pricing of medical services and procedures is subject togovernmental control. In the United States, there have been, and we expect thatthere will continue to be, a number of federal and state proposals to limitpayments by governmental payors for medical services and procedures. Althoughwe cannot predict whether such legislative or regulatory proposals will beadopted, the adoption of such proposals could have a material adverse effect onour business, financial condition and profitability.

 

*Medicare and Medicaid*

 

The Medicare program is a federal health benefit program administeredby the Centers for Medicare and Medicaid Services (CMS) that covers and paysfor certain medical care items and services for eligible elderly, blind, anddisabled 

 

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individuals, and individuals with end stage renal disease. The Medicaidprogram is a federal-state partnership under which states receive matchingfederal payments to fund healthcare services for the poor. Because theincidence of prostate cancer and BPH increases with age, we expect that asignificant percentage of our patients will be Medicare beneficiaries.  Because some private commercial healthinsurers and some state Medicaid programs may follow the coverage and paymentpolicies for Medicare, Medicare’s coverage and payment policies are verysignificant to our business.

 

As described in depth above, procedures using the ProUroScanTMsystem may be considered by Medicare as either a screening test or a diagnostictest depending on whether it is conducted routinely on healthy individuals orwhether the patient presents with a sign or symptom of the relevantdisease.  In order for Medicare to coverprocedures using the ProUroScanTM system as screening, the Secretaryof Health and Human Services (Secretary) would need to add the test to the listof appropriate procedures for prostate cancer screening.  This could be a significant hurdle toovercome.  We anticipate that the firstgeneration of  the ProUroScanTMsystem will be used to produce a surface map or a record of tissue elasticitymeasurements taken from a prostate to aid in documenting the size, shape andvolume of the prostate for men who present with a sign or symptom of prostatecancer or BPH.  Thus, providers whoperform prostate mapping using the first generation ProUroScanTMsystem likely will seek Medicare coverage as a diagnostic, rather than ascreening test.

 

Regardless of how they are covered, we anticipate that procedures usingthe ProUroScanTM system will be reimbursed either based upon thevalue of their unique billing and procedure code or as part of an officevisit.  Until a unique billing andprocedure code is established, we expect that providers will be able to bill for theprocedure using a miscellaneous Current Procedural Terminology (CPT) code.  Claims submitted under a miscellaneous codeare processed manually and include a special report to be used in determiningthe medical appropriateness of the procedure. The lack of a unique, permanent CPT code could slow market uptake of theProUroScanTM system.

 

In order to apply for a new, unique code, anapplication must be submitted to the American Medical Association’s (AMA) CPTEditorial Panel.  The process ofobtaining a new CPT code typically takes 14 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 whenestablishing the Medicare Physician Fee Schedule values.  The amount of reimbursement the providerreceives generally depends on the RVUs assigned to the procedure multiplied bya conversion factor.  Most private payersalso base their payment rates based on the RVUs adopted by CMS. There is asignificant risk that the reimbursement rate that results from this processcould be insufficient, hampering our ability to market and sell the ProUroScanTMsystem.  In the alternative, CMS maydecide that payment for the ProUroScanTM system procedure should bebundled into the payment for a covered office visit furnished to the patient onthe same day.   Such a determinationwould impede our ability to commercialize the ProUroScanTM system asphysicians and providers would probably not want to absorb the additionalexpense of our product without additional reimbursement.

 

We anticipate that the majority of our revenue generatedby the ProUroScanTM system will come from per test usage fees andthe sale of proprietary disposable supplies consumed in the testingprocess.  Revenues will also be generatedfrom the sales and leases of the ProUroScanTM systems.  The ProUroScanTM systems likelywill be placed in clinics under a variety of programs, including outrightsales, operating leases, financing leases or placements paid for by premiumspaid on the usage of the system.

 

Initially, we anticipate using a “patient pay model” for physicians to receive paymentfor performing the ProUroScanTM system procedure.  Under a patient pay model, in the absence ofcoverage from their health insurance, patients pay for the test out of theirown funds.  Medicare beneficiaries wouldsign an Advanced Beneficiary Notice (ABN) that would allow the provider tocollect from the patient.  This approachwas recommended by our reimbursement consultant based on the perceived value ofthe test, particularly for patients who have an abnormal DRE or PSA value.  Only one in four biopsies performed based onan abnormal PSA reading reveal prostate cancer, and only 50 percent ofsuspicious lesions found by DRE presented cancer on prostate biopsy. Giventhese statistics, 

 

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in cases where patients have abnormal DRE or PSAtest results or when a test result may not be clear, there is a high incentiveto seek additional diagnostic inputs so that patients can make an informed andreasonable decision for themselves and their family.  We believe that a sufficient number ofpatients will be willing to pay for the ProUroScanTM systemprocedure out of their personal funds to support the launch of our product inadvance of receiving favorable coverage decisions from third-partyinsurers.  The concept of a patient paymodel has been used successfully for a few other procedures (e.g.,computer-aided detection (CAD) for mammography), and we expect this to be our approachfor generating revenues during at least the early phases of productrollout.  As described above, providersalso will be able to bill under a miscellaneous CPT code until a unique CPTcode is created for the ProUroScanTM system procedure.

 

*Commercial Insurers*

 

Many private payors look to Medicare as a guideline in setting theircoverage policies and payment amounts. Unlike the Medicare program, however,private payors have no statutory impediment to covering screening tests.  The current coverage policies of theseprivate payors may differ from the Medicare program, and the payment rates theymake may 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.

 

***Industry and Competition***

 

We are not aware of any competitive productcurrently being sold based on the same technological features as the ProUroScanTMsystem.  Nonetheless, we expectcompetition to intensify in the prostate imaging and prostate diseasediagnostic market.

 

We do not expect to market the ProUroScanTM system as a general screening tool, and therefore will not bepositioning the system to compete directly with currently available screeningtests, including the DRE and PSA tests. Our strategy is to position our system as “adjunctive” to confirm theresults of these tests and identify the precise location of abnormal tissue, inan effort to increase the overall accuracy of prostate cancer detection.  However, because the system will be used in amanner similar to DRE and PSA, some physicians may initially perceive it to bein competition with these screening tests. Some period of market education may be required to differentiate oursystem and demonstrate how it can be used adjunctively to improve diagnosis andoutcomes.

 

In contrast to the DRE, the ProUroScanTM system creates a visual and physical record of where abnormal tissueexists in the prostate gland.  It canalso be used to conduct ongoing monitoring and surveillance of the status ofthe abnormal tissue that is found by either DRE or with the ProUroScanTM system.  In terms of conducting aphysician assessment of the prostate gland to detect abnormalities, we believethat the ProUroScanTMhas several advantages over a traditional DRE examination.  They include:

 

·                  it will be more sensitive and able to detect smaller nodules or tissue abnormalities on the surface of the prostate;

 

·                  it will be less affected by anatomic anomalies or obesity that now prevents physicians from fully palpating the prostate in a significant percentage of their patients;

 

·                  it will produce a real-time color image of the prostate;

 

·                  it will enable physicians to electronically store and compare the test results in patient files; and

 

·                  the test will be standardized, minimizing the differences in technique and experience of clinicians.

 

We believe that the ProUroScanTM system’s capability is limited to the examination of the prostate, and will not detect other conditions unrelated to the prostate that a physician may detect in the course of a standard DRE, such as internal 

 

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hemorrhoids, rectal cancer, stenosis (narrowing of the rectum), and atypical sphincter tone that may suggest neurological pathology.

 

The primary advantage of the ProUroScanTM system over the PSA and related tests is that it creates an actual image of the prostate, showing the physical presence and location of abnormal tissue formations.  By comparison, the PSA test is used to detect and quantify Prostate Specific Antigen, and can only infer the potential presence of prostate cancer.  An elevated PSA result does not necessarily mean a patient has prostate cancer, nor does a normal PSA mean a patient does not have prostate cancer (see “***Prostate Cancer Screening, Diagnosis and Treatment”*** above)***.***  Some diagnostics companies are working to develop tests with improved sensitivity and specificity to reduce the number of false positives and false negatives that are recorded.  Improvements in PSA testing should be viewed positively because the use of this test in conjunction with a physical assessment of the prostate using the ProUroScanTM system will enhance the overall capabilities of physicians to detect early stage prostate cancer.

 

Another test that uses inferred data to identify prostate cancer, yet to be approved in the United States, is the PCA3 Marker (the (PCA3”).  The PCA3 is a non-coding ribonucleic acid (“RNA”) believed to be a more accurate marker of prostate cancer than currently used diagnostics tests.  The PCA3 marker was licensed in 2000 by DiagnoCure Inc. of Quebec, Canada.  In 2003, DiagnoCure granted a worldwide license to Gen-Probe (San Diego, CA) for the development and licensing of a second generation PCA3-based test using their proprietary platform.  In 2006, Gen-Probe made the test available in analyte specific reagent format to 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 potentially represents a significant advance in the development of more sophisticated and sensitive detection methods for identifying early stage prostate cancer.    Gene fusion is another discovery that may lead to a test that potentially will be used to diagnose prostate cancer more accurately than current tests as well as predict prognosis.  Gen-Probe has licensed this technology too.

 

The key for patients and physicians is to have multiple and complementary detection approaches that can be used in combination with each other to enhance the overall scope and accuracy of the clinical findings.  Experts in the field have stressed that it is important to have both chemical *and* physical assessment tools so that the early stages of the disease can be detected, and assessments made of the physical position and progression of the disease over time.  Using the ProUroScanTM system in combination with an accurate chemical test should result in more patients with the disease being identified more accurately in a timely manner and the number of false positive reduced, minimizing the number of unnecessary biopsies.

 

Aside from large-scale imaging modalities such as magnetic resonance imaging, computed tomography and nuclear medicine, which due to their cost and limited availability will not be directly competitors of the ProUroScanTM system, the only imaging system in common use for prostates is the transrectal ultrasound (“TRUS”).  TRUS is primarily used to guide prostate biopsy to determine if cancer exists.  It is employed by urologists following the referral of a patient that has had a positive result from a DRE or PSA.  TRUS is not considered a primary screening tool by the American Urologic Association and is more costly and difficult to operate for most physicians.  We believe that the ProUroScanTM system will be much easier to operate and require significantly less training.  We also believe it will be less costly to acquire and maintain in a traditional medical office setting.  The ProUroScanTM also provides a permanent record that can be used to identify changes over time.  Nevertheless, technology is rapidly changing in the prostate imaging and the prostate disease diagnostic market, and other technology could come to market potentially displacing the ProUroScanTM system.

 

***Other Technology Licensed by the Company***

 

Wealso hold licenses for potential future products that are not the current focusof our development efforts.  Theseintellectual property rights include:

 

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Electrical Impedance Tomography (“EIT”) Technology

 

We have licensed rights for urologic applications ofEIT technology from RPI, for use in an imaging technology that measuresconductivity or resistivity in the body during thermal or cryotherapy treatmentprocedures.  In late 2005, we began ajoint development effort with Urologix, Inc. (“Urologix”) on our first EITproduct at RPI, pursuant to a July 2005 agreement. The parties expectedthe joint development project to involve several phases of research, testingand development, for which they would share equally in the costs of the workperformed. After completing Phase I of the development program in September 2006,it was determined that an assessment of certain key factors affecting thecompatibility of our EIT technology with Urologix’ equipment would be requiredbefore proceeding with Phase II.

 

On March 20, 2007, we executed an amendment tothe Urologix agreement to postpone any decision regarding the continuance ofthe remaining phases contemplated under the agreement, and gave each party theright to abandon the project for any reason with 5 days’ notice to theother.  To date, the agreement is stilleffective and neither party has given notice of cancellation.  We plan to conduct research related to thecompatibility issues if and when sufficient funding becomes available before adecision is made to move to Phase II of the program.

 

We have temporarily suspended payment of the minimumlicensing fees required by the RPI license agreement to maintain exclusiverights to the technology, but we do retain non-exclusive rights as long as thelicense agreement remains in effect. Under the terms of the license, as amended in July 2005, thelicense terminates if no licensed product is available for sale by July 13,2009.  We believe that due to theadditional project work required it is unlikely this deadline will beachieved.  If we are unsuccessful inrenegotiating or obtaining sufficient funds to continue development of thistechnology, resolving the key project factors noted above, or negotiating anextension of the RPI license, the development efforts with Urologix may beterminated, and we may abandon the EIT technology.

 

Directed Microwave Thermal Therapy for Treatment of BPH

 

We have also licensed certain rights from CS Medical Technology LLCassociated with minimally invasive microwave therapy for the treatment ofprostate disease, protected by five U.S. patents (expiring between 2009 and2019) and one foreign patent application.

 

Wedo not expect to fund any development of these technologies in the near future,and the abandonment or loss of our rights to these technologies will not have amaterial adverse effect on our business. Our rights and obligations underthe licenses from Profile, RPI and CS Medical are more fully described below.

 

***Intellectual Property***

 

Our objective as a medical device company is toeffectively and aggressively obtain, maintain and enforce patent protection forour products, formulations, processes, methods and other proprietarytechnologies, preserve our trade secrets and licenses, and operate withoutinfringing the proprietary rights of other parties both in the United Statesand in all other countries where we may do business.  Our policy is to actively seek to obtain,where appropriate, 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 have, to date, licensed the rights to 19U.S. patents and two U.S. patent applications. In addition, we have licensed rights to seven patents and seven patentapplications in Japan and several European countries.

 

We also depend upon the skills, knowledge andexperience of scientific and technical personnel that we hire or contract withoutside organizations, as well as our advisors and consultants.   To help protect our proprietary know-howthat is not patentable, and for inventions for which patents may be difficultto enforce, we rely on trade-secret 

 

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protection and confidentiality agreements.  To this end, we require all employees,consultants, advisors and other contractors to enter into confidentialityagreements that prohibit the disclosure of confidential information and, whereapplicable, require disclosure and assignment to us of the ideas, developments,discoveries and inventions important to our business.

 

We license from third parties various intellectual properties essential to our business.  The key intellectual property rights we license in relation to the ProUroScanTM consists of certain rights associated with prostate-imaging systems and related patented technology, from Profile. These rights are limited to the field of use of the diagnosis and treatment of enlarged prostate, prostatitis, prostate cancer, or other conditions of or disorders of the prostate, whether healthy or diseased, and any other condition of urologic disorder which may be diagnosed, imaged, or treated using any diagnostic or imaging process.  These rights include the rights to patents covering a method and device for elasticity imaging (patent expires in 2012), an apparatus for measuring mechanical parameters of the prostate and for imaging the prostate (patent expires in 2017), a device for palpation and mechanical imaging of the prostate (patent expires in 2019), real-time mechanical imaging of the prostate (patent expires in 2021), and a method for using a transrectal probe to mechanically image the prostate gland (patent expires in 2017).  Together, the technology licensed from Profile is protected by six U.S. patents, seven foreign patents (foreign patents expire in 2017), six foreign patent applications and, along with the Artann patent applications discussed below, is the basis for the imaging technology used in our ProUroScanTM system.  The license requires that we report our development activities to Profile each year and to pay for ongoing patent prosecution and maintenance costs.  The license requires no specific expenditure level to remain in force.

 

In connection with our current negotiations withArtann  to enter into a definitivedevelopment and licensing agreement, Artann has provided us with indications of their willingness to grant us exclusivelicense rights in the field of prostate assessment to two U.S. patentapplications (filed in May and June of 2005) associated withprostate-imaging systems and related non-patented technology.  These patent applications cover a method anddevice for real-time imaging of the prostate and a method and dual-arraytransducer probe for real-time mechanical imaging of the prostate.

 

Other intellectual property rights we possess, but are not currently developing, include:

 

·                  Certain rights associated with EIT imaging systems and related patented technology from RPI, including rights to processes for producing optimal current patterns for EIT (patent expires 2014) and a process and apparatus for distinguishing conductivities by electric computed tomography (patent expires in 2010).  Together, the methods covered by eight U.S. patents licensed from RPI (patents expire between 2010 and 2014) are the basis for the vision system portion of our proposed focused-beam microwave therapy product.  This license terminates if no licensed product is available for sale by July 13, 2009. In addition, if we cease to carry on our business, the RPI license agreement will terminate immediately.

 

We have undertaken a product development effort in conjunction with Urologix as fully described above under the caption “Electrical Impedance Tomography (“EIT”) Technology.”  We believe that due to the additional project work required it is unlikely this deadline will be achieved.  Although we believe that we will be able to successfully negotiate an extension of this deadline with RPI, we cannot give assurance of this.  If we are unsuccessful in obtaining sufficient funds to continue development of this technology, resolving the key project factors noted above, or negotiating an extension of the RPI license, the development efforts with Urologix may be terminated, and we may abandon the EIT technology.

 

·                  Certain rights associated with minimally invasive microwave therapy for the treatment o prostate disease from CS Medical.  These rights are limited to the field of use of the treatment of BPH, prostatitis, prostate cancer, or any other conditions of urologic disorder which may be diagnosed, imaged or treated using a catheter-based microwave technology or sensor imaging.  The rights include rights to two patents covering medical hyperthermia

 

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treatment and diagnosis using microwave devices (patents for both of which expire in 2019), microwave balloon angioplasty (patent expires 2009), and a microwave heat pipe array for hyperthermia (patent expires 2019).  We also have rights to a patent application for treatment of prostatic tissue that are pending in Europe.  Together, the five U.S. patents (expiration dates between 2007 and 2019) and one foreign patent application licensed from CS Medical is the basis for our proposed focused-beam microwave therapy product.  This license requires that we report our development activities to CS Medical each year, but requires no specific level of development expenditures.

 

***Manufacturing***

 

The ProUroCare system has two major proprietaryhardware components: a central processor and a rectal probe.  There are also certain off-the-shelfcomponents that are widely available.  Weintend for pre-clinical systems to be produced by Artann as part of the plannedproduct development program.

 

We expect to engage Quality System Regulation (“QSR”)compliant contract manufacturers to produce the proprietary components.  QSR requires manufacturers,including third-party manufacturers, to follow stringent design, testing,control, documentation and other quality assurance procedures during allaspects of the manufacturing process.  Because of the unique nature of the two majorproprietary components, it is highly likely that different manufactures wouldbe chosen to design, document and assemble the final versions of eachcomponent.  Our goal in both cases is toreduce the cost of manufacturing significantly over the first two years, takingadvantage of rapidly increasing manufacturing scale and large quantitypurchasing discounts, as well as engineering changes designed to eliminatecomponents and reduce component costs. We also anticipate working jointly with other development andmanufacturing companies to bring the cost of the equipment to the lowest costpossible.  It is possible, depending onwho our eventual distribution partner is and what their capabilities are, thatmanufacturing may be performed by them as part of our overall strategic relationship.(see “***Marketing and Distribution,”***above).

 

This approach to manufacturing also carries certainbusiness risks, including the risk that contract manufacturers may be unable tosupply our products in the required quantities, at appropriate quality levelsor at acceptable costs.  We may beadversely affected by any difficulties encountered by such third-partymanufacturers that result in product defects, production delays or theinability to fulfill orders on a timely basis.

 

***Government Regulation***

 

The proposed products we intend to develop, and marketare subject to the Federal Food, Drug, and Cosmetic Act (“FDCA”) asimplemented and enforced by the FDA andby comparable agencies in various states and various foreign countries.  To ensure that medical productsdistributed domestically and internationally are safe and effective for theirintended use, FDA and comparable authorities in other countries have imposedregulations that govern, among other things, the following activities that weor our contract manufacturers and suppliers perform or will perform:

 

·                  product design anddevelopment;

 

·                  product testing;

 

·                  product manufacturing;

 

·                  product labeling;

 

·                  product storage;

 

·                  premarket clearance orapproval;

 

·                  advertising and promotion;

 

·                  product marketing, sales anddistribution; and

 

·                  post-market surveillancereporting death or serious injuries and medical device reporting.

 

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FDAPremarket Clearance and Approval Requirements

 

Unlessan exemption applies, each medical device we wish to commercially distribute inthe U.S. will require either premarket notification (“510(k)”) clearance orapproval of a premarket approval application (“PMA”) from the FDA.  The FDA classifies medical devices into oneof three classes:

 

·Class I devices, which are subject to only general controls (e.g.,labeling, medical devices reporting, and prohibitions against adulteration andmisbranding) and, in some cases, to the 510(k) premarket clearancerequirements;

 

·Class II devices, generally requiring 510(k) premarket clearancebefore they may be commercially marketed in the United States (we believe theProUroScanTM system will be classified as a Class II device);and

 

·Class III devices, consisting of devices deemed by the FDA to pose thegreatest risk, such as life-sustaining, life-supporting or implantable devices,or devices deemed not substantially equivalent to a predicate device, generallyrequiring submission of a PMA supported by clinical trial data.

 

Devicesdeemed to pose lower risks are placed in either Class I or II, whichtypically requires the manufacturer to submit to the FDA a premarketnotification requesting permission to commercially distribute the device.  This process is generally known as 510(k) clearance.  Some low risk devices are exempted from thisrequirement.  Devices deemed by the FDAto pose the greatest risks are placed in Class III, requiring approval ofa PMA.

 

510(k) ClearancePathway

 

Whena 510(k) clearance is required, we must submit a premarket notificationdemonstrating that our proposed device is substantially equivalent to apreviously cleared 510(k) device or a device that was in commercialdistribution before May 28, 1976 for which the FDA has not yet called forthe submission of PMAs.  By regulation,the FDA is required to clear or deny a 510(k) premarket notificationwithin 90 days of submission of the application. As a practical matter,clearance may take longer.  The FDA mayrequire further information, including clinical data, to make a determinationregarding substantial equivalence.

 

Once filed, the FDA has 90 days in which to reviewthe 510(k) application and respond. Typically, the FDA’s response after reviewing a 510(k) is a requestfor additional data or clarification. Depending on the complexity of the application and the amount of datarequired, the process may be lengthened by several months or more.  If additional data is needed to support ourclaims, the 510(k) application process may be significantlylengthened.  Published FDA statisticsfrom 2004 (the most recent available) indicate that the average total time fromreceipt of a 510(k) application to final action (not including the time asubmission is on hold pending receipt of additional information) is 100 days,with 65 percent completed within 90 days.

 

If the FDA issues an order declaringthe device to be Not Substantially Equivalent (“NSE”) and places it into a Class IIIor PMA category, we can then request a de novo classification of theproduct.  De novo generally applies wherethere is no predicate device and the FDA believes the device is sufficientlysafe so that no PMA should be required. The request must be in writing and sent within 30 days from the receiptof the NSE determination.  The requestshould include a description of the device, labeling for the device, reasonsfor the recommended classification and information to support therecommendation.  The de novo process hasa 60 day review period.  If the FDAclassifies the device into Class II, the Company will then receive anapproval order to market the device. This device type can then be used as apredicate device for future 510(k) submissions. However, if the FDAsubsequently determines that the device will remain in the Class IIIcategory, the device cannot be marketed until the Company has obtained anapproved PMA.  If we are required tofollow a de novo process, an additional 60 to 90 days or more will be added onto the original 90 days required for the initial 510(k) review.

 

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Anymodification to a 510(k)-cleared device that would constitute a major change inits intended use, or any change that could significantly affect the safety oreffectiveness of the device, requires a new 510(k) clearance and may even,in some circumstances, require a PMA, if the change raises complex or novelscientific issues or the product has a new intended use.  The FDA requires every manufacturer to makethe determination regarding the need for a new 510(k) submission in thefirst instance, but the FDA may review any manufacturer’s decision.  If the FDA were to disagree with any of ourdeterminations that changes did not require a new 510(k), it could require usto cease marketing and distribution and/or recall the modified device until 510(k) clearanceor PMA approval is obtained.  If the FDArequires us to seek 510(k) clearance or PMA approval for anymodifications, we may be required to cease marketing and/or recall the modifieddevice, if already in distribution, until 510(k) clearance or PMA approvalis obtained and we could be subject to significant regulatory fines orpenalties.

 

Thereis no guarantee that the FDA will grant 510(k) clearance or PMA approvalof our products and failure to obtain necessary clearances or approvals for ourcurrent or future products could adversely affect our ability to grow ourbusiness.  Delays in receipt or failureto receive clearances or approvals, the loss of previously received clearancesor approvals, or the failure to comply with existing or future regulatoryrequirements could have a material adverse effect on our business.

 

PremarketApproval (PMA) Pathway

 

APMA must be submitted to the FDA if the device cannot be cleared through the510(k) process.  A PMA must besupported 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.  No device that we are marketing todate has required premarket approval. During the review period, the FDA will typically request additionalinformation or clarification of the information already provided.  Also, an advisory panel of experts fromoutside the FDA may be convened to review and evaluate the application andprovide recommendations to the FDA as to the approvability of the device.  The FDA may or may not accept the panel’srecommendation. In addition, the FDA will generally conduct a pre-approvalinspection of the manufacturing facility or facilities to ensure compliancewith the QSRs.

 

NewPMAs or PMA supplements are required for modifications that affect the safetyor effectiveness of the device, including, for example, certain types ofmodifications to the device’s indication 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 FDA will grant PMA approval of ourproducts and failure to obtain necessary approvals for our current or futureproducts would adversely affect our ability to grow our business.  Delays in receipt or failure to receiveapprovals, the loss of previously received approvals, or the failure to complywith existing or future regulatory requirements could reduce our sales,profitability and future growth prospects.

 

Clinical Trials

 

Clinical trials are generally required to support a PMA application and are sometimes required for 510(k) clearance.  If the device presents a “significant risk,” as defined by the FDA, to human health, the FDA requires the device sponsor to file an investigational device exemption, or IDE, application with the FDA and obtain IDE approval prior to commencing the human clinical trials.  Such trials generally require an IDE application approved in advance by the FDA for a specified number of patients and study sites, unless the product is deemed a non-significant risk device eligible for more abbreviated IDE requirements.  Clinical trials are subject to extensive monitoring, recordkeeping and reporting requirements. Clinical trials must be conducted under the oversight of an institutional review board (“IRB”) for the relevant clinical trial sites and must comply with FDA regulations, including but not limited to those relating to good clinical practices.  To conduct a clinical trial, we also are required to obtain the patients’ informed consent in 

 

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form and substance that complies with both FDA requirements and state and federal privacy and human subject protection regulations. We, the FDA 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 anticipated benefits.  Even if a trial is completed, the results of clinical testing may not adequately demonstrate the safety and efficacy of the device or may otherwise not be sufficient to obtain FDA approval to market the product in the U.S.  Similarly, in Europe the clinical study must be approved by a local ethics committee and in some cases, including studies with high-risk devices, by the ministry of health in the applicable country.

 

Pervasiveand Continuing Regulation

 

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

 

·                  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 one of our cleared devices;

 

·                  approval of product modifications that affectthe safety or effectiveness of one 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;

 

·                  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;

 

·                  regulations pertaining to voluntary recalls;and

 

·                  notices of corrections or removals.

 

Advertisingand promotion of medical devices, in addition to being regulated by the FDA,are also regulated by the Federal Trade Commission and by state regulatory andenforcement authorities.  Recently,promotional activities for FDA-regulated products of other companies have beenthe subject of enforcement action brought under healthcare reimbursement lawsand consumer protection statutes.  Inaddition, under the federal Lanham Act and similar state laws, competitors and otherscan initiate litigation relating to advertising claims.  In addition, we are required to meetregulatory requirements in countries outside the U.S., which can change rapidlywith relatively short notice.   If theFDA determines that our promotional materials or training constitutes promotionof an unapproved use, it could request that we modify our training orpromotional materials or subject us to regulatory or enforcement actions,including the issuance of an untitled letter, a warning letter, injunction,seizure, civil fine or criminal penalties. It is 

 

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alsopossible that other federal, state or foreign enforcement authorities mighttake action if they consider our promotional or training 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 thatevent, our reputation could be damaged and adoption of the products would beimpaired.

 

Furthermore,our products could be subject to voluntary recall if we or the FDA determine,for any reason, that our products pose a risk of injury or are otherwisedefective.  Moreover, the FDA can order amandatory recall if there is a reasonable probability that our device wouldcause serious adverse health consequences or death.

 

TheFDA has broad post-market and regulatory enforcement powers.  Our facilities and the manufacturingfacilities of our subcontractors will be subject to unannounced inspections bythe FDA to determine our the level compliance with the QSR and otherregulations.  Failure by us or by ourcontract manufacturers and suppliers to comply with applicable regulatoryrequirements can result in enforcement action by the FDA or other regulatoryauthorities, which may result in sanctions including, but not limited to:

 

·                  untitled letters, warning letters, fines,injunctions, consent decrees and civil penalties;

 

·                  unanticipated expenditures to address ordefend such actions

 

·                  customer notifications or repair,replacement, refunds;

 

·                  recall, detention or seizure of our products;

 

·                  operating restrictions or partial suspensionor total shutdown of production;

 

·                  refusing or delaying our requests for 510(k) clearanceor premarket approval of new products or modified products;

 

·                  operating restrictions;

 

·                  withdrawing 510(k) clearances on PMAapprovals that have already been granted;

 

·                  refusal to grant export approval for ourproducts; or

 

·                  criminal prosecution.

 

Inaddition, other government authorities influence the success of our business,including the availability of adequate reimbursement from third-party payors,including government programs such as Medicare and Medicaid.  Medicare and Medicaid reimbursement policiescan also influence corresponding policies of private insurers and managed careproviders, which can further affect our business.

 

Ifthe FDA determines that our promotional materials or training constitutespromotion of an unapproved use, it could request that we modify our training orpromotional materials or subject us to regulatory or enforcement actions,including the issuance of an untitled letter, a warning letter, injunction,seizure, civil fine or criminal penalties. It is also possible that otherfederal, state or foreign enforcement authorities might take action if theyconsider our promotional or training materials to constitute promotion of anunapproved use, which could result in significant fines or penalties underother statutory authorities, such as laws prohibiting false claims forreimbursement. In that event, our reputation could be damaged and adoption ofthe products would be impaired.

 

Regulationof The ProUroScanTM System

 

We believe our initial device willbe regulated by the FDA as a Class II device.  These devices typically are cleared formarketing by the FDA through a 510(k) application.  In order to obtain 510(k) clearance, wemust demonstrate that the ProUroScanTM system is substantiallyequivalent to a previously cleared product, referred to as a “predicate device.”  A device is substantially equivalent if ithas (a) the same intended use, and (b) either the same technologicalcharacteristics as a predicate device, or different technologicalcharacteristics, but is shown to be as safe and effective 

 

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as the predicate device.

 

In general, the data required to prove substantialequivalence in a 510(k) application is easier to collect than the safetyand efficacy data required for a PMA.  Inthe case of the ProUroScanTM system, much of the supporting datawill be gathered during the product-development phase, but clinical data likelywill be required.

 

We are currently in the process of developing abasic mapping and data maintenance claim reflecting the current needs of themarket and the capabilities of the system. Given that the system will be capable of providing physicians with anumber of different outputs, we are attempting to create a regulatory strategythat will enable us to begin marketing a basic system and then expand thelabeling claims to incorporate more sophisticated features as they aredeveloped and validated in clinical studies. The advantage of this approach is that it allows us to minimize the timeit will take to obtain an initial FDA approval and begin commercializing anoperational system.

 

Although the initial claim has yet to be finalized,the content of the claim will likely be limited to the system’s ability toproduce a surface map or a record of tissue elasticity measurements taken froma prostate to aid in documenting the size, shape and volume of the prostate.  Based on the scope of this claim and thepreliminary input received from consultants and clinical study sites, webelieve the initial system can be submitted to the FDA for market clearanceunder a 510(k) application.

 

We intend to conduct a small scale clinical trial tosupport our 510(k) submission for the basic mapping and data maintenanceclaim.  When system development has beencompleted, we will begin placing ProUroScanTM systems in a selectnumber of major medical centers to screen patients and collect data for theclinical study.  The actualnumber of patients that will be studied and the specific clinical protocol thatwill be followed will be significantly determined at a pre-InvestigationalDevice Exemption meeting that we anticipate having with the FDA in the firsthalf of 2008, prior to conducting clinical trials.  At that meeting, we will present informationabout the product and all relevant laboratory testing data.  We will also propose a strategy forvalidating our labeling claim and will present a clinical protocol that allinvestigative centers will be expected to follow, with the goal being to obtainenough clinical data to have sufficient confidence that the ProUroScanTMsystem will perform as defined in the product labeling.

 

It is anticipated that the FDAclinical study will require approximately three months to complete, and that anadditional month will be needed to analyze the data and prepare a formalsubmission to the agency.  As we believethat our clinical trial will be a non-significant risk device study, FDAapproval will not be required.  However,centers participating in the study will be required to obtain approval fromtheir IRB to protect the rights and welfare of all participants.  IRB approval has been granted for the firstProUroScanTM system studies at the Veteran’s Administration MedicalCenter in Minneapolis, Minnesota and at the Robert Wood Johnson UniversityHospital in New Brunswick, New Jersey. As new and more enhanced product features are developed, the Companyplans to file additional submissions with the FDA and to obtain expandedlabeling claims.  Depending on the exactnature of these claims, the approval process may require more extensiveclinical studies and possibly a PMA application.

 

Our clinical investigations will follow theapplicable FDA IDE regulations, including the requirements of informed consentand IRBs.  Prior to the commencement ofclinical investigations, we will have in place a complete set of standardoperating procedures (“SOP”s) as to clinical monitoring, responsibilities,selecting investigators, selecting monitors, device control, investigatoragreements, records, reports and labeling, among others.  All of these SOPs will conform to applicableFDA regulations.

 

As new and more enhanced product features aredeveloped, we plan to file additional submissions with the FDA and to obtainexpanded labeling claims.  Depending onthe exact nature of these claims, the approval process may require moreextensive clinical studies and possibly a full pre-market approval (“PMA”)application.  Such an application willlikely take significantly more time and be more comprehensive than the 510(k) approvalprocess. Once cleared or approved, the manufacturing, sale and performance ofour products will be subject to the ongoing FDA regulation and inspectionprocesses as described above.

 

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*Fraud and Abuse Laws*

 

Becauseof the significant federal funding involved in Medicare and Medicaid, Congressand the states have enacted, and actively enforce, a number of laws whosepurpose is to eliminate fraud and abuse in federal health care programs.  Once we commercialize the ProUroScanTM system, ourbusiness is subject to compliance with these laws.

 

*Anti-Kickback Statutes and Federal False Claims Act*

 

The federal healthcare programs Anti-Kickback Statute prohibits personsfrom knowingly and willfully soliciting, offering, receiving or providingremuneration, directly or indirectly, in exchange for or to induce either thereferral of an individual, or the furnishing or arranging for a good orservice, for which payment may be made under a federal healthcare program suchas Medicare or Medicaid.  The definitionof “remuneration” has been broadly interpreted to include anything of value,including for example gifts, discounts, the furnishing of free supplies,equipment or services, credit arrangements, payments of cash and waivers ofpayments. Several courts have interpreted the statute’s intent to mean that ifany one purpose of an arrangement involving remuneration is to induce referralsof federal healthcare covered business, the statute has been violated.Penalties for violations include criminal penalties and civil sanctions such asfines, imprisonment and possible exclusion from Medicare, Medicaid and otherfederal healthcare programs. In addition, some kickback allegations have beenclaimed to violate the Federal False Claims Act, discussed in more detailbelow.

 

The Anti-Kickback Statute is broad and prohibits many arrangements andpractices that are lawful in businesses outside of the healthcare industry.Recognizing that the Anti-Kickback Statute is broad and may technicallyprohibit many innocuous or beneficial arrangements, Congress authorized theOffice of Inspector General of the U.S. Department of Health and HumanServices, or OIG, to issue a series of regulations, known as “safe harbors.”  These safe harbors, issued by the OIGbeginning in July 1991, set forth provisions that, if all their applicablerequirements are met, will assure healthcare providers and other parties thatthey will not be prosecuted under the Anti-Kickback Statute. The failure of atransaction or arrangement to fit precisely within one or more safe harborsdoes not necessarily mean that it is illegal or that prosecution will bepursued. However, conduct and business arrangements that do not fully satisfyeach applicable safe harbor may result in increased scrutiny by governmentenforcement authorities such as the OIG.

 

Manystates have adopted laws similar to the Anti-Kickback Statute. Some of thesestate prohibitions apply to referral of patients for healthcare items orservices reimbursed by any source, not only the Medicare and Medicaid programs.Government officials have focused their enforcement efforts on marketing ofhealthcare services and products, among other activities, and recently havebrought cases against companies, and certain sales, marketing and executivepersonnel, for allegedly offering unlawful inducements to potential or existingcustomers in an attempt to procure their business.

 

Another development affecting the healthcare industry is the increaseduse of the federal Civil False Claims Act and, in particular, actions broughtpursuant to the False Claims Act’s “whistleblower” or “qui tam” provisions. TheFalse Claims Act imposes liability on any person or entity who, among otherthings, knowingly presents, or causes to be presented, a false or fraudulentclaim for payment by a federal healthcare program. The qui tam provisions ofthe False Claims Act allow a private individual to bring actions on behalf ofthe federal government alleging that the defendant has submitted a false claimto the federal government and to share in any monetary recovery. In recentyears, the number of suits brought against healthcare providers by privateindividuals has increased dramatically. In addition, various states haveenacted false claim laws analogous to the Civil False Claims Act, although manyof these state laws apply where a claim is submitted to any third-party payorand not merely a federal healthcare program.

 

When an entity is determined to have violated the False Claims Act, itmay be required to pay up to three times the actual damages sustained by thegovernment, plus civil penalties of between $5,500 to $11,000 for each separatefalse 

 

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claim. There are many potential bases for liability under the FalseClaims Act. Liability arises, primarily, when an entity knowingly submits, orcauses another to submit, a false claim for reimbursement to the federalgovernment. The False Claims Act has been used to assert liability on the basisof inadequate care, kickbacks and other improper referrals, and improper use ofMedicare numbers when detailing the provider of services, in addition to themore predictable allegations as to misrepresentations with respect to theservices rendered. In addition, companies have been prosecuted under the FalseClaims Act in connection with alleged off-label promotion of products.  Our future activities relating to thereporting of wholesale or estimated retail prices for our products, thereporting of discount and rebate information and other information affectingfederal, state and third-party reimbursement of our products, and the sale andmarketing of our products, may be subject to scrutiny under these laws. We areunable to predict whether we would be subject to actions under the False ClaimsAct or a similar state law, or the impact of such actions. However, the costsof defending such claims, as well as any sanctions imposed, could significantlyaffect our financial performance.

 

*HIPAA and Other Fraud and Privacy Regulations*

 

Among other things, the Health Insurance Portability and AccountabilityAct of 1996, or HIPAA, created two new federal crimes: healthcare fraud andfalse statements relating to healthcare matters. The HIPAA health care fraudstatute prohibits, among other things, knowingly and willfully executing, orattempting to execute, a scheme to defraud any healthcare benefit program,including private payors. A violation of this statute is a felony and mayresult in fines, imprisonment and/or exclusion from government-sponsoredprograms. The HIPAA false statements statute prohibits, among other things,knowingly and willfully falsifying, concealing or covering up a material factor making 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 the two new federal healthcare crimes,regulations implementing HIPAA also establish uniform standards governing theconduct of certain electronic healthcare transactions and protecting thesecurity and privacy of individually identifiable health information maintainedor transmitted by healthcare providers, health plans and healthcareclearinghouses, which are referred to as “covered entities.” Three standardshave been promulgated under HIPAA’s regulations: the Standards for Privacy ofIndividually Identifiable Health Information, which restrict the use anddisclosure of certain individually identifiable health information, the Standardsfor Electronic Transactions, which establish standards for common healthcaretransactions, such as claims information, plan eligibility, payment informationand the use of electronic signatures, and the Security Standards, which requirecovered entities to implement and maintain certain security measures tosafeguard certain electronic health information. Although we are not a coveredentity and therefore not directly subject to these standards, we expect thatour customers generally will be covered entities and may ask us tocontractually comply with certain aspects of these standards, particularlybecause we expect that the ProUroScanTMsystem****will store patient information and test 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.

 

Inaddition to federal regulations issued under HIPAA, some states have enactedprivacy and security statutes or regulations that, in some cases, are morestringent than those issued under HIPAA. In those cases, it may be necessary tomodify our planned operations and procedures to comply with the more stringentstate laws. If we fail to comply with applicable state laws and regulations, wecould be subject to additional sanctions.

 

**Employees**

** **

We currently have only two employees, and expect toconduct much of our research and development, market research, clinical andregulatory function, and other business operations through the use of a varietyof consultants and medical-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 towardspecific and changing goals during our 

 

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development stage. We anticipate hiring approximately seven additional employees in theareas of engineering, regulatory compliance, marketing and quality controlwithin the next 12 months.  Some or allof these functions may be performed by contracted individuals or consultants asmanagement deems most effective.  Todate, we have conducted our research and development activities related to ouracquired technologies and proposed products on a contract basis with ArtannLaboratories, Inc., Devicix, LLC and Minnetronix, Inc.

 

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**IMPORTANT NOTICES TO INVESTORS; SAFE HARBOR STATEMENT**

 

Statements in this Annual Report on Form 10-KSB which are notpurely historical are forward-looking statements.  These statements with respect to the goals,plan objectives, intentions, expectations, financial condition, results ofoperations, future performance and business of our Company, including, withoutlimitation: (i) our ability to successfully complete all clinical trialsand commercial development of our products and secure all necessary federal andother regulatory approvals to introduce and market our products in the UnitedStates and around the world; (ii) our ability to fund our working capitalneeds over the next 12 to 24 months; (iii) our ability to successfullyintroduce our products into the medical device markets; and (iv) allstatements preceded by, followed by or that include the words “may,” “would,” “could,”“should,” “expects,” “projects,” “anticipates,” “believes,” “estimates,” “plans,”“intends,” “targets” or similar expressions.

 

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 2008 and 2009 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 FACTORSASSOCIATED WITH OUR BUSINESS,OPERATIONS AND SECURITIES**

** **

**As a development stage company, we have nooperating history and our business plan has not yet been fully tested.  We anticipate incurring future losses untilour products are completed, regulatory approval is secured and our products areintroduced into the United States and worldwide markets.**

** **

The Company, conducting business through ourwholly-owned subsidiary, ProUroCare Inc., is a development-stage company.  We have yet to commence active operations ormanufacture or sell any products associated with the proprietary urology-basedimaging and therapeutic technologies that we intend to market.  We have no prior operating history from whichto evaluate our success, or our likelihood of success, in operating ourbusiness, generating any revenues or achieving profitability.  As of December 31, 2007, we havegenerated no revenue and have recorded losses since inception of approximately$16.3 million.  We are proposing to enterthe highly competitive urology-based imaging and therapeutic industries.  There can be no assurance that our plans fordeveloping and marketing our urology-based products will be successful, or thatwe will ever attain significant sales or profitability.  We anticipate that we will incur losses inthe near future.

 

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** **

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

 

We have incurred operating losses, accumulateddeficit and negative cash flows from operations since inception.  As of December 31, 2007, we had anaccumulated deficit of approximately $16.3 million.  The Company has not yet generated anyrevenues.  These factors, among others,raise substantial doubt about our ability to continue as a going concern.  Our Consolidated Financial Statementsincluded in this Annual Report do not include any adjustments related torecoverability and classification of asset carrying amounts or the amount andclassification of liabilities that might result should we be unable to continueas a going concern.

 

The Company’s independent registered public accountingfirm included an explanatory paragraph in their report on the Company’sfinancial statements indicating that such deficit accumulated during thedevelopment stage raises substantial doubt as to the Company’s ability tocontinue as a going concern.  Thelikelihood of success of the Company must be considered in light of theexpenses, difficulties and delays frequently encountered in connection withdevelopment stage businesses and the competitive environment in which theCompany will operate.  The Company’sability to achieve profitability is dependent in large part on obtaining FDAclearance for the ProUroScanTMsystem, achieving of third party coverage and reimbursement, gaining marketacceptance of the ProUroScanTM system, establishing distributionchannels and forming relationships with third-party manufacturers.  There can be no assurance that the Companywill successfully market the ProUroScanTM system or operateprofitably.

 

**We are currently in need of financing and will need additional financingduring 2008, and any such financing will likely be dilutive to our existingshareholders.**

 

We do not currently have sufficient funds tocomplete the development of our products and gain approval of them from theFDA.  As of February 29, 2008, wehad approximately $230,000 cash on hand and current liabilities ofapproximately $4.1 million.  We estimatethat we will need approximately $3.5 million of cash over the next 12 months tocomplete the development of a first generation system, submit a premarket notificationapplication to FDA and obtain FDA clearance of a 510(k) for a basiclabeling mapping and data maintenance claim. In addition we have $2.2 million of secured debt and $733,334 ofconvertible debt (both of which mature at the end of February, 2009) and othershort term liabilities exceeding $1,150,000.

 

During the next 12 months, we plan to raiseapproximately $5.1 million through private or public offerings of our debt orequity securities, alternative financing sources that may become available tous, or a combination of these.  Weanticipate that the net proceeds from such financings will be sufficient tofund our operations and retire approximately $700,000 of short termliabilities. We intend to address the $2.2 million secured debt that matures inFebruary, 2009 by seeking an equity investment or licensing fee from astrategic marketing partner, or by seeking an extension of the maturitydates.  We expect that the convertibledebt will be converted into common stock during the next 12 months.  If we are unsuccessful in obtaining an equityinvestment or licensing fee or an extension of the maturity date of the secureddebt, or if the convertible debt is not converted into our common stock, wewill need to raise additional funds.

 

Sources of alternative financing include possiblestrategic investments from medical device companies that may be interested inmarketing products in the prostate cancer detection market.  In addition to financial support, a successfulcollaboration with such a company would allow us to gain access to down streammarketing, manufacturing, and sales support. However, if our financing efforts are unsuccessful or significantlydelayed for any reason, or if our product development efforts experiencesignificant unforeseen delays, we may not have sufficient funds to completethese objectives, and will require additional financing.  There can be no assurance that we will besuccessful in obtaining such financing, if needed.

 

Approximately $2.3 million of our outstandingconvertible debentures will automatically convert into equity upon our closingan underwritten public offering.  Inaddition, to date we have issued a total of 334,000 warrants to date in our2007 and 2008 Private Placements, and additional warrants may be issuedpursuant to our financing efforts.

 

We are attempting to raise enough cash tocomplete the development of a first generation ProUroScanTM system and to seek or obtain FDA clearanceof a 510(k) on a basic mapping and data maintenance claim.  However, if our financing efforts areunsuccessful or significantly delayed for any reason, or if our productdevelopment efforts experience significant unforeseen delays, we may not havesufficient funds to complete these objectives, and will require additionalfinancing.  If additional funds areraised by the issuance of convertible debt or equity securities, such as theissuance of stock, the issuance and exercise of warrants, or the issuance andconversion of convertible debentures, then existing shareholders will experiencedilution 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.

 

 

 

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**Even if we raise enough cash in our financing effortsto complete development of a first generation****ProUroScanTM****system and to obtain FDAclearance of a 510(k) on a basic mapping and data maintenance claim, wewill still require additional financing to launch our product into the market.**

 

Assuming the successful completion of financingefforts and if product development is completed on schedule, we expect topursue one 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, such as the issuanceof stock, the issuance and exercise of warrants, or the issuance and conversionof convertible debentures, then existing shareholders will experience dilutionin 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.

 

**If we are unable to secure a distribution partner for the commerciallaunch of our first generation ProUroScanTM system, we may requireadditional financing to launch our product into the market.**

 

We cannot be sure that we will beable to secure a distribution partner on terms acceptable to us, or atall.  If we fail to establish such arrangementswhen, and as necessary, we could be required to undertake distribution activityat our expense, which could significantly increase our capital requirements andmay delay the commercialization of our products.

 

**If FDA clearance is delayed, including because we arenot able to raise enough funds to get us through the regulatory process, wecould potentially be forced to cease operations.**

 

If adequate funds are not available on a timelybasis, or are not available on acceptable terms, we may be unable to fundexpansion, or to develop or enhance our products.  If we are forced to slow our developmentprograms, or put them on hold, it would delay our efforts to obtain regulatoryclearances or approvals needed, and thus delay market entry for our products.  Ultimately, if no additional financing isobtained beyond what has been secured to date, we 

 

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could potentially be forced to cease operations.

 

**Our assets are pledged to securea $1.2 million senior bank note and a $600,000 note issued to an investor and,as a result, are not available to secure other senior debt financing.  Upon the occurrence of an event of default,our assets will be assigned to guarantors of the senior bank note and theholder of such $600,000 promissory note.**

 

Our $1.2 million senior debt financing through CrownBank, Minneapolis, Minnesota, has required us to pledge all of our assets andcertain licenses, as well as to provide personal guarantees of certain 5%shareholders.  In addition, we haveissued a subordinated promissory note in the amount of $600,000 to aninvestor.  Such note has a subordinatedinterest in all of our assets and certain licenses.  As such, the Company will not be in aposition in the future to pledge its assets to secure any debt or lendingfacility, in the event we desire or need to borrow such funds on a securedlending basis.  It is doubtful that theCompany would be able to obtain financing on an unsecured basis.

 

Moreover, under the terms and conditions of theCrown Bank facility, and our agreement with such guarantors, in the event ofany default by the Company with its senior lender that causes the personalguarantees to be called and honored, the Company and its lender have agreedthat all the Company’s assets shall be assigned to such guarantors, pro rata,in consideration of such breach and obligation to pay under the respectiveguarantees.  In addition, the holder ofthe $600,000 promissory note has a subordinated interest in all of the Company’sassets in the event of a default under the note.  Thus, common shareholders of the Company, andany existing and future investors in the Company’s common stock, would, if theforegoing breach and circumstances occurred, not have access or recourse to theCompany’s assets and collateral, and thus, would likely face a complete loss oftheir investment in the Company.

 

**Our products have not been, and may never be, fully commerciallycompleted and developed.**

 

Only a limited number of complete ProUroScanTMsystems have been built for testing, clinical validations and demonstrationpurposes to assess the feasibility of the device and to provide a means to testand develop future systems. Nevertheless, we have not built any commercial models.  The completion of development of our proposedproducts remains subject to all the risks associated with the development andmanufacture of new products based on innovative technologies, includingunanticipated technical or other problems, failures to meet FDA requirements orperformance objectives and the possible insufficiency of the funds allocatedfor the completion of such development, which could result in a change in thedesign, delay in the development or abandonment of such applications andproducts.  Consequently, there can be noassurance that our products will be successfully developed or manufactured. Ourfailure to complete the development of products will have a materially adverseeffect on our business.

 

**We are relying upon Artann Laboratories, Inc. (“Artann”) to completedevelopment of the ProUroScan**TM**system and will not be able to control the pace of thatdevelopment. ****Failure to establish a newdevelopment and licensing agreement on terms acceptable to the Company wouldsignificantly delay the development and market introduction of the ProUroScanTMsystem and would have a material adverse effect on our business****.**

 

Much of the early development of the ProUroScanTMsystem was accomplished under two development agreements between the Companyand Artann, a scientific technology company focused on early-stage technologydevelopment.  On April 16, 2007, weentered into a cooperation agreement with Artann that establishes a platformfor joint cooperation in establishing a new development agreement, which willdefine a process for the joint development of a next generation prostatemechanical imaging system with enhanced functionalities and the licensing ofthe intellectual property related thereto. We are currently in active negotiations with Artann to enter into adevelopment and licensing agreement that will provide the foundation for futuredevelopment of the ProUroScanTM system, although no assurances canbe given in this regard.  Failure toestablish a new development and licensing agreement on terms acceptable to the Companywould significantly delay the development and market introduction of theProUroScanTM system and would have a material adverse effect on ourbusiness.

 

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**Failure toobtain a license for intellectual properties owned by Artann would have amaterial adverse effect on our business.**

 

Artann has filed two additional U.S. patentapplications (filed in May and June of 2005) that build on our basepatents.  These patent applications covera method and device for real-time imaging of the prostate and a method anddual-array transducer probe for real-time mechanical imaging of the prostate.  In our current negotiations on a newdevelopment and licensing agreement, Artann has provided us with indications oftheir willingness to grant us exclusive license rights to the two patentapplications in the field of prostate assessment , as well as relatednon-patented technology. We are currently in active negotiations with Artann toenter into a development and licensing agreement that will provide thefoundation for future development of the ProUroScanTM system, although**, no assurances can be given in this regard.  Failure to obtain exclusive licenses to theseintellectual properties would have a material adverse effect on our business.**

 

**The commercialization of our products may be significantly delayed bygovernmental regulation and any and all such delays, if they occur, may have amaterial adverse effect on our business.**

 

The proposed products we intend to develop, assembleand market are subject to regulation by the FDA and by comparable agencies incertain states and various foreign countries. The process of complying with the requirements of the FDA and comparableagencies is costly, time consuming and burdensome, especially for apre-revenue, development stage company. Although we have secured the assistance of regulatory consultants tohelp direct our regulatory compliance and filings, we have not yet submitted apremarket notification, or 510(k) application to obtain FDA clearance forour ProUroScanTMsystem and no assurances can be giventhat such filings will be acceptable to the FDA or comparable agencies.

 

We believe the ProUroScanTM system with a basic mapping and data maintenance claim will be regulated by theFDA as a Class II device and will require the clearance of a 510(k) application.  By regulation, the FDA is required to clearor deny a 510(k) premarket notification within 90 days of submission ofthe application, but as a practical matter, clearance may take muchlonger.  In addition, if we are requiredto follow a de novo process, an additional time period will be added on to theinitial 510(k) review.  The *de novo* process is intended to apply to low risk productsthat have been classified as class III because they were found to be notsubstantially equivalent (“NSE”) to any identifiable predicate device during a510(k) review by the FDA. The process allows the recipient of an NSEletter to request a risk-based down classification into Class I or II tobe made by the FDA.  If the FDAdetermines that the product is a class III medical device, it will require thesubmission and approval of a PMA in order for the company top market theproduct in the United States.

 

Thereis no guarantee that the FDA will grant timely 510(k) clearance, if atall, for the ProUroScanTMsystem with basic mapping and datamaintenance claim and failure to obtain necessary clearances orapprovals for our current or future products would have a material adverseeffect on our business.  Further, even if acceptable, we may encountersignificant delays which could have a material adverse effect our business.  In addition, 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.

 

**Even if successfully developed, our products may not be commerciallyviable.**

 

Even if we are able to successfully develop ourproducts, we may not be able to contract for the manufacture in scale of suchproducts in commercial quantities at prices that will be commerciallyviable.  Further, there is risk that ourproducts may not prove to be as effective as currently available medical ordiagnostic products or those developed in the future.  The inability to successfully completedevelopment of a product or application or a determination by us, forfinancial, technical or other reasons not to complete development of anyproduct or application, particularly in instances in which we have madesufficient capital expenditures, could have a material adverse effect on ourbusiness.

 

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**Even if successfully developed, our products may not be accepted by themarketplace.**

 

Our products, even if successfully developed, willbe competing against existing treatments and competing products in the medicaldevice marketplace, including those developed in the future that may render theProUroScanTMsystem obsolete.  Currently available screening methods thatcompete with the ProUroScanTM system include the traditional DRE andthe PSA test. The DRE, in combination with a PSA test, is today’s “standard ofcare” to evaluate patients for prostate cancer or other ailments relating tothe prostate.  In addition, othermodalities that can be used for diagnostic imaging include transrectalultrasound, magnetic resonance imaging, computed tomography and nuclearmedicine.  Therefore, there can be noassurance that physicians, providers, patients, third-party payors or themedical device market, in general, will accept our products.

 

**A failure to successfullyimplement a “patient pay” sales model prior to establishing third partyreimbursement would have a material adverse effect on our product sales andfinancial results.**

 

Until third-party reimbursement coverage for theProUroScanTM system procedure is established, we anticipate using a “patient pay model” forphysicians to receive payment.  Under apatient pay model, in the absence of coverage from their health insurance,patients pay for the test out of their own funds.  We believe that a sufficient number ofpatients will be willing to pay for the ProUroScanTM systemprocedure out of their personal funds to support the launch of our product inadvance of receiving favorable coverage decisions from third-party insurers,but there can be no assurance of this. Any failure to successfully establish a patient pay model would have amaterial adverse effect on our prouct sales and financial results.

 

**Our failure to receivethird-party coverage and reimbursement for our products, when in themarketplace, could result in diminished marketability of our products.**

 

We do not currently receive coverage andreimbursement from any party for the use of our products because we have noproducts fully developed and currently available for sale in themarketplace.  As a result, we have nottaken any steps to obtain approval for coverage and reimbursement for the useof any of our proposed products.  Thesuccess of our future medical device products will materially depend on theability of medical service providers to obtain third-party reimbursement fromprivate and public insurance sources, such as Medicare, Medicaid and variousforeign governments when using our products. It may be difficult to predict the timing and outcome of reimbursementdecisions.  Importantly, there are noassurances that such reimbursement will ever be obtained.

 

Becausethe incidence of prostate cancer and BPH increases with age, we expect that asignificant percentage of our patients will be Medicare beneficiaries.  Obtaining Medicare coverage and reimbursementwill be critical to our success; however, ensuring adequate Medicare reimbursement can be alengthy and expensive endeavor and we cannot provide assurances that we will besuccessful.  In addition, theU.S. Congress may pass laws that impact coverage and reimbursement forhealthcare services, including Medicare reimbursement to physicians andhospitals.   Furthermore, many privatepayors look to Medicare’s coverage and reimbursement policies in setting theircoverage policies and reimbursement amounts. If the Centers for Medicare and Medicaid Services (CMS), the federalagency that administers the Medicare program, or Medicare contractors limitcoverage or payments to physicians for the ProUroScanTMsystem, privatepayors may similarly limit coverage or payments. In addition, statelegislatures may enact laws limiting or otherwise affecting the level of Medicaidreimbursement for procedures using theProUroScanTM system.  As aresult, physicians may not purchase our ProUroScanTMsystem, and ourbusiness and financial results would be adversely affected.

 

Generally, Medicaredoes not cover and pay for items and services that are not reasonable ornecessary for the diagnosis or treatment of illness or injury or to improve thefunctioning of a malformed body member. This means that Medicare does not cover and pay for preventativeservices, including routine screening tests for patients who do not presentwith any signs or symptoms of disease, unless the law specifically provides forsuch coverage.  Such 

 

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statutory coveragecurrently exists for prostate cancer screening tests.  Specifically, the law states that Medicarewill cover a prostate screening test that consists of a DRE and/or a PSA bloodtest provided for the purpose of early detection of prostate cancer to a man over50 years of age who has not had such test during the preceding year.  In addition, the law provides the Secretaryof Health and Human Services (Secretary) the authority to cover other prostatescreening tests based upon changes in technology and standards of medicalpractice, availability, effectiveness, costs and other factors deemedappropriate by the Secretary.  Thus, forthe ProUroScanTM system to receiveMedicare coverage as a prostate screening test, the Secretary would need to addthe test to the list of appropriate procedures for prostate cancerscreening.  This could be a significant hurdle for the ProUroScanTM system to receive Medicare coverage as a prostatescreening test.

 

On the other hand, obtaining Medicare coverage as adiagnostic test is more straightforward. Generally, Medicare covers medically necessary diagnostic tests if apatient presents with a sign or symptom of the disease.  For example, the PSA test is covered as adiagnostic test when used to differentiate benign from malignant disease in menwith lower urinary tract signs and symptoms (e.g., hematuria, slow urinestream, hesitancy, urgency, frequency, nocturia and incontinence) as well aswith patients with palpably abnormal prostate glands on physician exam, and inpatients with other laboratory or imaging studies that suggest the possibilityof a malignant prostate disorder.  Weanticipate that the first generation of the ProUroScanTM system will be used to produce a surface map or arecord of tissue elasticity measurements taken from a prostate to aid indocumenting the size, shape and volume of the prostate for men who present asign or symptom of prostate cancer or BPH. Thus, providers who perform prostate mapping using the firstgeneration ProUroScanTMsystem likely will seek Medicare coverage as a diagnostic, rather than ascreening test.

 

Regardless ofwhether the ProUroScanTMsystem is coveredas a screening tool or a diagnostic test, there is a risk that Medicare andother payors will bundle payment for it into the payment for a covered officevisit furnished to the patient on the same day. For example, Medicare currently bundles billing and payment for a DREinto payment for a covered evaluation and management office visit when the twoservices are furnished to a Medicare beneficiary on the same day.  If the DRE is the only service or is providedas part of an otherwise non-covered service, it may be separately paid if othercoverage requirements are met.  On theother hand, the PSA typically is separately paid as a clinical diagnosticlaboratory service.  Specifically, CMScould determine that due to the ease and short amount of time needed to performthe ProUroScanTM system procedure, separate reimbursement is notwarranted if the physician already is billing an office visit.

 

In order forphysicians and providers who perform procedures using the ProUroScanTM system to receive separate reimbursement,they must bill a Current Procedure Terminology (CPT) code that appropriatelydescribes the service performed.  Although initially physicians and providers will be able to bill amiscellaneous code to submit claims for ProUroScanTM systemprocedures, eventually we will want to apply for a unique CPT code.  The CPT application process is lengthy, andthere is no guarantee that we will receive a unique CPT code or that we willreceive a unique CPT code in a timely manner. Should we receive a unique CPT code, the code is then valued forpurposes of receiving reimbursement by the American Medical Association’sRelative Value Scale Update Committee. The valuation process depends on the amount of time the procedure takesand difficulty of work involved, the practice expense and the malpracticeexpense associated with using the ProUroScanTM system.  CMS then takes the recommendation of thiscommittee into account when establishing the reimbursement amount.  The amount of reimbursement the physicianwill receive generally depends on the values assigned to the various componentsof the procedure multiplied by a conversion factor.  This value is updated annually as part of theMedicare Physician Fee Schedule.  Thereis no guarantee that this process will result in an appropriate level ofreimbursement or an amount that supports the price and revenues we haveprojected.

 

At this time, we donot know the extent to which physicians or providers would consider third-partyreimbursement levels adequate to cover the cost of our products.  Failure by physicians or providers to receivean amount that they consider to be adequate reimbursement could deter them frompurchasing or using our products and limit our sales growth.  In addition, Medicare physician fee schedulepayments may decline over time, which could deter physicians 

 

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from purchasing andusing the ProUroScanTM system.  If physicians or providers are unable to justifythe costs of the ProUroScanTMsystem or they arenot adequately compensated for using our product, they may refuse to purchaseor use them, which would significantly harm our business.

 

Notwithstandingcurrent or future FDA clearances, if granted, third-party payors may denyreimbursement if the payor determines that the ProUroScanTMsystem isunnecessary, inappropriate, not cost-effective or experimental, or is used fora non-approved indication.  Further, allthird-party payors, whether governmental or private, whether inside theU.S. or outside, are developing increasingly sophisticated methods ofcontrolling healthcare costs. These cost control methods include prospectivepayment systems, capitated rates, benefit redesigns, or pre-authorizationrequirements. 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 no assurance that currentlevels of reimbursement will not be decreased or eliminated in the future, orthat future legislation, regulation, or reimbursement policies of third-partypayors will not otherwise adversely affect the demand for the ProUroScanTM system or our ability to sell the ProUroScanTM system on a profitable basis.

 

In internationalmarkets, market acceptance of our ProUroScanTMsystem will likelydepend in large part on the availability of reimbursement within prevailinghealthcare payment systems. Reimbursement and healthcare payment systems ininternational markets vary significantly by country, and by region in somecountries, and include both government-sponsored healthcare and privateinsurance. We may not obtain international reimbursement approvals in a timelymanner, if at all. In addition, even if we do obtain internationalreimbursement approvals, the level of reimbursement may not be enough tocommercially justify expansion of our business into the approving jurisdiction.To the extent we or our customers are unable to obtain coverage orreimbursement for procedures using our technology in major internationalmarkets in which we seek to market and sell our technology, our internationalrevenue growth would be harmed, and our business and results of operationswould be adversely affected.

 

**Once we commercialize the****ProUroScanTM system, w****e maybe subject, 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 notcontrol referrals of healthcare services or bill directly to Medicare, Medicaidor other third-party payors directly, many healthcare laws and regulations willapply to our business. For example, we could be subject to healthcare fraud andabuse and patient privacy regulation and enforcement by both the federalgovernment and the states in which we conduct our business. The healthcare lawsand regulations 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 healthcaresector is, and in recent years has been, under heightened scrutiny as thesubject of government investigations and enforcement actions involvingmanufacturers who allegedly offered unlawful inducements to potential orexisting customers in an attempt to procure their business, includingspecifically arrangements with physician consultants. We may have arrangementswith physicians and other entities which may be subject to scrutiny. Forexample, we may lease the ProUroScanTMsystem tophysicians or others through consulting agreements.  Payment for these consulting servicessometimes may be in the form of cash, stock options or royalties.** **If our operationsare found to be in violation of any of the laws described above or any othergovernmental regulations that apply to us, we may be subject to penalties,including civil and criminal penalties, damages, fines, exclusion from theMedicare and Medicaid programs, and the curtailment or restructuring of ouroperations. Any penalties, damages, fines, exclusions, curtailment orrestructuring of our operations could adversely affect our ability to operateour 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 do businessare found to be non-compliant with applicable laws, they may be subject tosanctions, 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 our sales and marketingefforts will be the training of a sufficient number of physicians and othermedical staff to properly use the ProUroScanTM system.  We rely on physicians and other medical staffto devote adequate time to learn to use our products.  Convincing physicians and other medical staffto dedicate the time and energy for adequate training in the use of new medicaltechnologies is challenging, and we cannot guarantee that this will occur.  If physicians and other medical staff are notproperly trained, they may misuse or ineffectively use our products.  Insufficient training may result inunsatisfactory patient outcomes, patient injury and related liability ornegative publicity, which could have an adverse effect on our product sales orcreate substantial potential liabilities.

 

**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 our sales and marketingefforts is the training of a sufficient number of physicians and other medicalstaff to properly use the ProUroScanTM system.  We rely on physicians and other medical staffto devote adequate time to learn to use our products.  Convincing physicians and other medical staffto dedicate the time and energy for adequate training in the use of our systemis challenging, and we cannot guarantee that this will occur.  If physicians and other medical staff are notproperly trained, they may misuse or ineffectively use our products.  Insufficient training may result inunsatisfactory patient outcomes, patient injury and related liability ornegative 

 

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publicity, which could have an adverse effect on ourproduct sales or create substantial potential liabilities.

 

**There is no guarantee that the FDA will grant 510(k) clearanceor PMA approval of our future products and failure to obtain necessaryclearances or approvals for our future products would adversely affect ourability to grow our business.**

 

Inthe future, we may seek to obtain additional indications for use of the ProUroScanTM system beyondthe basic mapping and data maintenanceclaim.  For example, we believe that asecond generation system may be capable of identifying the specific3-dimensional location of lesions found in the prostate.  We believe that this system may also be ableto create a 3-dimensional image of the position of the lesions and allow thephysician to rotate the image to assist in identifying the actual position ofthe lesion in the prostate gland.  Webelieve that this second generation system may provide a more thoroughdiagnosis of the patient’s condition. Future generations of the ProUroScanTM system also mayinclude the capability of guiding biopsies to suspected cancer sites, at alower cost than current ultrasound approaches. Some of these expanded claims may require FDA clearance of a510(k).  Other claims may require theapproval of a PMA.  Moreover, some of theadditional claims we may seek may require clinical trials to support regulatoryapproval, and we may not successfully complete these clinical trials.  The FDA may not approve or clear futuregenerations of the ProUroScanTMsystem for the indications that are necessary or desirable forsuccessful commercialization. Indeed, the FDA may refuse our requests for 510(k) clearanceor premarket approval of new products. Failure to receive clearance or approvalfor our new products would have an adverse effect on our ability to expand ourbusiness.

 

**Clinical trials necessary tosupport our future submissions will be expensive and may require the enrollmentof large numbers of patients, and suitable patients may be difficult toidentify and recruit****. Delays or failures in our clinical trials will prevent us fromcommercializing any modified or new products and will adversely affect ourbusiness, operating results and prospects.**

 

Initiating and completingclinical trials necessary to support a 510(k) for the ProUroScanTMsystem, or future generations of the ProUroScanTMsystem, or PMA application for future generation of the ProUroScanTM system, willbe time consuming and expensive and the outcome uncertain.  Moreover, the results of early clinicaltrials are not necessarily predictive of future results, and any product weadvance into clinical trials may not have favorable results in later clinicaltrials.

 

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, thenature of the trial protocol, the attractiveness of, or the discomforts andrisks associated with, the treatments received by enrolled subjects, theavailability of appropriate clinical trial investigators, support staff, andproximity of patients to clinical sites and able to comply with the eligibilityand exclusion criteria for participation in the clinical trial and patientcompliance. For example, patients may be discouraged from enrolling in ourclinical trials if the trial protocol requires them to undergo extensive post-treatmentprocedures or follow-up to assess the safety and effectiveness of our productsor if they determine that the treatments received under the trial protocols arenot attractive or involve unacceptable risks or discomforts. In addition,patients participating in clinical trials may die before completion of thetrial or suffer 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.  Further, the FDA mayrequire us to submit data on a greater number of patients than we originallyanticipated and/or for a longer follow-up period or change the data collectionrequirements or data analysis applicable to our clinical trials. Delays inpatient enrollment or failure of patients to continue to participate in aclinical trial may cause an increase in costs and delays in the approval andattempted commercialization of our products or result in the failure of theclinical trial. In addition, despite considerable time and expense invested inour clinical trials, FDA may not consider our data adequate to 

 

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demonstrate safety andefficacy. Such increased costs and delays or failures could adversely affectour business, operating results and prospects.

 

Moreover, we are currentlydeveloping clinical trial protocols for an initial clinical study to support a510(k) on a basic mapping and data maintenance claim.  It is anticipated that the FDA clinicalstudies will require approximately three months to complete, and that anadditional month will be needed to analyze the data and prepare a formalsubmission to the FDA.  Centersparticipating in the study will be required to obtain approval from an internalInstitutional Review Board (“IRB”) to protect the rights and welfare of allparticipants and to satisfy FDA requirements for what we believe will be anon-significant risk study.  However, theFDA could disagree with our determination that this is a non-significant riskstudy, and thus subject us to the agency’s Investigational Device Exemption (“IDE”)requirements for a significant risk study. This will require, among other things, FDA approval, for which there isno guarantee that we would obtain such approval.

 

**If the third parties on which werely to conduct our clinical trials and to assist us with pre-clinicaldevelopment do not perform as contractually required or expected, we may not beable to obtain regulatory approval for or commercialize our products.**

 

Wedo not have the ability to independently conduct our pre-clinical and clinicaltrials for our products and we must rely on third parties, such as contract researchorganizations, medical institutions, clinical investigators and contractlaboratories to conduct such trials.  Ifthese third parties do not successfully carry out their contractual duties orregulatory obligations or meet expected deadlines, if these third parties needto be replaced, or if the quality or accuracy of the data they obtain iscompromised due to the failure to adhere to our clinical protocols orregulatory requirements or for other reasons, our pre-clinical developmentactivities or clinical trials may be extended, delayed, suspended orterminated, and we may not be able to obtain regulatory approval for, orsuccessfully commercialize, our products on a timely basis, if at all, and ourbusiness, operating results and prospects may be adversely affected.Furthermore, our third-party clinical trial investigators may be delayed inconducting our clinical trials for reasons outside of their control.

 

**Even if our products are cleared or approved byregulatory authorities, if we or our contract manufacturers or suppliers failto comply with ongoing FDA or other foreign regulatory authority requirements,or if we experience unanticipated problems with our products, these productscould be subject to restrictions or withdrawal from the market.**

 

Anyproduct for which we obtain clearance or approval, and the manufacturingprocesses, reporting requirements, post-approval clinical data and promotionalactivities for such product, will be subject to continued regulatory review,oversight and periodic inspections by the FDA and other domestic and foreignregulatory bodies. In particular, we and our contract manufacturers andsuppliers will be required to comply with FDA’s Quality System Regulations, orQSR, and International Standards Organization, or ISO, regulations for themanufacture of our products and other regulations which cover the methods anddocumentation of the design, testing, production, control, quality assurance,labeling, packaging, storage and shipping of any product for which we obtain clearanceor approval. Regulatory bodies, such as the FDA, enforce the QSR and otherregulations through periodic inspections. The failure by us or one of ourcontract 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 lettersor untitled letters;

 

·                           fines and civilpenalties;

 

·                           unanticipatedexpenditures to address or defend such actions;

 

·                           delays inclearing or approving, or refusal to clear or approve, our products;

 

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·                           withdrawal orsuspension of approval of our products or those of our third-party suppliers bythe FDA or other regulatory bodies;

 

·                           product recallor seizure;

 

·                           orders forphysician notification or device repair, replacement or refund;

 

·                           interruption ofproduction;

 

·                           operatingrestrictions;

 

·                           injunctions;and

 

·                           criminalprosecution.

 

Ifany of these actions were to occur it would harm our reputation and cause ourproduct sales and profitability to suffer and may prevent us from generatingrevenue. Furthermore, our contract manufacturers and suppliers may not be incompliance with all applicable regulatory requirements which could result inour failure to supply our products in required quantities, if at all.

 

Evenif regulatory clearance or approval of a product is granted, such clearance orapproval may be subject to limitations on the intended uses for which theproduct may be marketed and reduce our potential to successfully commercializethe product and generate revenue from the product. If the FDA determines thatour promotional materials, labeling, training or other marketing or educationalactivities constitute promotion of an unapproved use, it could request that wecease or modify our training or promotional materials or subject us toregulatory enforcement actions. It is also possible that other federal, stateor foreign enforcement authorities might take action if they consider ourtraining or other promotional materials to constitute promotion of anunapproved use, which could result in significant fines or penalties underother statutory authorities, such as laws prohibiting false claims forreimbursement.

 

Inaddition, we may be required to conduct costly post-market testing andsurveillance to monitor the safety or effectiveness of our products, and wemust comply with medical device reporting requirements, including the reportingof adverse events and malfunctions 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.**

 

TheFDA and similar foreign governmental authorities have the authority to requirethe recall of commercialized products in the event of material deficiencies ordefects in design or manufacture.  In thecase of the FDA, the authority to require a recall must be based on an FDAfinding that there is a reasonable probability that the device would causeserious injury or death.  In addition,foreign governmental bodies have the authority to require the recall of ourproducts in the event of material deficiencies or defects in design or manufacture.  Manufacturers may, under their owninitiative, recall a product if any material deficiency in a device isfound.  A government-mandated orvoluntary recall by us or one of our contract manufacturers or suppliers couldoccur as a result of component failures, manufacturing errors, design orlabeling defects or other 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.  TheFDA requires that certain classifications of recalls be reported to FDA within10 working days after the recall is initiated. Companies are required tomaintain certain records of recalls, even if they are not reportable to theFDA.  We may initiate voluntary recallsinvolving our products in the future that we determine do not requirenotification of the FDA.  If the FDAdisagrees with our determinations, they could require us to report thoseactions as recalls.  A future recallannouncement could harm our reputation with customers and negatively affect oursales.  In 

 

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addition,the FDA could take enforcement action for failing to report the recalls whenthey were conducted.

 

**If our products cause or contribute to a death or aserious injury, or malfunction in certain ways, we will be subject to medicaldevice reporting regulations, which can result in voluntary corrective actionsor agency enforcement actions.**

 

Underthe FDA medical device reporting regulations, medical device manufacturers arerequired to report to the FDA information that a device has or may have causedor contributed to a death or serious injury or has malfunctioned in a way thatwould likely cause or contribute to death or serious injury if the malfunctionof the device or one of our similar devices were to recur.  If we fail to report these events to the FDAwithin the required timeframes, or at all, FDA could take enforcement actionagainst us.  Any such adverse eventinvolving our products also could result in future voluntary correctiveactions, such as recalls or customer notifications, or agency action, such asinspection or enforcement action.* *Any corrective action, whethervoluntary or involuntary, as well as defending ourselves in a lawsuit, willrequire the dedication of our time and capital, distract management fromoperating our business, and may harm our reputation and financial results.

 

**We havelimited experience in assembling and testing our products and may encounterproblems or delays in the assembly of our products or fail to meet certainregulatory requirements which could result in an adverse effect on our businessand financial results.**

 

Wehave limited experience in assembling and testing our ProUroScanTM system, and no experience in doing so on acommercial scale. To become profitable, we must assemble and test the ProUroScanTM system incommercial quantities in compliance with regulatory requirements and at anacceptable cost. Increasing our capacity to assemble and test our products on acommercial scale will require us to improve internal efficiencies. We mayencounter a number of difficulties in increasing our assembly and testingcapacity, including:

 

·                  managing production yields;

 

·                  maintaining quality controland assurance;

 

·                  providing component andservice availability;

 

·                  maintaining adequate controlpolicies and procedures;

 

·                  hiring and retainingqualified personnel; and

 

·                  complying with state,federal and foreign regulations.

 

Ifwe are unable to satisfy commercial demand for our ProUroScanTM system due to our inability to assembleand test our ProUroScanTMsystem, our ability to generate revenue would be impaired, marketacceptance of our products could be adversely affected and customers mayinstead purchase or use, our competitors’ products.

 

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

 

Fromtime to time, legislation is drafted and introduced in Congress that couldsignificantly change the statutory provisions governing the clearance orapproval, manufacture and marketing of a medical device. In addition, FDAregulations and guidance are often revised or reinterpreted by the agency inways that may significantly affect our business and our products. It isimpossible to predict whether legislative changes will be enacted or FDAregulations, guidance or interpretations changed, and what the impact of suchchanges, if any, may be.

 

Withoutlimiting the generality of the foregoing, Congress has recently enacted, andthe President has signed into law, the Food and Drug Administration AmendmentsAct of 2007 (the “Amendments”).  TheAmendments require, among other things, that FDA propose, and ultimatelyimplement, regulations that will require manufacturers to label medical deviceswith unique identifiers unless a waiver is received from FDA.  Once implemented, compliance with those 

 

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regulationsmay require us to take additional steps in the manufacture of our products andlabeling.  These steps may requireadditional resources and could be costly. In addition, the Amendments will require us to, among other things, payannual establishment registration fees to the FDA for each of our FDAregistered facilities.

 

**Rapid technological change in our competitive marketplace may renderour proposed products obsolete or may diminish our ability to compete in themarketplace.**

 

The prostate cancer detection, urology-based imagingand medical device markets are extremely competitive, dominated by large andwell financed competition and are subject to rapid technological advances andchanges.  The discovery of newtechnologies and advances in the application of such technologies to themedical marketplace in general, and the market for urology-based imaging productsin particular, may render our products obsolete or non-competitive.  Any such changes and advances could force usto abandon our currently proposed products, which would have a material adverseeffect on our business.

 

**We will depend upon others for the manufacturing of our products, whichwill subject our business to the risk that we will be unable to fully controlthe supply of our products to the market.**

 

Our ability to develop, manufacture and successfullycommercialize our proposed products depends upon our ability to enter into andmaintain contractual and collaborative arrangements with others.  Initially, we do not intend to establish anyof our own manufacturing facilities for any of our proposed products.  Instead, we intend to retain****FDA QSR compliant and FDA registeredcontract manufacturers.  There can be noassurance that such manufacturers will be able to supply our products in therequired quantities, at appropriate quality levels or at acceptable costs.  We may be adversely affected by anydifficulties encountered by such third-party manufacturers that result inproduct defects, production delays or the inability to fulfill orders on atimely basis.  If a manufacturer cannotmeet our quality standards and delivery requirements in a cost-efficientmanner, we could suffer interruptions of delivery while we arrange foralternative manufacturing sources.  Anyextended disruption in the delivery of our products could result in ourinability to satisfy customer demand for our products.  Consequently, our inability to obtainalternative sources on a timely basis may have a material adverse effect on ourbusiness.

 

**Our reliance on third-party manufacturers and other third parties inother aspects of our business may reduce any profits we may earn from ourproducts and may negatively affect future product development.**

 

We intend to partner with one or more companies tocommercialize products manufactured by QSR compliant and FDA registeredcontract manufacturers, and in connection therewith, we will likely be requiredto enter into manufacturing, licensing and distribution arrangements with thirdparties.  These arrangements will likelyreduce our product profit margins.  Inaddition, the identification of new product candidates for development mayrequire us to enter into licensing or other collaborative agreements withothers, including medical device and pharmaceutical companies and researchinstitutions.  These collaborativeagreements may require us to pay license fees, make milestone payments or payroyalties or grant rights, including marketing rights, to one or moreparties.  Any such arrangement willreduce our profits.  Moreover, thesearrangements may contain covenants restricting our product development orbusiness efforts in the future.

 

**We may not be able to enter into manufacturing agreements or othercollaborative agreements on terms acceptable to us, if at all, which could havea material adverse effect on our business.**

 

We cannot be sure that we will be able to enter intomanufacturing or other collaborative arrangements with third parties on termsacceptable to us, if at all.  If we failto establish 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 these capital requirements, it may have amaterial adverse effect on our business.

 

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**We expect to rely materially on Artann and other consultants andcontractors, some of whom may be partially or wholly paid through issuances ofcommon stock dilutive to our shareholders.**

 

We materially rely on consultants and contractors toperform a significant amount of research and development, pre-manufacturing,clinical, regulatory and marketing activities. We expect that certain of the consultants and contractors will acceptpayment of a significant portion of their compensation in the form of ourequity securities.  We believe that thevalue of such equity compensation may exceed $1 million during the next 12months.  Any such issuances could bedilutive to shareholders.

 

**The funding provided by thegovernment from the $3,000,000 Small Business Innovation Research Phase IICompetitive Renewal grant awarded to Artann by the National Institutes ofHealth (“NIH”) may be reduced or delayed. If such reduction or delay occurs, this may have a material adverseeffect on our business.**

 

Artann, who weexpect to work with to complete development of the ProUroScanTMsystem, depends in large part on grants and awardsfrom the U.S. government for its operations. The funds from the grant areintended to offset the funds needed by us to bring our system to completion**.**  Artann hasindicated that there is approximately $2 million of remaining funding availablefor this purpose under the grant.  TheNIH does not guarantee funding associated with grant awards.  The funding is subject to changes in U.S.government funding of NIH programs, Artann’s ability to perform the proposedwork and Artann’s compliance with the rules and regulations of the NIH andthe federal government.  If a reductionor delay in funding related to the NIH grant occurs, it could have a materialadverse effect on our business.

 

**We are highly dependent on the services provided by certain keypersonnel.**

 

We are highly dependent upon the services of ourexecutive officers, Richard Carlson and Richard Thon.  We have not obtained “key-man” life insurancepolicies insuring the lives of either of these persons.  If the services of either of these personsbecome unavailable to us, for any reason, our business could be adverselyaffected.

 

**We license from third parties, and do not own or control, keyintellectual property critical to our products.**

 

We have licensed from third parties intellectualproperty covered by patents and patent applications.  No assurance can be given that suchprotections will be properly maintained by the parties controlling suchintellectual property, or that such licenses will be honored and notbreached.  The intellectual propertylicensed from third parties includes technology that is critical to ourproposed products.  If the partiescontrolling such intellectual property breach our licenses, or fail toadequately maintain, assert and defend such intellectual property, and we areunable to defend the intellectual property in case of such failure, we may notbe able to maintain the technological, and thereby competitive, edge that webelieve we now possess.  Any such loss ofintellectual property protections would likely have a material adverse effecton our business.

 

**If we lose our right to license and use from third parties certaincritical intellectual property for any reason, our entire business would be injeopardy.**

 

If we breach or fail to perform the materialconditions of, or fail to extend the term of, an agreement that licensescritical intellectual property, we may lose all or some of our rights to suchcritical intellectual property and our licenses may terminate.  If we should lose our right to license anduse technology covered by our licenses that is critical to our business, suchloss would have a materially adverse effect on our business.  In such a case, the viability of the Companywould be in question. Our only alternatives would be to find existing andnon-infringing technology to replace that lost, if any exists, or develop newtechnology ourselves.  The pursuit of anysuch alternative would likely cause significant delay in the development andintroduction of our proposed products.

 

36

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**The protections for the intellectual property we license from otherparties may be successfully challenged by third parties.**

 

We license from third parties various keyintellectual property.  No assurance canbe given that any intellectual property claims will not be successfullychallenged by third parties.  Anychallenge to our intellectual property, regardless of merit, would likelyinvolve costly litigation which could have a material adverse effect on ourbusiness.  If a successful challenge weremade to intellectual property that is critical to our proposed products, thepursuit of any such alternative would likely cause significant delay in thedevelopment and introduction of such products. Moreover, a successful challengecould call into question the validity of our business.

 

**We will begin to lose patent protection on our licensedprostate-imaging systems and related patent technologies beginning in2012.  As we lose patent protection on our critical licensed technologies,it may have a material adverse effect on our business.**

 

Werely on certain licensed patents to provide us with exclusive rights for ourtechnology.  One of these licensedpatents will expire in 2012, another in 2013, while the remainder will expirebetween 2016 and 2021..  As we begin tolose certain patent protections on our licensed prostate-imaging systems andrelated critical patented technologies in 2012, we may face strong competitionas a result, which could have a material adverse effect our business.

 

**We may not be able to successfully compete against companies in ourindustry with greater resources, or with any competition.**

 

The diagnostic business, specifically, and themedical device and life sciences business, generally, are competitive.  If our development plan is successful, weexpect to experience significant competition in the medical device market.  Although we believe that we may have aproprietary niche in the prostate imaging marketplace, many factors beyond ourcontrol, including, but not limited to, government regulation, will likelyencourage new competitors.  In particular,several large companies will compete with us in the prostate imagingbusiness.  Many of the companies thatwill be in direct competition with us have significantly greater resources,more personnel and longer operating histories than we do.  Therefore, no assurance can be given that wewill be able to successfully compete with these, or any other companies in themarketplace, if at all.

 

**Our common stock is illiquid and may be difficult to sell.**

 

Trading of our common stock is conducted on theOver-The-Counter Bulletin Board. Management believes that this has an adverse effect on the liquidity ofour common stock, not only in terms of the number of securities that can bebought and sold at a given price, but also through delays in the timing oftransactions and reduction in analyst coverage of our Company.  This may result in lower prices for ourcommon stock than might otherwise be obtained if wemet the criteria to list our securities on alarger or more established exchange, such as the NASDAQ Capital Market andcould also result in a larger spread between the bid and asked prices for ourcommon stock.

 

**There is currently limited trading volume in our common stock, whichmay make it difficult to sell shares of our common stock.**

 

There has been only limited trading activity in ourcommon stock.  The relatively smalltrading volume will likely make it difficult for our shareholders to sell theirshares as, and when, they choose. Furthermore, small trading volumes generally depress market prices.  As a result, investors may not always be ableto resell shares of our common stock publicly at the time and prices that theyfeel are fair or appropriate.

 

**Because our stock is deemed a “penny stock,” you may have difficultyselling shares of our common stock.**

 

Our common stock is a “penny stock” and is thereforesubject to the requirements of Rule 15g-9 under the Securities 

 

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Exchange Act of 1934, as amended.  Under this rule, broker-dealers who sellpenny stocks must provide purchasers of these stocks with a standardizedrisk-disclosure document prepared by the Securities and Exchange Commission (“SEC”).  The penny stock rules severely limit theliquidity of securities in the secondary market, and many brokers choose not toparticipate in penny stock transactions. As a result, there is generally less trading in penny stocks.  If you become a holder of our common stock,you may not always be able to resell shares of our common stock publicly at thetime and prices that you feel are fair or appropriate.  Under applicable regulations, our commonstock will generally remain a penny stock until and for such time as itsper-share price is $5.00 or more (as determined in accordance with SECregulations), or until we meet certain net asset or revenue thresholds.  These thresholds include the possession ofnet tangible assets (that is, total assets less intangible assets andliabilities) in excess of $5,000,000, and the recognition of average revenuesequal to at least $6,000,000 for each of the last three years.  We do not anticipate meeting any of thethresholds in the foreseeable future.

 

**The shares and warrants that may be issued in futurefinancings may trigger an “ownership change” as defined by the Internal RevenueCode of 1986, as amended (the “Code”) and o****urability to use operating loss carryforwards to offset income in future yearsmay be limited.**

 

As of December 31, 2007, the Company hadgenerated net operating loss carryforwards of approximately $4.1 million which,if not used, will begin to expire in 2021. 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 analyzedthe merger and private placement transactions that occurred in April 2004along with subsequent equity transactions and we believe that they do notconstitute such an ownership change. However, in combination with private placement transactions completed inlate 2007 and early 2008, contemplated future financing transactions may triggersuch an ownership change resulting in a significant limitation of our abilityto use operating loss carryforwards to offset future income in future years.

 

**Our business and products subject us to the risk of product liabilityclaims.**

 

The manufacture and sale of medical products and theconduct of clinical trials using new technology involve customary risks ofproduct liability claims.  There can beno assurance that our insurance coverage limits will be adequate to protect usfrom any liabilities which we might incur in connection with the clinicaltrials or the commercialization of any of our products.  Product liability insurance is expensive andin the future may not be available on acceptable terms, if at all.  A successful product liability claim or seriesof claims brought against us in excess of our insurance coverage would have amaterial adverse effect on our business. In addition, any claims, even if not ultimately successful, could have amaterial adverse effect on the marketplace’s acceptance of our products.

 

**We have never paid dividends and do not expect to pay dividends in theforeseeable future.**

 

We have never paid dividends on our capital stockand do not anticipate paying any dividends for the foreseeable future.

 

38

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###### ***ITEM2:  DESCRIPTION OF PROPERTY***

###### *** ***

Our executive offices are temporarily located at5500 Wayzata Boulevard, Suite 310, Golden Valley, MN 55416, where we rentexcess space in the offices of a former Company director on a month-to-monthbasis.  Our rental cost for thesetemporary offices is approximately $2,200 per month, which we believe is atmarket for similar office space in Minneapolis, Minnesota.  Upon successful completion of our currentfunding efforts, we expect to relocate to permanent office space ofapproximately 2,000 square feet.  We donot own any real property.  We have noofficial policy on investments in real estate, interests in real estate,real-estate mortgages, or securities of or persons primarily engaged in realestate activities

 

**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**

 

**CorporateActions**

 

OnSeptember 4, 2007 and December 27, 2007, the Board and the holders ofa majority of the shares of the Company’s then-outstanding Common Stock (the“Consenting Stockholders”), respectively, adopted a resolution to effect astock combination, or reverse stock split, pursuant to which every ten (10) sharesof the Company’s outstanding Common Stock would be exchanged for one (1) newshare of Common Stock.

 

TheNevada General Corporation Law permits the holders of a majority of the sharesof the Company’s outstanding Common Stock to approve and authorize actions bywritten consent of a majority of the shares outstanding as if the action wereundertaken at a duly constituted meeting of the stockholders of the Company. OnDecember 27, 2007, Consenting Stockholders holding an aggregate of8,100,103 shares (pre-split) of Common Stock, representing approximately 50.5%of the total shares of Common Stock entitled to vote on the matter set forthherein, consented in writing without a meeting to effect a stock combination,or reverse stock split, pursuant to which every ten (10) shares of theCompany’s outstanding Common Stock would be exchanged for one (1) new share ofCommon Stock. As a result, no further votes will be needed to approve the reversestock split. At December 27, 2007, the Company had outstanding 16,050,882total shares (pre-split) of Common Stock.

 

Detailsof this corporate action were reported on a Definitive Information Statement Pursuant to Section 14(c) of theSecurities Exchange Act of 1934 filed January 14, 2008.

 

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**PART II**

 

**ITEM 5: MARKET FOR COMMON EQUITY ANDRELATED STOCKHOLDER MATTERS**

 

**General**

** **

Our common stock has been quoted on theOver-The-Counter Bulletin Board, or “OTCBB,” since December 2003.  Our common stock is currently quoted on theOTCBB under the trading symbol “PUMD.” The following table lists the high and low bid information for theCompany’s common stock as quoted on the OTCBB by quarter from January 1,2006 through December 31, 2007:

** **
| ** **               | ** ** | **Price Range** | ** ** |
|--------------------------|------------|----------------------|------------|
| **Quarter Ended**   | ** ** | **High**             | ** ** | **Low** | ** ** |
| March 31,  2006     |       | $                    | 10.00      |   | $ | 5.00 |   |
| June 30,  2006      |       | $                    | 8.50       |   | $ | 3.70 |   |
| September 30,  2006 |       | $                    | 6.80       |   | $ | 4.20 |   |
| December 31,  2006  |       | $                    | 6.60       |   | $ | 3.50 |   |
| March 31,  2007     |       | $                    | 6.70       |   | $ | 4.10 |   |
| June 30,  2007      |       | $                    | 5.80       |   | $ | 2.90 |   |
| September 30,  2007 |       | $                    | 5.90       |   | $ | 2.00 |   |
| December 31,  2007  |       | $                    | 3.50       |   | $ | 0.80 |   |

 

The above quotations from the OTCBB reflectinter-dealer prices, without retail mark-up, mark-down or commission, and maynot represent actual transactions.  The number ofholders of record of our common stock as of December 31, 2007 wasapproximately 151.  The Company has neverpaid dividends on our capital stock and we do not anticipate paying dividendsfor the foreseeable future.

 

**Recent Sales ofUnregistered Securities**

 

***Common Stock***

 

In connection with the renewal of our Crown Bank notes to,among other things, extend the maturity date of such notes to February 28,2009, we obtained loan guarantee extensions from three guarantors, and weborrowed $600,000 from the Phillips W. Smith Family Trust and used the proceedsto retire $600,000 of the original Crown Bank loan obligation.  As consideration to the Phillips W. Smith Family Trust forlending funds to us and to James Davis, Bruce Culver and William Reiling forextending their guarantees through February 28, 2009, we issued to them anaggregate amount of 122,222 shares of our common stock on December 28,2007.

** **

***Convertible Promissory Note Issuances***

** **

**On December 27,2007, we closed on the sale of $1,050,000 of units consisting of unsecured,subordinated, convertible promissory notes (the “2007 Notes”) and common stockpurchase warrants (the “2007 Warrants”) in a private placement (the “2007 PrivatePlacement”).  Our net cash proceeds were$712,923, after deducting $337,077 of expenses of the offering (including$105,000 of commissions paid to the placement agent) and excluding from thecash proceeds the conversion into units of $25,000 of loans made to the Companyby James Davis and $25,000 of certain loans from the Company’s directors.  At the closing, we issued $997,500 inprincipal amount of 2007 Notes and 2007 Warrants to purchase 210,000 shares ofcommon stock.  The 2007 Notes bearinterest at 10 percent per year, mature on June 27, 2009, and will convertinto the type of equity securities offered by the Company in any underwrittenpublic offering prior to maturity at 70 percent of the public offeringprice.  In the event a public offering**

** **

**40**

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** **

**is not completedbefore the maturity date, the entire principal and unpaid accrued interest willconvert into the Company’s common stock at $0.05 per share.  The Company may, at its option, prepay the 2007Notes anytime on or after December 27, 2008.  The 2007 Warrants will become exercisableupon the earlier of the closing of a public offering or the maturity date ofthe 2007 Notes, and will remain exercisable until December 31, 2012.  The exercise price will be 50 percent of thepublic offering price, or in the event a public offering is not completedbefore the maturity date, 50 percent of the closing price of the Company’scommon stock on the maturity date of the 2007 Note.**

** **

**On December 27,2007, the Company also converted $150,000 of existing loans from James Davisinto a note and warrants similar to those described above.  The principal amount of the note issued to Mr. Daviswas $142,500.  Mr. Davis alsoreceived warrants to purchase 30,000 shares of the Company’s common stock.  The terms of the note and warrants issued to Mr. Davisare the same as those issued in the 2007 Private Placement, except that hisnote is convertible into the type of equity securities offered by the Companyin an underwritten public offering at 50 percent of the public offeringprice.  In addition, Mr. Davisagreed that the equity securities issued upon conversion of his note and thecommon stock issued upon exercise of his warrant will not be transferable for aperiod of one year beginning on the effective date of the public offeringtriggering conversion of the note.**

** **

***Warrants***

 

On November 30, 2007, the Company borrowed for workingcapital purposes $25,000 from James Davis, a five percent shareholderof the Company.  We converted theprincipal amount of this short-term loan into units under the 2007 PrivatePlacement on December 27, 2007, and issued to Mr. Davis warrants to purchase 700 shares of common stock at anexercise price of $5.00 per share pursuant to the terms of the promissory note.

 

**ITEM 6:MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**

 

The accompanying Plan of Operation should be read inconjunction with the audited financial statements, and notes thereto, includedin this Annual Report on Form 10-KSB.

 

***Assets; P******roperty Acquisitions and Dispositions***

 

Our primary assets are licenses and cash, which arethe foundation for our proposed product offerings.  These assets****are pledged tosecure a $1.6 million senior bank note and also to secure a note issued to aninvestor in the amount of $600,000 and, as a result, are not available tosecure other senior debt financing.  We anticipate purchasing approximately$135,000 of computer equipment, development tools and molds, software andproduction tooling during the next 12 months. We do not anticipate selling any significant equipment or other assetsin the near term.

 

***Current Operations – Employees and Expenses***

 

We currently employ only two employees.  We conduct our research and development,market research, regulatory and other business operations through the use of avariety of consultants and medical device development contractors.  We believe that using consultants andcontractors to perform these functions is more cost effective than hiringfull-time employees and affords us flexibility in directing our resourcesduring our development stage.  As weprepare for submission to the FDA and market launch of our ProUroScanTMsystem, over the next 12 months we expect to hire approximately 7 employees inthe areas of engineering, regulatory compliance, marketing and qualitycontrol.  During the next 12 months, weexpect to complete the development of clinical ProUroScanTM systems,conduct clinical trials and file a 510(k) submission with the FDA, beginthe CE mark registration process in the European Union, and establish strategicmarketing and contract manufacturing relationships in anticipation ofregulatory clearance to enter the market.

 

We incur ongoing expenses that are directly related to being a publicly tradedcompany, including professional audit and legal fees, financial printing, pressreleases and transfer agent fees.  Wecurrently occupy temporary offices within 

 

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the office of a former Company director, for whichwe accrue rent on a month-to-month basis of approximately $2,200 permonth.  Upon successful completion of ourcurrent funding efforts, we expect to relocate to permanent offices ofapproximately 2,000 square feet.  Otherexpenses incurred include executive officer compensation, expensing of stockoptions, travel, insurance, telephone, supplies and other miscellaneousexpenses.  In the next 12 months, theCompany anticipates that it will spend approximately $1.3 million in marketingand administrative expenses.  Of these,the Company expects that approximately $550,000 will be for compensation,benefits and payroll taxes, and approximately $180,000 will be for consultingcosts.

 

Theremaining work to prepare the ProUroScanTM system for FDA clinical studies consists primarily ofengineering and user interface refinements, safety and bio-testing, andcompletion of documentation and validation studies.  Over the next 12 months, we expect this workto be performed by Artann and other independent contractors.  We are actively engaged in negotiations withArtann to complete the remaining phases of the ProUroScanTM project, and anticipatecompleting a development agreement by the end of the second quarter of2008.  A significant portion of thesecosts are eligible for coverage under Artann’s September, 2006 NIH grant.  Although the terms of our developmentagreement have yet to be finalized, we expect that a combination of cash andequity will be provided to Artann, spread out over the next five years.  We are also negotiating a license agreementwith Artann to provide access to certain patents, know how and futureintellectual property associated with prostate mechanical imaging.  We expect that payment for these interestswill be paid by a combination of licensing fees and royalties.  Over the next twelve months, we expect thatcash and equity payments to all outside contractors for research, developmentand clinical work, net of amounts reimbursed from the NIH grant, may rangebetween $2 and $3 million.

 

Wealso anticipate developing a small internal engineering team with competenciesin electrical and mechanical engineering and software design and development tofill specific project requirements not covered by Artann or other outsidecontractors.  Internal salaries, benefitsand miscellaneous departmental expenses for software and hardware development,regulatory work and project management over the next 12 months are estimated at$240,000.

 

***Financing Plan***

 

We do not currently have sufficient funds tocomplete the development of our products and gain approval of them from theFDA.  As of February 29, 2008, wehad approximately $230,000 cash on hand and current liabilities ofapproximately $4.1 million.  We estimatethat we will need approximately $3.5 million of cash over the next 12 months tocomplete the development of a first generation system, submit a premarketnotification application to FDA, obtain FDA clearance of a 510(k) for abasic labeling mapping and data maintenance claim.  In addition we have $2.2 million of secureddebt and $733,334 of convertible debt, both of which mature at the end ofFebruary, 2009, and other short term liabilities exceeding $1,150,000.

 

During the next 12 months, we plan to raiseapproximately $5.1 million through private or public offerings of our debt orequity securities, alternative financing sources that may become available tous, or a combination of these.  Weanticipate that the net proceeds from such financings will be sufficient tofund our operations and retire approximately $700,000 of short termliabilities. We intend to address the $2.2 million secured debt that matures inFebruary, 2009 by seeking an equity investment or licensing fee from astrategic marketing partner, or by seeking an extension of the maturity dates.  We expect that the convertible debt will beconverted into common stock during the next 12 months.  If we are unsuccessful in obtaining an equityinvestment or licensing fee or an extension of the maturity date of the secureddebt, or if the convertible debt is not converted into our common stock, wewill need to raise additional funds.

 

Sources of alternative financing include possiblestrategic investments from medical device companies that may be interested inmarketing products in the prostate cancer detection market.  In addition to financial support, asuccessful collaboration with such a company would allow us to gain access todown stream marketing, manufacturing, and sales support.

 

Approximately $2.3 million of our outstandingconvertible debentures will automatically convert into equity upon our closingan underwritten public offering.  Inaddition, to date we have issued a total of 334,000 warrants to date in our2007 and 2008 Private Placements, and additional warrants may be issued pursuantto our financing efforts.

 

Weare attempting to raise enough cash to complete the development of a firstgeneration ProUroScanTM system and to seek or obtain FDA clearanceof a 510(k) on a basic mapping and data maintenance claim.  However, if our financing efforts areunsuccessful or significantly delayed for any reason, or if our productdevelopment efforts experience significant unforeseen delays, we may not havesufficient funds to complete these objectives, and will require additionalfinancing.  If additional funds areraised by the issuance of convertible debt or equity securities, such as theissuance of stock, or the issuance and exercise of warrants or the issuance andconversion of convertible debentures, then existing shareholders will experiencedilution in their ownership interests. If additional 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 commonstock.  .If adequate funds are not available through these initiatives on atimely basis, or are not available on acceptable terms, we may be unable tofund expansion, or to develop or enhance our products.  Ultimately, if no additional financing isobtained beyond what has been secured to date, we could potentially be forcedto cease operations.  See “Risk Factors”beginning on page 22.

 

 

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***Going Concern***

 

We have incurred operating losses, accumulateddeficit and negative cash flows from operations since inception.  As of December 31, 2007, we had anaccumulated deficit of approximately $16.3 million.  These factors, among others, raisesubstantial doubt about our ability to continue as a going concern.  Our Consolidated Financial Statementsincluded in this annual report do not include any adjustments related torecoverability and classification of asset carrying amounts or the amount andclassification of liabilities that might result should we be unable to continueas a going concern.

 

See Part I, Item 1 under thecaption “RISK FACTORS ASSOCIATED WITH OUR BUSINESS, OPERATIONS AND SECURITIES”.

 

***Critical Accounting Policies***

 

Ourcritical accounting policies are policies which have a high impact on thereporting of our financial condition and results, and require significantjudgments and estimates.  Our criticalaccounting policies relate to (a) the valuation of stock-basedcompensation awarded to employees, directors, loan guarantors and consultantsand (b) the accounting for debt with beneficial conversion features.

 

Valuation of Stock-Based Compensation

 

Effectiveas of February 17, 1999 (inception), the Company adopted Statement ofFinancial Accounting Standard No. 123 (revised 2004), **Share-BasedPayment**(“SFAS 123(R)”), which requires the measurement andrecognition of compensation expense for all share-based payment awards made toemployees 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 vesting period.

 

Debt with BeneficialConversion Features

 

Thebeneficial conversion features of the promissory notes were valued using theBlack-Scholes pricing model. The resulting original issue discount is amortizedover the life of the promissory notes using the straight-line method, whichapproximates the interest method.

 

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**ITEM 7:  FINANCIALSTATEMENTS**

 

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-9    |
|                                                           |   |
| Notes  to Consolidated Financial Statements                    | F-11   |

 

F-1

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Shareholders,Audit Committee and Board of Directors

ProUroCare Medical Inc.

Golden Valley, MN

 

We have audited theaccompanying consolidated balance sheets of ProUroCare Medical Inc. (adevelopment stage company) as of December 31, 2007 and 2006, 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, 2007. 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 theeffectiveness of 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 by managementas 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 31,2007 and 2006 and the results of their operations and their cash flows for theyears then ended and the period from August 17, 1999 (inception) to December 31,2007, 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 raisessubstantial doubt 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 28, 2008

 

F-2

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**ProUroCare Medical Inc.**

(A DevelopmentStage Company)

 

ConsolidatedBalance Sheets

 
| ** **                                                                                                                     | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                     | ** ** | **2007**              | ** ** | **2006**              | ** ** |
| **Assets**                                                                                                                     | ** ** | ** **            | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                |       |                  |       |                  |       |
| Cash                                                                                                                           |       | $                     | 400,613    |                  | $          | 2,407 |   |
| Restricted cash                                                                                                                |       | 44,000                |       | —                |       |
| Prepaid expenses                                                                                                               |       | 21,733                |       | 15,459                |       |
| Total current  assets                                                                                                          |       | 466,346               |       | 17,866                |       |
| Equipment and  furniture, net                                                                                                  |       | 605                   |       | 3,739                 |       |
| Deferred  offering expenses                                                                                                    |       | 132,638               |       | —                |       |
| Debt issuance  costs, net                                                                                                      |       | 439,321               |       | 573,013               |       |
|                                                                                                                           |       | $                     | 1,038,910  |                  | $          | 594,618 |   |
| **Liabilities and Shareholders’ Deficit**                                                                                 |       |                  |       |                  |       |
| Current  liabilities:                                                                                                          |       |                  |       |                  |       |
| Notes payable,  net of original issue discount                                                                                 |       | 263,143               |       | 174,338               |       |
| Accounts payable                                                                                                               |       | 484,375               |       | 385,793               |       |
| Accrued expenses                                                                                                               |       | 801,925               |       | 662,226               |       |
| Loans from  officers and directors                                                                                             |       | 10,450                |       | 15,450                |       |
| Total current  liabilities                                                                                                     |       | 1,559,893             |       | 1,237,807             |       |
|                                                                                                                           |       |                  |       |                  |       |
| Commitments and  contingencies (note 6)                                                                                        |       |                  |       |                  |       |
| Long-term bank  debt                                                                                                           |       | 1,600,000             |       | 2,200,000             |       |
| Long-term note  payable                                                                                                        |       | 600,000               |       | —                |       |
| Long-term  convertible debentures, net of original issue discount                                                              |       | 970,600               |       | 209,983               |       |
| Total  liabilities                                                                                                             |       | 4,730,493             |       | 3,647,790             |       |
|                                                                                                                           |       |                  |       |                  |       |
| Shareholders’  deficit:                                                                                                   |       |                  |       |                  |       |
| Common stock,  $0.00001 par value. Authorized 50,000,000 shares; issued and outstanding 1,727,311  and 1,439,969, respectively |       | 17                    |       | 14                    |       |
| Additional  paid-in capital                                                                                                    |       | 12,586,496            |       | 10,111,612            |       |
| Deficit  accumulated during the development stage                                                                              |       | (16,278,096           | )          | (13,164,798           | )          |
| Total  shareholders’ deficit                                                                                              |       | (3,691,583            | )          | (3,053,172            | )          |
|                                                                                                                           |       | $                     | 1,038,910  |                  | $          | 594,618 |   |

 

See accompanyingnotes to consolidated financial statements.

 

F-3

----

 

**ProUroCareMedical Inc.**

(A DevelopmentStage Company)

 

ConsolidatedStatements of Operations

 
| ** **                                      | ** ** | ** **            | ** ** | ** **            | ** ** | **Period from**    | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | ** **            | ** ** | ** **            | ** ** | **August 17,**     | ** ** |
| ** **                                      | ** ** | ** **            | ** ** | ** **            | ** ** | **1999**                | ** ** |
| ** **                                      | ** ** | **Year ended**   | ** ** | **Year ended**   | ** ** | **(inception) to** | ** ** |
| ** **                                      | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,**   | ** ** |
| ** **                                      | ** ** | **2007**              | ** ** | **2006**              | ** ** | **2007**                | ** ** |
| Operating  expenses:                            |       |                  |       |                  |       |                    |       |
| Research and  development                       |       | $                     | 143,628    |                  | $          | 246,119                 |       | $ | 4,857,552 |   |
| General and  administrative                     |       | 1,305,274             |       | 1,596,050             |       | 7,804,496               |       |
|                                            |       |                  |       |                  |       |                    |       |
| Total operating  expenses                       |       | 1,448,902             |       | 1,842,169             |       | 12,662,048              |       |
|                                            |       |                  |       |                  |       |                    |       |
| Operating loss                                  |       | (1,448,902            | )          | (1,842,169            | )          | (12,662,048             | )          |
| Interest income                                 |       | 1,278                 |       | —                |       | 17,758                  |       |
| Interest expense                                |       | (1,312,220            | )          | (1,089,762            | )          | (3,252,430              | )          |
| Debt  extinguishment expense                    |       | (353,454              | )          | (27,922               | )          | (381,376                | )          |
|                                            |       |                  |       |                  |       |                    |       |
| Net loss                                        |       | $                     | (3,113,298 | )                     | $          | (2,959,853              | )          | $ | (16,278,096 | ) |
|                                            |       |                  |       |                  |       |                    |       |
| Net loss per  common share:                     |       |                  |       |                  |       |                    |       |
| Basic and  diluted                              |       | $                     | (1.98      | )                     | $          | (2.07                   | )          | $ | (16.96 | ) |
|                                            |       |                  |       |                  |       |                    |       |
| Weighted average  number of shares outstanding: |       |                  |       |                  |       |                    |       |
| Basic and  diluted                              |       | 1,572,555             |       | 1,428,540             |       | 960,062                 |       |

 

See accompanying notes to consolidated financial statements.

 

F-4

----

 

**ProUroCare Medical Inc.**

(A DevelopmentStage Company)

 

ConsolidatedStatements of Shareholders’ 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                    |       |
|                                                                                                                                                           |       |                  |       |        |       |            |       |                   |       |                      |       |
| 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                   |       |
|                                                                                                                                                                |            |                       |            |             |            |                 |            |                        |            |                           |            |  |  |  |  |

 

F-5

----

 
| ** **                                                                                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **                | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **                | ** ** |
| ** **                                                                                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**    | ** ** | **Total**                 | ** ** |
| ** **                                                                                                                                                                                                                                                                                    | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                                                                                                                                                                    | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** ** |
| 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**                | ** ** |
| ** **                                                                                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **             | ** ** | ** **                | ** ** |
| 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 $6.70 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                    |       |
|                                                                                                                                                                                                                                                                                               |            |                       |            |             |            |                 |            |                        |            |                           |            |  |  |

 

F-6

----

 
| ** **                                                                                                                                           | ** ** | ** **       | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**            | ** ** | ** **           | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                                                           | ** ** | ** **       | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**        | ** ** | ** **           | ** ** |
| ** **                                                                                                                                           | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the**         | ** ** | **Total**            | ** ** |
| ** **                                                                                                                                           | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                           | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**              | ** ** | **equity (deficit)** | ** ** |
| 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 for 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 $6.70 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               |       |
|                                                                                                                                                 |       |             |       |        |       |            |       |                   |       |                 |       |
| 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 debentures 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 debentures 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  witha note payable on 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               |       |

 

F-7

----

 
| ** **                                                                                                                                                                                                                      | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**               | ** ** | ** **                | ** **      |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|---------------------------|------------|---------------------------|-----------------|
| ** **                                                                                                                                                                                                                      | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **accumulated**           | ** ** | ** **                | ** **      |
| ** **                                                                                                                                                                                                                      | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **during the ** | ** ** | **Total**                 | ** **      |
| ** **                                                                                                                                                                                                                      | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **development** | ** ** | **shareholders’**    | ** ** |
| ** **                                                                                                                                                                                                                      | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **stage**                 | ** ** | **equity (deficit)** | ** **      |
| 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 $6.70 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                   |            |
|                                                                                                                                                                                                                            |       |                  |       |        |       |            |       |                      |       |                      |            |
| 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 debentures 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 a 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 debentures 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                    |            |
|                                                                                                                                                                                                                            |       |                  |       |        |       |            |       |                      |       |                      |            |
| 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** | **)** |
|                                                                                                                                                                                                                                 |            |                       |            |             |            |                 |            |                           |            |                           |                 |  |  |  |  |

 

See accompanying notes toconsolidated financial statements.

 

F-8

----

 

**ProUroCare Medical Inc.**

(A DevelopmentStage Company)

 

ConsolidatedStatements of Cash Flows

 
| ** **                                                                                                              | ** ** | ** **                             | ** ** | ** **                             | ** ** | **Cumulative**                                                        | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | ** **                             | ** ** | ** **                             | ** ** | **period from**                                                  | ** ** |
| ** **                                                                                                              | ** ** | **Year ended  December 31,** | ** ** | **Year ended  December 31,** | ** ** | **August 17,  1999 (inception)  to December 31,** | ** ** |
| ** **                                                                                                              | ** ** | **2007**                               | ** ** | **2006**                               | ** ** | **2007**                                                              | ** ** |
| Cash flows from  operating activities:                                                                                  |       |                                   |       |                                   |       |                                                                  |       |
| Net loss                                                                                                                |       | $                                      | (3,113,298 | )                                      | $          | (2,959,853                                                            | )          | $ | (16,278,096 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                                            |       |                                   |       |                                   |       |                                                                  |       |
| Depreciation and  amortization                                                                                          |       | 3,134                                  |       | 3,897                                  |       | 20,192                                                                |       |
| Gain on sale of  furniture and equipment                                                                                |       | —                                 |       | (2,200                                 | )          | (2,200                                                                | )          |
| Stock-based  compensation                                                                                               |       | 549,384                                |       | 344,234                                |       | 1,705,102                                                             |       |
| Issuance of  common stock for services rendered                                                                         |       | —                                 |       | 53,738                                 |       | 156,904                                                               |       |
| Issuance of  common stock for debt guarantees                                                                           |       | 88,889                                 |       | —                                 |       | 88,889                                                                |       |
| Warrants issued  for services                                                                                           |       | 72,000                                 |       | —                                 |       | 540,636                                                               |       |
| Warrants issued  for debt guarantees                                                                                    |       | —                                 |       | —                                 |       | 320,974                                                               |       |
| Warrants issued  for debt extinguishment                                                                                |       | 310,657                                |       | —                                 |       | 310,657                                                               |       |
| Amortization of  note payable original issue discount                                                                   |       | 113,102                                |       | 114,769                                |       | 242,187                                                               |       |
| Amortization of  convertible debt original issue discount                                                               |       | 244,859                                |       | 209,983                                |       | 454,842                                                               |       |
| Amortization of  debt issuance and deferred offering costs                                                              |       | 506,639                                |       | 505,645                                |       | 1,284,169                                                             |       |
| 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                                                                                                                |       | —                                 |       | 547                                    |       | (189,554                                                              | )          |
| Prepaid expenses                                                                                                        |       | 36,311                                 |       | 34,336                                 |       | 89,289                                                                |       |
| Accounts payable                                                                                                        |       | (46,520                                | )          | 691                                    |       | 730,455                                                               |       |
| Accrued expenses                                                                                                        |       | 229,042                                |       | 34,354                                 |       | 1,009,988                                                             |       |
|                                                                                                                    |       |                                   |       |                                   |       |                                                                  |       |
| Net cash used in  operating activities                                                                                  |       | (963,004                               | )          | (1,659,859                             | )          | (7,224,473                                                            | )          |
|                                                                                                                    |       |                                   |       |                                   |       |                                                                  |       |
| Cash flows from  investing activities:                                                                                  |       |                                   |       |                                   |       |                                                                  |       |
| Purchases of  equipment and furniture                                                                                   |       | —                                 |       | —                                 |       | (20,797                                                               | )          |
| Deposit into a  restricted cash account                                                                                 |       | (44,000                                | )          | —                                 |       | (44,000                                                               | )          |
|                                                                                                                    |       |                                   |       |                                   |       |                                                                  |       |
| Net cash used in  investing activities                                                                                  |       | (44,000                                | )          | —                                 |       | (64,797                                                               | )          |
|                                                                                                                    |       |                                   |       |                                   |       |                                                                  |       |
| Cash flows from  financing activities:                                                                                  |       |                                   |       |                                   |       |                                                                  |       |
| Proceeds of note  payable, bank                                                                                         |       | —                                 |       | —                                 |       | 500,000                                                               |       |
| Payments of note  payable, bank                                                                                         |       | —                                 |       | (400,000                               | )          | (500,000                                                              | )          |
| Proceeds of  notes payable                                                                                              |       | 275,000                                |       | 240,500                                |       | 615,500                                                               |       |
| Payment of notes  payable                                                                                               |       | (54,442                                | )          | (202,812                               | )          | (1,037,296                                                            | )          |
| Proceeds from  long-term notes payable and bank debt                                                                    |       | 1,550,000                              |       | 2,200,000                              |       | 3,750,000                                                             |       |
| Payments on  long-term bank debt                                                                                        |       | (600,000                               | )          | —                                 |       | (600,000                                                              | )          |
| Proceeds from  warrants                                                                                                 |       | 50,000                                 |       | —                                 |       | 50,000                                                                |       |
| Payments for  debt issuance costs                                                                                       |       | (293,260                               | )          | (231,966                               | )          | (525,226                                                              | )          |
| Payment for  rescission of common stock                                                                                 |       | —                                 |       | —                                 |       | (100,000                                                              | )          |
| Net advances  from (payments to) Clinical Network, Inc.                                                            |       | —                                 |       | (8,943                                 | )          | —                                                                |       |
| Proceeds from  loans from officers and directors                                                                        |       | 157,150                                |       | 15,450                                 |       | 172,600                                                               |       |
| Payments of  loans from officers and directors                                                                          |       | (126,850                               | )          | —                                 |       | (126,850                                                              | )          |
| Payments for deferred  offering expenses                                                                                |       | —                                 |       | —                                 |       | (28,827                                                               | )          |
| Cost of reverse  merger                                                                                                 |       | —                                 |       | —                                 |       | (162,556                                                              | )          |
| Net proceeds  from issuance of common stock                                                                             |       | 447,612                                |       | 50,000                                 |       | 5,682,538                                                             |       |
|                                                                                                                    |       |                                   |       |                                   |       |                                                                  |       |
| Net cash  provided by financing activities                                                                              |       | 1,405,210                              |       | 1,662,229                              |       | 7,689,883                                                             |       |
|                                                                                                                    |       |                                   |       |                                   |       |                                                                  |       |
| Net increase in  cash                                                                                                   |       | 398,206                                |       | 2,370                                  |       | 400,613                                                               |       |
|                                                                                                                    |       |                                   |       |                                   |       |                                                                  |       |
| Cash, beginning  of the period                                                                                          |       | 2,407                                  |       | 37                                     |       | —                                                                |       |
|                                                                                                                    |       |                                   |       |                                   |       |                                                                  |       |
| Cash, end of the  period                                                                                                |       | $                                      | 400,613    |                                   | $          | 2,407                                                                 |       | $ | 400,613 |   |

** **

**F-9**

----

** **
| ** **                                                                                                                                                                               | ** ** | ** **            | ** ** | ** **            | ** ** | **Cumulative**                | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                               | ** ** | ** **            | ** ** | ** **            | ** ** | **period from**          | ** ** |
| ** **                                                                                                                                                                               | ** ** | ** **            | ** ** | ** **            | ** ** | **August 17,**           | ** ** |
| ** **                                                                                                                                                                               | ** ** | **Year ended**   | ** ** | **Year ended**   | ** ** | **1999 (inception)**     | ** ** |
| ** **                                                                                                                                                                               | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **to December 31,** | ** ** |
| ** **                                                                                                                                                                               | ** ** | **2007**              | ** ** | **2006**              | ** ** | **2007**                      | ** ** |
| Supplemental  cash flow information:                                                                                                                                                     |       |                  |       |                  |       |                          |       |
| Cash paid for  interest                                                                                                                                                                  |       | $                     | 235,355    |                  | $          | 214,509                       |       | $ | 593,336 |   |
|                                                                                                                                                                                     |       |                  |       |                  |       |                          |       |
| Non-cash  investing and financing activities:                                                                                                                                            |       |                  |       |                  |       |                          |       |
| Conversion of  notes payable into long-term convertible debentures                                                                                                                       |       | $                     | 175,000    |                  | $          | —                        |       | $ | 175,000 |   |
| Conversion of  loans from directors into long-term convertible debentures                                                                                                                |       | 25,000                |       | —                |       | 25,000                        |       |
| Deferred  offering costs included in accounts payable                                                                                                                                    |       | 109,988               |       | —                |       | 109,988                       |       |
| Deferred  offering costs included in accrued expenses                                                                                                                                    |       | 22,650                |       | —                |       | 22,650                        |       |
| Debt issuance  costs included in accounts payable                                                                                                                                        |       | 55,817                |       | —                |       | 55,817                        |       |
| Warrants issued pursuant  to notes payable                                                                                                                                               |       | 112,440               |       | 103,247               |       | 324,187                       |       |
| Prepaid expenses  financed by note payable                                                                                                                                               |       | 42,585                |       | 37,312                |       | 111,022                       |       |
| Common stock  issued in lieu of cash for accrued expenses                                                                                                                                |       | 111,993               |       | —                |       | 229,636                       |       |
| Common stock  issued for debt issuance cost                                                                                                                                              |       | 66,666                |       | 22,750                |       | 158,167                       |       |
| Common stock  issued in lieu of cash for accounts payable                                                                                                                                |       | 20,704                |       | —                |       | 122,291                       |       |
| Common stock  issued in lieu of cash for loans from officers and directors                                                                                                               |       | 10,300                |       | —                |       | 10,300                        |       |
| Proceeds from  sale of furniture and equipment                                                                                                                                           |       | —                |       | 2,200                 |       | 2,200                         |       |
| Convertible debt  issued as debt issuance costs related to guarantee of long-term debt  (recorded as a beneficial conversion in additional paid-in capital) applied  to accounts payable |       | —                |       | 733,334               |       | 733,334                       |       |
| Issuance of note  payable for redemption of common stock                                                                                                                                 |       | —                |       | —                |       | 650,000                       |       |
| Warrants issued  for debt issuance costs                                                                                                                                                 |       | —                |       | —                |       | 242,612                       |       |
| Conversion of  accounts payable to note payable                                                                                                                                          |       | —                |       | —                |       | 241,613                       |       |
| Deposits applied  to note payable and accrued interest                                                                                                                                   |       | —                |       | —                |       | 142,696                       |       |
| Deposits applied  to accounts payable                                                                                                                                                    |       | —                |       | —                |       | 45,782                        |       |
| Assumption of  liabilities in the Profile, LLC transaction                                                                                                                               |       | —                |       | —                |       | 25,000                        |       |
| Deposits applied  to accrued expenses                                                                                                                                                    |       | —                |       | —                |       | 1,076                         |       |

** **

See accompanying notes to consolidated financial statements.

 

F-10

----

 

**ProUroCareMedical Inc.**

 

**ADevelopment Stage Company**

** **

**Notesto Consolidated Financial Statements**

** **

**December 31,2007 and 2006 and the period fromAugust 17, 1999 (inception) to December 31, 2007**

** **

**(1) Description of Business and Summary of Significant 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 that is developingdiagnostic equipment and treatments for enlarged prostates and other maleurological conditions.  The Company’sdevelopmental activities, conducted by its wholly owned operating subsidiaryProUroCare Inc. (“PUC”), have included the acquisition of several technologylicenses, the development of a strategic business plan and a senior managementteam, product development, and fund raising activities.

 

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

 

Pursuant to a mergeragreement effective April 5, 2004 (the “Merger”), PUC became a whollyowned operating subsidiary of Global Internet Communications, Inc. (“Global”),which changed its name to ProUroCare Medical Inc. on April 26, 2004.  In connection with the Merger, the Companycompleted a private placement of 220,500 shares of common stock (the “2004 PrivatePlacement”) pursuant to Rule 506 promulgated under the Securities Act of1933, as amended.

 

On December 27, 2007, the Company’s shareholders, in awritten action executed by shareholders holding a majority of the Company’scommon stock, approved a one-for-ten reverse split of the Company’s commonstock without acorresponding reduction in the number of authorized shares of the Companycapital stock (the “Reverse Split”).  Thereverse stock split became effective on February 14, 2008.  The exercise price and the number of sharesof common stock issuable under the Company’s outstanding convertibledebentures, options and warrants were proportionately adjusted to reflect thereverse stock split for all periods presented.

 

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly owned subsidiary, PUC. Significant inter-company accounts and transactions have been eliminatedin consolidation.

 

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

*** ***

All share data has beenrestated to give effect to the Reverse Split.

 

At the effective time of theMerger, all 350,100 shares of common stock of PUC that were outstandingimmediately prior to the Merger and held by PUC shareholders were cancelled,with one share of ProUroCare common stock issued to Global.  Simultaneously, the non-dissentingshareholders of PUC received an aggregate of 960,300 shares of common stock ofGlobal in exchange for their aggregate of 

 

F-11

----

 

320,100 shares of PUC.  The share data in this paragraph has beenrestated to give effect to the Reverse Split, as noted above.

 

All share data has beenrestated to give effect to the Merger under which each PUC share was convertedinto three shares of Global.

 

***(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 Standard (“SFAS”) No. 123 (revised2004), **Share-BasedPayment**(“SFAS 123R”), which requires the measurement andrecognition of compensation expense for all share-based payment awards made toemployees 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. The resulting original issue discount is amortizedover the life of the promissory notes (generally no more that 24 months) usingthe 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 stock split (see Note 1(b)).  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 commonshare in subsequent years.  All optionsand warrants outstanding were antidilutive for the years ended December 31,2007 and 2006 and the period from August 17, 1999 (inception) to December 31,2007 due to the Company’s net losses. 1,167,686 and 635,343 shares of common stock issuable under our stockoptions, warrants, convertible debentures, and contingent shares and warrantsissuable under agreements with loan guarantors were excluded from thecomputation of diluted net loss per common share for the years ended December 31,2007 and 2006, respectively, because their effect was anti-dilutive for thoseyears.  In addition, the shares issuablepursuant to the convertible notes and warrants issued in connection with our December 27,2007 private placement and the similar convertible notes and warrants issued in

 

F-12

----

 

connectionwith the conversion of notes payable, as described in Note 9(c), were excludedfrom the computation of diluted net loss per common share for the year ended December 31,2007 because their effect was anti-dilutive. The number of such shares issuable will be determined at a future date.

 

***(e)***                      Comparative Figures

*** ***

Certain comparative figureshave been reclassified to conform to the financial statement presentationadopted in the current year.

 

***(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 withacquisition of licenses for technology are recognized at the fair value ofstock and cash used as consideration. The annual discount rates used in thesecalculations reflect the high commercial risk of a development stage businessand are typically within the range of 40–60 percent.

 

Costs of acquiringtechnology which has no alternative future uses are expensed immediately asresearch and development expense.

 

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

*** ***

The Company reviewslong-lived assets and certain identifiable intangibles for impairment wheneverevents or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. Recoverability of assets to be held and used ismeasured by a comparison of the carrying amount of an asset to futureundiscounted net cash flows expected to be generated by the asset. If suchassets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the assets exceeds thefair value of the assets. Assets to be disposed of are reported at the lower ofthe carrying amount or fair value less costs to sell.

 

During the years ended December 31,2007 and 2006, and the period from August 17, 1999 (inception) to December 31,2007, the Company did not record any impairment charge.

 

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

*** ***

Effective August 17,1999, the Company adopted the fair value recognition provisions of FinancialAccounting Standards Board (“FASB”) SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”), to record option and warrant issuances,including stock-based employee compensation. The Company’s policy is to grant stock options at fair value at the dateof grant, and to record the expense at fair value as required by SFAS 123,using the Black-Scholes pricing model.

 

EffectiveJanuary 1, 2006, the Company adopted SFAS No. 123R, that focusesprimarily on accounting for transactions in which an entity obtains employeeservices in share-based payment transactions. This statement replaced SFAS 123, and supersedes Accounting PrinciplesBoard (“APB”) Opinion No. 25,

 

F-13

----

 

“Accountingfor Stock Issued to Employees.”  SFAS123R requires all companies to expense the fair value of employee stock optionsand similar awards, which has been the Company’s policy to date.  Stock-based employee and non-employeecompensation cost related to stock options was $453,384, $344,234, and$1,582,078 for the years ended December 31, 2007 and 2006, and the periodfrom August 17, 1999 (inception) to December 31, 2007, respectively,or $0.29, $0.24, and $1.65 on a per share basis.  The Company estimates the amount of futurestock-based compensation expense related to currently outstanding options to beapproximately $37,300 and $1,800 for the years ending December 31, 2008and December 31, 2009, respectively. The Company recognizes the expense related to the fair value of theaward straight-line over the vesting period.

 

The Black-Scholesoption-pricing model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable. Inaddition, option pricing models require the input of highly subjectiveassumptions. Because the Company’s employee and consultant stock options havecharacteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, the existing models may not necessarily provide a reliablesingle measure of the fair value of the Company’s employee stock options.

 

In determining the compensation cost of the optionsgranted during the years ended December 31, 2007 and 2006, as specified bySFAS 123R and SFAS 123, the fair value of each option grant has been estimatedon the date of grant using the Black Scholes pricing model and the weightedaverage assumptions used in these calculations are summarized as follows:

 
| ** **                        | ** ** | **For the years ended  December 31,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                                  | ** ** | **2006** | ** ** |
| Risk-free  Interest Rate          |       | 4.90                                                      | %          | 4.74 | % |
| Expected Life of  Options Granted |       | 4.0 years                                                 | (1)        | 2.9 years | (1) |
| Expected  Volatility              |       | 133.4                                                     | %          | 132.7 | % |
| Expected  Dividend Yield          |       | 0                                                         |       | 0 |   |

 

----

(1) Calculated as the average ofthe vesting periods and the contractual term of the options.

 

Theexpected life of the options is determined using a simplified method, computedas the average of the option vesting periods and the contractual term of theoption.  For performance based optionsthat vest upon the occurrence of an event, the Company uses an estimate of whenthe event will occur as the vesting period used in the Black-Scholescalculation for each option grant. Because of the limited trading history of the Company’s stock, theexpected volatility is based on a simple average of daily price data since thedate of the Merger on April 5, 2004. Management expects and estimates that substantially all employee stockoptions will vest, and therefore the forfeiture rate used was zero.  The risk-free rates for the expected terms ofthe stock options and awards are based on the U.S. Treasury yield curve ineffect at the time of grants.

 

***(k)***                     Warrants

*** ***

In accordance with EmergingIssues Task Force (“EITF”) No. 96-18, “Accounting for Equity Instrumentsthat are Issued to Other than Employees for Acquiring, or in Conjunction withSelling, Goods and Services” and EITF No. 98-5, “Accounting forConvertible Securities with Beneficial Conversion Features or ContingentlyAdjustable Conversion Ratios” (“EITF No. 98-5”), the Company has electedto utilize the fair-value method of accounting for warrants issued tonon-employees as consideration for goods or services received, includingwarrants issued to lenders and guarantors of 

 

F-14

----

 

Company debt (see Notes 8,9, and 10).  The weighted-average fairvalue of the warrants granted during the years ended December 31, 2007 and2006 was $3.80 and $5.20, respectively, and such warrants are immediatelyvested and exercisable on the date of grant.

 

The fair value of stock warrants is the estimatedpresent value at grant date using the Black-Scholes pricing model with thefollowing weighted average assumptions:

 
| ** **                           | ** ** | **For the years ended  December 31,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                           | ** ** | **2007**                                                  | ** ** | **2006** | ** ** |
| Risk-free  Interest Rate             |       | 4.68                                                      | %          | 4.66 | % |
| Expected Life of  Warrants Issued(1) |       | 4.9 years                                                 |       | 5 years |   |
| Expected  Volatility                 |       | 135.0% percent                                            |       | 135.3 | % |
| Expected  Dividend Yield             |       | 0                                                         |       | 0 |   |

 

----

(1) The contractualterm of the warrants.

 

Theexpected volatility is based on daily price data since the date of the Mergeron April 5, 2004.  Based on the lackof history to calculate a forfeiture rate, the Company has not adjusted thecalculated value of the options.  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 are expensed as incurred.

 

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

*** ***

Debt issuance costs areamortized over the term of the related debt as interest expense using the straight-linemethod, 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 retired, and approximately $42,800 of debt issuance cost related tothat portion of the notes was expensed as debt extinguishment expense.  The debt issuance cost associated with theremaining Crown Bank notes were amortized as interest expense until December 28,2007, when the notes were modified to extend the maturity date of the notes to February 28,2009.  The Company evaluated thismodification in accordance with EITF 96-19 “Debtor’s Accounting for aModification or Exchange of Debt Instruments”.  The change in the agreement did not qualify asan extinguishment of debt; therefore, debt issuance cost from the old debt iscarried forward.  The remaining $39,370 ofunamortized debt issuance cost, together with $12,000 of bank fees associatedwith the extension, is being amortized using the straight-line method over thenew term of the notes as interest expense, which approximates the interestmethod.

 

F-15

----

 

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 matures 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 using the straight-line method, whichapproximates the interest method.

 

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 9(c)).  Direct costs of theoffering totaling $337,077, including underwriting fees, legal and accountingexpenses, and printing costs were recorded as a debt issuance cost asset andare being amortized using the straight-line method, which approximates the interestmethod, over the 18-month term of the convertible debentures.

 

**Debt issuance costsare summarized as follows:**

 
| ** **                  | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
| Debt issuance  costs, gross |       | $        | 452,113    |     | $          | 1,025,931 |   |
| Less  amortization          |       | (12,792  | )          | (452,918 | )          |
|                        |       |     |       |     |       |
| Debt issuance  costs, net   |       | $        | 439,321    |     | $          | 573,013 |   |

 

Amortization expense related to debt issuance costs was $506,639,$505,645, and $1,284,169 for the years ended December 31, 2007 and 2006and the period from August 17, 1999 (inception) to December 31, 2007,respectively.

 

Futureamortization of debt issuance costs for the years succeeding December 31,2007 are as follows:

 
| **Year** | ** ** | **Amortization** | ** ** |
|----------|------------|------------------|------------|
| 2008     |       | $                | 315,097    |   |
| 2009     |       | 124,224          |       |
| Total    |       | $                | 439,321    |   |

 

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

*** ***

The legal fees related tothe Company’s January 2008 private placement of convertible debentures andan anticipated public offering it expects to complete in the first quarter of2008 were recorded as a deferred offering cost asset as of December 31,2007.  The deferred costs related to theCompany’s January 2008 private placement offering became debt issuancecost upon the closing of the offering, and are being amortized as interestexpense over the term of the debentures using the straight-line method, whichapproximates the interest method (see Note 13). The deferred costs related to the anticipated public offering will berecorded as a cost of the offering upon its closing, or expensed as a generaland administrative expense if no such closing occurs.

 

***(p)***                     Restricted Cash

*** ***

Pursuant to the renewal ofthe Crown Bank promissory notes (see Note 9(a)), the Company agreed to depositwith Crown Bank four months worth of future interest payments due under thenotes.  The Company has further agreed todeposit with Crown Bank all of the interest due on the notes through

 

F-16

----

 

maturity upon the closing,and out of the net proceeds of, afuture underwritten public offering of equity securities of the Company.  The funds on deposit are not available to theCompany for any purpose other than for debt service on the Crown Bankpromissory notes.

 

***(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

*** ***

DuringFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159 permits entities to choose tomeasure many financial instruments and certain other items at fair value. SFAS159 is effective for fiscal years beginning after November 15, 2007. The Company does not believe the adoption of SFAS 159 will have on its resultsof operations and financial position.

 

DuringDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements an amendment of ARB No. 51”(“SFAS 160”).  SFAS 160 establishesaccounting and reporting standards for noncontrolling interests in subsidiariesand for the deconsolidation of subsidiaries and clarifies that a noncontrollinginterest in a subsidiary is an ownership interest in the consolidated entitythat should be reported as equity in the consolidated financialstatements.  SFAS 160 also requiresexpanded disclosures that clearly identify and distinguish between theinterests of the parent owners and the interests of the noncontrolling ownersof a subsidiary.  SFAS 160 is effectivefor fiscal years beginning on or after December 15, 2008.  The Company does not believe that theadoption of SFAS 160 will have a material effect on its results of operationsor financial position.

 

DuringDecember 2007, the FASB issued SFAS No. 141 (Revised 2007), “BusinessCombinations” (“SFAS 141R)”).  While SFAS141R retains the fundamental requirement of SFAS 141 that the acquisitionmethod of accounting (which SFAS 141 called the *purchase method*) be used for all business combinations, SFAS141R now establishes the principles and requirements for how an acquirer in abusiness combination:  recognizes andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed, and any noncontrolling interests in the acquiree;recognizes and measures the goodwill acquired in the business combination orthe gain from a bargain purchase; and determines what information should bedisclosed in the financial statements to enable the users of the financialstatements to evaluate the nature and financial effects of the businesscombination.** **SFAS141R is effective for fiscal years beginning on or after December 15,2008.  The Company does not believe thatthe adoption of SFAS 141R will have a material effect on its results ofoperations or financial position.

 

DuringMarch 2008, the FASB issued SFAS No. 161, “Disclosure aboutDerivative Instruments and Hedging Activities” (“SFAS 161”).  SFAS 161 is intended to improve financialreporting about derivative instruments and hedging activities by requiringenhanced disclosures to enable investors to better understand their effects onan entity’s financial position, financial performance, and cash flows.  SFAS 161 also improves transparency about thelocation and amounts of derivative instruments in an entity’s financialstatements; how derivative instruments and related hedging activities areaccounted for under Statement 133; and how derivative instruments and relatedhedged items affect its financial position, financial performance, and cashflows.

 

F-17

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SFAS161 is effective for financial statements issued for fiscal years and interimperiods beginning after November 15,2008, with early applicationencouraged.  The Company does not believethe adoption of SFAS 161 will have a material effect on its results ofoperations or financial position.

 

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

 

The Company incurred netlosses of $3,113,298, $2,959,853, and $16,278,096 and negative cash flows fromoperating activities of $1,007,004, $1,659,859, and $7,268,473 for the yearsended December 31, 2007 and 2006 and for the cumulative period from August 17,1999 (inception) to December 31, 2007, respectively. From July 2001through January 2002, the Company entered into several licensearrangements to develop the licensed technologies into diagnostic equipment andtreatments for enlarged prostates and other male urological conditions. Since January 2002,the Company’s efforts to develop the licensed technologies have beensignificantly delayed at times due to a lack of sufficient capitalresources.  The Company anticipatesmaterially increasing its expenditures for technology development activitiesand building the Company’s infrastructure over the near term.  Implementation of the Company’s business planis dependent upon the successful transition of its product development programinto a viable product with market penetration and profitability and obtainingsufficient capital to fund these developmental activities.

 

We do not currently have sufficient funds tocomplete the development of our products and gain approval of them from theFDA.  As of February 29, 2008, wehad approximately $230,000 cash on hand and current liabilities ofapproximately $4.1 million.  We estimatethat we will need approximately $3.5 million of cash over the next 12 months tocomplete the development of a first generation system, submit a premarketnotification application to FDA, obtain FDA clearance of a 510(k) for abasic labeling mapping and data maintenance claim.  In addition we have $2.2 million of secureddebt and $733,334 of convertible debt, both of which mature at the end ofFebruary, 2009, and other short term liabilities exceeding $1,150,000.

 

During the next 12 months, we plan to raiseapproximately $5.1 million through private or public offerings of our debt orequity securities, alternative financing sources that may become available tous, or a combination of these.  Weanticipate that the net proceeds from such financings will be sufficient tofund our operations and retire approximately $700,000 of short termliabilities. We intend to address the $2.2 million secured debt that matures inFebruary, 2009 by seeking an equity investment or licensing fee from astrategic marketing partner, or by seeking an extension of the maturity dates.  We expect that the convertible debt will beconverted into common stock during the next 12 months.  If we are unsuccessful in obtaining an equityinvestment or licensing fee or an extension of the maturity date of the secureddebt, or if the convertible debt is not converted into our common stock, wewill need to raise additional funds.

 

Sources of alternative financing include possible strategic investmentsfrom medical device companies that may be interested in marketing products inthe prostate cancer detection market.  Inaddition to financial support, a successful collaboration with such a companywould allow us to gain access to down stream marketing, manufacturing, andsales support. However, if our financing efforts are unsuccessful orsignificantly delayed for any reason, or if our product development effortsexperience significant unforeseen delays, we may not have sufficient funds tocomplete these objectives, and will require additional financing.

 

Approximately $2.3 million of our outstanding convertible debentureswill automatically convert into equity upon our closing an underwritten publicoffering.  In addition, to date we haveissued a total of 334,000 warrants to date in our 2007 and 2008 privateplacement transactions, and additional warrants may be issued pursuant to ourfinancing efforts.

 

 

F-18

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We are attempting to raise enough cash to complete the development of afirst generation ProUroScanTM system and to seek or obtain FDAclearance of a 510(k) on a basic mapping and data maintenance claim.  If additional funds are raised by theissuance of convertible debt or equity securities, such as the issuance ofstock, or the issuance and exercise of warrants or the issuance and conversionof convertible debentures, then existing shareholders will experience dilutionin their ownership interests.  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 commonstock.  If adequate funds are not available through these initiatives on a timelybasis, or are not available on acceptable terms, we may be unable to fund expansion,or to develop or enhance our products. Ultimately, if no additional financing is obtained beyond what has beensecured to date, we could potentially be forced to cease operations.

 

Assuming successful completion of our currentfinancing efforts and if product development is completed on schedule, weexpect to pursue one or more additional rounds of funding during 2009 and 2010 toprovide the additional working capital needed to fund a significant commerciallaunch into the urology market.  If additionalfunds are raised by the issuance of convertible debt or equity securities, suchas the issuance of stock, the issuance and exercise of warrants, or theissuance and conversion of convertible debentures, then existing shareholderswill experience dilution in their ownership interest.  If additional funds are raised by theissuance of debt or certain equity instruments, we may become subject tocertain operational limitations, and such securities may have rights senior tothose of our existing holders of common stock.

 

**(3)**                     Equipment and Furniture

** **

Equipment and furnitureconsisted of the following at December 31:

 
| ** **                     | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Computer  equipment            |       | $        | 11,563     |     | $          | 11,563 |   |
| Furniture                      |       | 4,279    |       | 4,279    |       |
|                           |       | 15,842   |       | 15,842   |       |
| Less accumulated  depreciation |       | (15,237  | )          | (12,103  | )          |
|                           |       | $        | 605        |     | $          | 3,739 |   |

 

Depreciation expense was$3,134, $3,897, and $20,192 for the years ended December 31, 2007 and 2006and the period from August 17, 1999 (inception) to December 31, 2007,respectively.

 

**(4)**                     Accrued Expenses

** **

Accruedexpenses consisted of the following at December 31:

 
| ** **                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Accrued  compensation, benefits, and related taxes |       | $        | 535,537    |     | $          | 482,139 |   |
| Accrued interest                                   |       | 156,222  |       | 83,696   |       |
| Contracted  development                            |       | 35,000   |       | —   |       |
| Legal fees                                         |       | 29,750   |       | —   |       |
| Audit fees                                         |       | 21,250   |       | 35,550   |       |
| Consulting fees                                    |       | 15,000   |       | 15,000   |       |
| Directors’ fees                               |       | 9,166    |       | 45,832   |       |
| Other                                              |       | —   |       | 9        |       |
|                                               |       | $        | 801,925    |     | $          | 662,226 |   |

 

F-19

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**(5)**                     License Agreements

** **

***Profile LLC***

*** ***

In January 2002,Profile granted the Company an exclusive license for prostate imaging systemsin exchange for 323,077 shares of the Company’s common stock and the assumptionof $25,000 of Profile net liabilities. On March 22, 2002, in exchange foreliminating certain covenants of the license agreement, the Company issuedProfile an additional 76,923 shares of its common stock.  The license requires royalties ranging from1.05 percent to 3.05 percent of defined revenues.  The field of use for the exclusive license islimited to the diagnosis and treatment of enlarged prostate, prostatitis,prostate cancer, or other conditions of or disorders of the prostate which maybe diagnosed, imaged, or treated using any diagnostic or imaging process.  The license will terminate upon the later ofthe date of expiration of the last patent to expire included in the licensedtechnology or the date that the Company permanently ceases the sale of devicesusing the technology.

 

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.

 

***CS Medical***

*** ***

In July 2001, theCompany licensed certain microwave technology from CS Medical.  The worldwide, exclusive license is limitedto the field of use of the treatment of enlarged prostates, prostatitis,prostate cancer, and other urological disorders, and terminates with theexpiration of the last patent to expire that is the subject of the license andrequires defined royalty payments.

 

As consideration for thelicense, the Company exchanged 300,000 shares of its common stock valued at$475,000. This consideration was expensed as research and development.

 

Under the terms of thelicense agreement, royalty payments are to be made quarterly in an amount equalto 0.5 percent of the amount that net sales of the Company’s products thatincorporate the licensed technology exceed $500,000 in that quarter.  In the absence of revenues, we are notobligated to make any royalty payments to CS Medical.

 

***RPI Agreement***

*** ***

In July 2001, theCompany entered into a license agreement with Rensselaer Polytechnic Institute(“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. On July 27, 2005,the Company and RPI entered into Amendment No. 1 to the RPI license.  Under the terms of the amended license,  the license period continues until theexpiration of RPI patents unless earlier terminated due to lack of performance,as outlined below.

 

Consideration for thelicense was $50,000, paid in two $25,000 installments, which were expensed asresearch and development in fiscal 2001. Royalties are payable to RPI on the basis of 3 percent of the net salesof the therapeutic product if the primary function of the device is tomographyor 1 percent of net sales if the primary function of the final system is nottomography.  RPI is entitled to receiveminimum annual licensing fees of $20,000 to maintain the license.

 

F-20

----

 

**We have temporarily suspendedpayment of the minimum licensing fees required by the RPI license agreement tomaintain exclusive rights to the technology, but we do retain non-exclusiverights as long as the license agreement remains in effect.  Under the terms of the amended license, thelicense terminates if no licensed product is available for sale by July 13,2009.  We believe that due to theadditional project work required it is unlikely this deadline will beachieved.  Although we believe that wewill be able to successfully negotiate an extension of this deadline with RPI,we cannot give assurance of this.  If weare unsuccessful in obtaining sufficient funds to continue development of thistechnology, resolving the key project factors noted above, or negotiating anextension of the RPI license, the development efforts with Urologix may beterminated, and we may abandon the EIT technology**

** **

**(6)**                     Commitments and Contingencies

** **

***(a)***                     Lease

*** ***

TheCompany’s executive offices are temporarily located within the offices of aformer Company director, Mr. Nazarenko. Our rental cost for these temporary offices is approximately $2,129 permonth, which we believe is at market for similar office space in Minneapolis,Minnesota.

 

Rent expense for the yearsended December 31, 2007 and 2006, and the period from August 17, 1999(inception) to December 31, 2007 was $ 21,286, $47,519, and $233,144,respectively.

 

***(b)***                     Employment Agreements

*** ***

OnJuly 21, 2007, PUC entered into an employment agreement with its ChiefFinancial Officer, Richard Thon.  Theagreement extends through June 30, 2009. The agreement provides for aminimum annual salary of $140,000, a cash incentive bonus potential of up to 30percent of Mr. Thon’s base pay and eligibility to participate in an annualgrant of options to purchase shares of common stock, as determined by theCompany’s Board of Directors.  Theagreement provides for severance payments if the Company terminates Mr. Thonwithout cause or if Mr. Thon terminates the agreement for good reason,including four months of base salary plus one month of base salary for eachyear of service (up to a maximum of nine months of base salary), payment ofearned bonuses, continued payment of existing health and life insurancebenefits for a period of four months and immediate vesting of all unvestedstock options then held by Mr. Thon. In addition, within a one-year period following a “change in control” ofthe Company, upon termination without cause, unacceptable demotion or reductionin responsibilities, or a relocation of more than 100 miles, Mr. Thon willreceive as severance, six months of base salary plus one month of base salaryfor each year of service (up to a maximum of 12 months of base salary), andimmediate vesting of all unvested stock options then held by Mr. Thon.  The agreement prohibits Mr. Thon fromdirectly or indirectly participating in the ownership, management, operation orcontrol of a competitive business for a period of one year after his employmentwith the Company terminates.

 

Duringthe year ended December 31, 2006, the Company was also party to anemployment agreement with Mr. Taylor, its former Chief Executive Officer,which terminated with his retirement from that position effective November 1,2006.  Mr. Taylor continued to beemployed by the Company in a transition role until March 31, 2007.  The employment agreement with Mr. Taylorprovided for an annual salary of $190,000 and maximum bonus potential of 75percent of his base pay.  Due to fundinglimitations, the Company was unable to pay Mr. Taylor’s salary between June 15,2006 and March 31, 2007.  On May 11,2007, the Company entered into an agreement with Mr. Taylor to defer thepayment of his accrued salary further according to an agreed uponschedule.  Under the terms of theagreement, the Company agreed to pay Mr. Taylor’s accrued salary totaling$141,017 in installments of $5,000 per month from June 1, 2007 through December 1,2007, with the $106,017 balance being paid prior to December 28,2007.  The Company did not make $101,017of the required December 28, 2007 payment. On February 14, 2008, theCompany paid the balance of the accrued salary plus $8,316 

 

F-21

----

 

pursuant to certain late payment clauses in thedeferred payment agreement (see Note 13). No further payments are due to Mr. Taylor under either hisemployment agreement or the deferred payment agreement.  As consideration for his agreement to defer payment of his accruedsalary, the Company extended the original one-year period that Mr. Taylormay exercise 45,000 of his stock options (including options gifted to hischildren) following his termination of employment until April 1, 2012 (seeNote 10(h)).

 

TheCompany was also party to an employment agreement with Mr. Grossman, itsformer President and Chief Operating Officer, that expired on January 31,2007.  The Company elected not to renewthe employment agreement.  Mr. Grossman’sagreement provided for an annual salary of $175,000 with a maximum bonuspotential of 50 percent of his base pay. Due to funding limitations, the Company was unable to pay Mr. Grossman’ssalary between June 15, 2006 and January 23, 2007.  On May 11, 2007, the Company enteredinto an agreement with Mr. Grossman to defer the payment of his accruedsalary further according to an agreed upon schedule.  The Company paid Mr. Grossman’s accruedsalary totaling $103,990 in installments of $4,000 on May 15, 2007, $6,000on June 1, 2007, and $8,000 per month from July 1, 2007 through December 1,2007, with the $45,990 balance paid out of the proceeds of the 2007 PrivatePlacement on December 28, 2007.  Asconsideration for his agreement to defer payment of his accrued salary, theCompany extended the original one-year period that Mr. Grossman mayexercise 45,000 of his stock options (including options gifted to his children)following his termination of employment until February 1, 2012 (see Note10(h)).  Except in the event of a breachof the agreement, the parties also agreed to release and waive each other fromall damages, actions, lawsuits, or claims the other party may have arising outof the employment of Mr. Grossman and the conclusion of that employment.

 

At December 31, 2007, approximately $313,000 ofour current senior management’s salaries and bonuses had not been paid, andwere recorded as an accrued expense.

 

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

 

The Company is involved inroutine legal proceedings in the conduct of the ordinary course of itsbusiness.

 

***(d)***                     Artann 2007 Cooperation Agreement

*** ***

On April 16, 2007, the Company entered into an agreement (the “CooperationAgreement”) with Artann Laboratories Inc. (“Artann”) in which the partiesagreed to terminate their previous research and development agreement and touse their best efforts to finalize a new development agreement within areasonable period of time.  TheCooperation Agreement establishes a platform for joint cooperation inestablishing the new development agreement, which will define a process for thejoint development of a next generation prostate mechanical imaging system withenhanced functionalities.  TheCooperation Agreement terminates the research and development agreement, andreleases each party from all undischarged obligations and liabilities underthat 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 will berecorded as research and development expense. The Company also paid to Artann $35,000 on January 11, 2008, as afirst payment for work already completed under the proposed developmentagreement.

 

F-22

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**(7)**                     Income Taxes

** **

The Company has generated net operating losscarryforwards of approximately $4.1 million which, if not used, will begin toexpire in 2021.  Federal and state taxlaws impose significant restrictions on the utilization of net operating losscarryforwards in the event of a change in ownership of the Company thatconstitutes an “ownership change,” as defined by Section 382 of theCode.  The Company has analyzed theMerger and private placement transactions that occurred in April 2004, andbelieves that they do not constitute such an ownership change.  However, additional shares and warrantslikely to be issued pursuant to the Company’s current financing efforts (seeNote 2), together with certain transactions occurring in the previous 36-monthperiod, may constitute a change in ownership that could subject the Company’suse of its net operating loss carryforwards to the above limitations.  Based on the Company’s estimates, thelimitation would apply to substantially all of the $4.1 million net operatingloss carryforwards.

 

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:

 
| ** **                                               | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|----------------------------------------------------------|------------|------------|------------|------------|------------|
| Deferred tax  assets                                     |       |       |       |       |       |
| Net operating  loss carryforwards                        |       | $          | 1,566,000  |       | $          | 1,153,000 |   |
| Capitalized  start up costs                              |       | 2,450,000  |       | 2,100,000  |       |
| Expenses paid  with options and warrants                 |       | 836,000    |       | 598,000    |       |
| Capitalized  licenses                                    |       | 416,000    |       | 461,000    |       |
| Other                                                    |       | 149,000    |       | 164,000    |       |
| Deferred tax  liability                                  |       |       |       |       |       |
| Beneficial  conversion feature of convertible debentures |       | (347,000   | )          | (201,000   | )          |
| Less: valuation  allowance                               |       | (5,070,000 | )          | (4,275,000 | )          |
| Net deferred tax  assets                                 |       | $          | 0          |       | $          | 0 |   |

 

Thechange in the valuation allowance was $795,000, $725,000, and $5,070,000 forthe years ended December 31, 2007 and 2006 and the period from August 17,1999 (inception) to December 31, 2007, 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 2007 and 2006 issuances of convertible debt and the remaining deferred taxliability at December 31, 2007 and 2006 was $347,000 and $201,000,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, 2007 and 2006.

 

F-23

----

 

Reconciliation between thefederal statutory rate and the effective tax rates for the years ended December 31,2007 and 2006 and the period from August 17, 1999 (inception) to December 31,2007 is as follows:

 
| ** **                           | ** ** | **2007** | ** ** | **2006** | ** ** | **Period from  August 17,  1999  (inception) to  December 31,  2007** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|-------------------------------------------------------------------------------------------|------------|
| 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    |       | 2.5      |       | 4.1      |       | 2.4                                                                                       |       |
| Expired warrants  and options        |       | 2.6      |       | —   |       | 0.6                                                                                       |       |
| Capitalized  license fees            |       | —   |       | —   |       | 1.1                                                                                       |       |
| Change in  valuation allowance       |       | 33.4     |       | 34.4     |       | 34.4                                                                                      |       |
| Effective tax  rate                  |       | 0.0      | %          | 0.0      | %          | 0.0                                                                                       | %          |

 

InJuly 2006, the FASB issued Interpretation No. 48, “Accounting forUncertainty in Income Taxes” (“FIN 48”). FIN 48 prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in its tax return.FIN 48 also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure and transition. FIN 48 iseffective in fiscal years beginning after December 15, 2006. Theprovisions of FIN 48 are to be applied to all tax positions upon initialadoption, with the cumulative effect adjustment reported as an adjustment tothe opening balance of retained earnings. The Company adopted FIN 48 as of January 1,2007, and the adoption had no significant impact on the Consolidated FinancialStatements.

 

Thefollowing are disclosures made pursuant to the initial adoption of FIN 48:

 

The Company has adopted the policy of classifying interest in interestexpense and penalties in general and administrative expense.  The Company had recorded no accrued interestor penalties as of the date of adoption.

 

The Company had no significant unrecognized tax benefits as of December 31,2007 and, likewise, no significant unrecognized tax benefits that, ifrecognized, would affect the effective tax rate.  The Company has generated net operating losscarryforwards of approximately $4.1 million which, if not used, will begin toexpire in 2021.  Federal and state taxlaws impose significant restrictions on the utilization of net operating losscarryforwards in the event of a change in ownership of the Company thatconstitutes an “ownership change,” as defined by Section 382 of theInternal Revenue Code of 1986, as amended (the “Code”).

 

The Company 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 2004 - 2006 State of Minnesota 2004 - 2006

 

The net operating losscarryforwards are subject to examination until they expire.

 

**(8)       Notes Payable**

** **

On June 1, 2006, PUC borrowed $75,000 from Mr. Roman Pauly,and in connection therewith issued to Mr. Pauly a promissory note tomature on August 30, 2006.  On August 24,2006, the promissory note was 

 

F-24

----

 

amended to mature on the first of the Company’sclosing of an aggregate of $1 million of net proceeds under its financingefforts (see Note 2)or October 29, 2006.  On January 22, 2007, the Company repaid$25,000 of 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 closes on an aggregate of $750,000or more of additional financing following the date of the amendment.  The promissory note and amendments theretobears an interest at the prime rate.  Interestexpense recorded during the years ended December 31, 2007 and 2006 relatedto this note was $4,208 and $3,678, respectively.  In connectionwith the promissory note, the Company issued a five-year warrant (immediatelyexercisable) to Mr. Pauly to acquire a total of 3,750 shares of theCompany’s common stock at $5.00 per share. In connection with the amendments, following repayment of the promissorynote, the Company will issue a five-year warrant to Mr. Pauly to acquire41.7 shares of the Company’s common stock at $5.00 per share for each day thepromissory note is outstanding after August 30, 2006 (see Note10(f)).  The guidance provided by EITF IssueNo. 96-19 “Debtor’s Accounting for a Modification or exchange of DebtInstruments (“EITF No. 96-19”) indicates that a substantial modificationof debt terms should be accounted for as an extinguishment of debt.  The present value of the cash flows under theAugust 24, 2006 modification was greater than 10 percent different fromthe present value of the cash flows under the original agreement.  Accordingly, the accrual of warrants to beissued pursuant to the amended note were recorded as debt extinguishmentexpense (see Note 10(f)). On January 3, 2008 and February 29, 2008,the Company repaid $33,000 and $7,650 of the principal of the promissory note,respectively (see Note 13).

 

On November 30, 2006, the Company borrowed $100,000 from AdronHoldings, LLC (“Adron”).  In connectiontherewith, the Company issued to Adron an unsecured promissory note that borean annual interest rate of 60 percent and was set to mature on January 2,2007.  Under the terms of the promissorynote, the Company issued a five-year warrant to Adron’s partners to acquire5,000 shares of Company common stock at $5.00 per share, and additionalfive-year warrants to acquire 5,000 shares at $5.00 per share when the loan wasnot repaid on January 2, 2007 (see Note 10(f)).  On March 20, 2007, theCompany amended the promissory note to reduce the annual interest rate to 30percent and extendits due date until the first of (1) the Company’s closing on an aggregateof $750,000 or more of additional financing following the date of the amendment,or (2) April 30, 2007.  Inconnection with the amendment, the Company issued to Adron’s partnersfive-year warrants dated February 1, 2007 to acquire a total 5,000 sharesof Company common stock at $5.00 per share, and following repayment of thepromissory note, the Company will issue additional five-year warrant to Adron’spartners to acquire 166.7 shares of the Company’s common stock for each day thepromissory note is outstanding on and after March 1, 2007, at $5.00 pershare.  On August 8, 2007, theCompany further amended the promissory note to increase the annual interestrate to 42 percent beginning May 1, 2007 and further extend its due dateto the first of (1) the Company’s closing on $750,000 of new financing or (2) September 15,2007.  The guidance provided by EITF No. 96-19indicates that a substantial modification of debt terms should be accounted foras an extinguishment of debt.  Thepresent value of the cash flows under the modifications was greater than 10percent different from the present value of the cash flows under the existingagreements.  Accordingly, the accrual ofwarrants to be issued pursuant to the amended note were recorded as debtextinguishment expense (see Note 10(f)). In January, 2008, the Company repaid all of the outstanding principalamount of the promissory note (see Note13).

 

OnApril 17, 2007, the Company borrowed $75,000 from Alex Nazarenko, aCompany director.  In consideration, theCompany executed and delivered to Mr. Nazarenko a $75,000 unsecured demandpromissory note.  The note bore interestat an annual rate of prime plus one percent, and was repaid on May 8,2007.  The Company recorded $380 ofinterest expense related to this note.

 

OnMay 25, 2007, the Company borrowed $42,585 from a commercial lender pursuantto an insurance policy financing agreement. The financing agreement called forten monthly installment payments of $4,453 beginning July 1, 2007, with animputed annual interest rate of 9.85 percent. The proceeds were paid directly to an insurance company as a prepaymenton an insurance policy.  Interest expenseduring the year ended 

 

F-25

----

 

December 31,2007 was $2,728.

 

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 ofprime plus one percent.  The Companyrecorded $1,676 of interest expense related to this note.  The principal amounts of these loans wererepaid to Mr. Nazarenko on December 28, 2007.

 

**On July 31,2007, the Company borrowed for working capital purposes $100,000 from the SmithTrust (a 5 percent shareholder) pursuant to a promissory note.  The note bears interest at the Prime Rate(7.25 percent on December 31, 2007)**.  Following repayment of the promissory note, the Companywill issue a five-year warrant to the investor to acquire 100 shares of theCompany’s common stock at $5.00 per share each day the promissory note isoutstanding (see Note 10(f)).  On January 3, 2008, the Company repaid$66,000 of this note.  On March 11, 2008, the Company amended the promissorynote with the Smith Trust.  Under theterms of the amendment, unpaid principal and interest will be payable upon theCompany’s closing of an aggregate of $500,000 or more of financing followingthe date of the amendment (see Note 13).

** **

On August 29, 2007, October 31,2007, and November 30, 2007 the Company borrowed for working capital needs$50,000, $100,000 and $25,000, respectively from James Davis (a 5 percentshareholder) pursuant to promissory notes. Each note bore interest at the Prime Rate.  Upon the December 27, 2007 conversion ofthese notes into the convertible debentures of the Company (see Note 9(c)),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 were valued at$28,340 using the Black-Scholes pricing model, which were expensed as interestexpense.

** **

**At various times during the years ended December 31,2007 and 2006, the Company received short-term, unsecured loans from certainofficers and directors 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, 2007 and2006, the Company had borrowed a total of $10,450 and $15,450 from fourofficers and directors.**

** **

**Notespayable, net of original issue discount are summarized as follows:**

 
| ** **                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Notes payable,  gross                          |       | $        | 263,143    |     | $          | 190,450 |   |
| Less: original  issue discount                 |       | —   |       | (16,112  | )          |
| Notes payable,  net of original issue discount |       | $        | 263,143    |     | $          | 174,338 |   |

 

**(9)       Long term debt**

 

***(a)       Long-term bank debt***

 

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 (8.25 and 9.25 percent at December 31, 2007 and 2006).  On February 28, 2006, the Company issueda second promissory note to Crown Bank in the amount of $1,000,000, also at aninterest rate of the prime rate plus one percent.  The average interest rate of the notes was9.05 and 9.10 percent for the years ended December 31, 2007 and 2006,respectively.  The promissory notes weresecured by a pledge of all Company assets, including two technology licensesthat were assigned to Crown Bank, and were guaranteed by Bruce Culver, JamesDavis, William Reiling, and the Smith Trust. In consideration for their guarantees, the Company issued 

 

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10percent unsecured convertible subordinated debentures totaling $733,334 to thefour guarantors (see Note 9(c)).

 

OnOctober 15, 2007, the Company retired $600,000 of the Crown BankPromissory notes, and on October 31, 2007, the Company renewed theremaining notes to mature in February 2009. In connection with therenewal, and as a condition to the effectiveness of the terms and conditions ofthe renewal of the notes, the Company agreed to deposit into an escrow withCrown Bank four months worth of future interest payments due under thenotes.  On December 28, 2007, theCompany deposited $44,000 into Crown Bank as the four months’ interestrequirement, thereby making effective the terms of the renewed notes.  The Company has further agreed to depositinto escrow with Crown Bank all of the interest due on the notes throughmaturity upon the closing, and out of the net proceeds of, an underwritten public offering of equitysecurities of the Company.  Theguidance provided by EITF No. 96-19 indicates that a substantialmodification of debt terms should be accounted for as an extinguishment ofdebt.  The present value of the cashflows under the modification of the Crown Bank notes was less than 10 percentdifferent 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, we issued to them an aggregateamount of 88,889 shares of our common stock on December 28, 2007.  The $88,889 value of the shares was recordedas interest expense.  We also agreed toissue to them: (i) an aggregate amount of 17,778 shares of our commonstock if the Crown Bank promissory notes remain outstanding on October 31,2008 and (ii) five-year warrants to acquire a maximum aggregate of 44,445shares of our common stock at an exercise price of $2.00.  The total aggregate number of shares subjectto the warrants will be determined by dividing 266,667 by the per share pricein an underwritten public offering (not less than $2.00), minus 88,889.  The warrants will be issued on the earlier of(i) the date of an underwritten public offering or (ii) October 31,2008, and will be exercisable beginning on the one-year anniversary of thatdate.

 

***(b)******        ******Long-term notes payable***

 

On October 31, 2007,the Company issued a promissory note for $600,000 in favor of the Smith Trusteffective as of October 15, 2007. The proceeds were used to retire $600,000 of the Crown Bank promissorynotes.  The promissory note issued to theSmith Trust matures on February 28, 2009, bears interest at 1.0 percentover the prime rate (8.25 percent at December 31, 2007), and has asubordinated security interest in all of the Company’s assets.  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 value of which was recorded as debt issuance cost asset (see Note1(n)).  We also agreed to issue to theSmith Trust: (i) an aggregate amount of 6,667 shares of our common stockif the Crown Bank promissory notes remain outstanding on October 31, 2008and (ii) five-year warrants to acquire a maximum aggregate of 16,667shares of our common stock at an exercise price of $2.00.  The total aggregate number of shares subjectto the warrants will be determined by dividing 100,000 by the per share pricein an underwritten public offering (not less than $2.00), minus 33,333.  The warrants will be issued on the earlier of(i) the date of an underwritten public offering or (ii) October 31,2008, and will be exercisable beginning on the one-year anniversary of thatdate.

 

**On March 11, 2008, the Company amendedthe promissory note with the Smith Trust. Under the terms of the amendment, interest accrued pursuant to thepromissory note will be payable on the maturity date, rather than payablemonthly (see Note 13).**

 

F-27

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***(c)******         ******Long-term convertible debentures***

 

Asconsideration to the guarantors to provide their guarantees for the Crown Bankpromissory notes (see Note 9(a)), the Company issued $733,334 of unsecuredconvertible 10 percent debentures.  Allof the debentures mature three years from the date of issue (coincident withthe closing dates of the promissory notes as noted above) and are convertibleinto 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.

 

Theembedded conversion feature of the convertible debentures does not meet all thecharacteristics of a derivative instrument as described in SFAS No. 133 (“Accountingfor Derivative Instruments and Hedging Activities”), and therefore was notseparated from the host contract and accounted for as a derivative.  The embedded conversion feature does notprovide for net settlement, the shares to be issued pursuant to the exercise ofthe conversion feature will be unregistered and, due to the large number ofshares involved and the thinly traded market for the Company’s shares, cannotbe 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 No. 98-5 againstthe convertible debt liability and is alsobeing amortized as interest expense over the term of the convertibledebentures.  See Note 7 for the deferredincome tax effects of the beneficial conversion feature.

 

On March 21, 2007, the Company and thefour guarantors of the Company’s Crown Bank promissory notes (see Note 9(a))agreed to amend the related debenture agreements.  Pursuant tothe revised debenture agreements, among other things, the Company issued atotal 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 No. 96-19 indicates that a substantial modificationof debt terms should be accounted for as an extinguishment of debt.  The present value of the cash flows under theMarch 20, 2007 modification was greater than 10 percent different from thepresent value of the cash flows under the original agreement.  Accordingly, the warrants issued, valued at$26,829 using the Black-Scholes method, were recorded as debt extinguishmentexpense.  No other gain or loss wasrecorded.

 

**On December 27, 2007, the existing holders of the10 percent unsecured convertible subordinated debentures issued by the Companyagreed to 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 shareupon the closing of an underwritten public offering by the Company.  The $733,334 outstanding principal amount ofthe debentures will convert into 244,445 shares of the Company’s commonstock.  As of December 31, 2007,$68,043 of unpaid accrued interest related to the debentures wasoutstanding.  Interest will continue toaccrue on the debentures until they are converted or otherwise retired.**

** **

**On December 27, 2007, the Company closed on thesale of $1,050,000 of units consisting of unsecured, subordinated, convertiblepromissory notes (the “2007 Notes”) and common stock purchase warrants**

 

F-28

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**(the “2007 Warrants”) in a private placement (the “2007Private Placement”).  Net cash proceedsto the Company were $712,923, after deducting $337,077 of expenses of theoffering (including $105,000 of commissions paid to the placement agent) andexcluding from the cash proceeds the conversion into units of $25,000 of loansmade to the Company by James Davis and $25,000 of certain loans from theCompany’s directors.  The net proceedswill be used to pay certain existing obligations, fund research and developmentefforts and for general corporate purposes.**

** **

**At the closing, the Company issued $997,500 in principalamount of 2007 Notes and 2007 Warrants to purchase 210,000 shares of commonstock.  The 2007 Notes bear interest at10 percent per year, mature on June 27, 2009, and will convert into thetype of equity securities offered by the Company in any underwritten publicoffering prior to maturity at 70 percent of the public offering price.  In the event a public offering is notcompleted before the maturity date, the entire principal and unpaid accruedinterest will convert into the Company’s common stock at $0.05 per share.  The Company may, at its option, prepay the2007 Notes anytime on or after December 27, 2008.  The 2007 Warrants will become exercisableupon the earlier of the closing of a public offering or the maturity date ofthe 2007 Notes, and will remain exercisable until December 31, 2012.  The exercise price will be 50 percent of thepublic offering price, or in the event a public offering is not completedbefore the maturity date, at 50 percent of the closing price of the Company’scommon stock on the maturity date of the 2007 Note.**

** **

**On December 27, 2007, the Company also converted$150,000 of existing loans from James Davis into a note and warrants similar tothose described above.  The principalamount of the note issued to Mr. Davis was $142,500.  Mr. Davis also received warrants topurchase 30,000 shares of the Company’s common stock.  The terms of the note and warrants issued to Mr. Davisare the same as those issued in the 2007 Private Placement, except that hisnote is convertible into the type of equity securities offered by the Companyin an underwritten public offering at 50 percent of the public offeringprice.  In addition, Mr. Davisagreed that the equity securities issued upon conversion of his note and thecommon stock issued upon exercise of his warrant will not be transferable for aperiod of one year beginning on the effective date of the public offeringtriggering conversion of the note.**

** **

Theembedded conversion features of the 2007 Notes and the notes issued to Mr. Davisdo not meet all the characteristics of a derivative instrument as described inFASB Statement 133, and therefore were not separated from the host contractsand accounted for as derivatives.  Theembedded conversion features are indexed to the Company’s common stock, andwould be classified in stockholders’ equity under the guidance of EITF 00-19 (“Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock”), if they were freestanding derivatives.  The embedded conversion feature contains anexplicit limit on the number of shares to be delivered, the Company hassufficient authorized and unissued shares available to settle the maximumnumber of shares and the debenture agreement does not contain a net cashsettlement feature.  The beneficialconversion features of the promissory notes, valued at $595,666 using theBlack-Scholes pricing model, were recorded as an original issue discount asdefined in EITF No. 98-5 against the convertible debt liability, and isbeing amortized as interest expense over the term of the convertibledebentures.  See Note 7 for the deferredincome tax effects of the beneficial conversion features.

 

F-29

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

 

Future maturities of long-term promissory notes andconvertible debentures for the years succeeding December 31, 2007 are asfollows:

 
| **Year**                          | ** ** | **Paid in Cash** | ** ** | **Original Issue  Discount** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|----------------------------|------------|-----------------------------------|------------|-----------|------------|
| 2008                              |       | $                          | —     |                              | $          | (662,035  | )          | $ | (662,035 | ) |
| 2009                              |       | 4,073,334                  |       | (240,699                          | )          | 3,832,635 |       |
| Total                             |       | $                          | 4,073,334  |                              | $          | (902,734  | )          | $ | 3,170,600 |   |
| Of which,                         |       |                       |       |                              |       |      |       |
| Long-term bank  debt              |       | 1,600,000                  |       | —                            |       | 1,600,000 |       |
| Long-term note  payable           |       | 600,000                    |       | —                            |       | 600,000   |       |
| Long-term  convertible debentures |       | 1,873,334                  |       | (902,734                          | )          | 970,600   |       |

 

**(10)     Shareholders’ Equity**

** **

***(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

 

Pursuant to a merger agreement effective April 5, 2004, PUC becamea wholly owned operating subsidiary of Global, which changed its name toProUroCare Medical Inc. on April 26, 2004.

 

Prior to the Merger, Profile had notified the Company of a possiblebreach of its license agreement with the Company, and had also dissented fromthe Merger proposal as the registered holder of securities beneficially ownedby certain shareholders holding, in the aggregate, 30,847 (pre-merger) sharesof PUC’s common stock.  Effective on April 4, 2004, theparties reached an agreement pursuant to which Profile waived any existingdefaults under the Profile 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 

 

F-30

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one share of PUC common stock issued to Global.  Simultaneously, the former shareholders ofPUC common stock received an aggregate of 960,300 shares of common stock ofGlobal, representing approximately 82.1 percent of Global’s common stockoutstanding immediately after the Merger.

 

Global was a non-operating public shell company at the time of theMerger.  Accordingly, the Mergertransaction was recorded as a recapitalization rather than a businesscombination.  The assets and liabilitiesresulting from the reverse acquisition were the former PUC assets andliabilities (at historical cost) plus a $13,500 accrued Global liability(assumed at historical cost).  There wereno other assets or liabilities on Global’s books at the time of theMerger.  The Company recorded costsassociated with the 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 of 1933, as amended (the “Securities Act”).The initial closing occurred on April 5, 2004, at which time the Companyissued 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 additional 22,500 shares at $20.00 per share,aggregating to gross proceeds of $450,000. Costs associated with the private placement (including the subsequentregistration 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 sold 5,814 shares of its common stock to Mr. Scott Smith, adirector of the Company, and 5,814 shares of our common stock to aninvestor.  The per share selling price of$4.30 was based 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.

 

·                  Duringthe year ended December 31, 2007, the Company sold 125,000 of the Company’sInvestment Units at a price of $4.00, with total gross proceeds of$500,000.  The Investment Units were soldin tranches of 31,250 Units each to four investors on January 18, January 23,February 28 and May 1.  EachInvestment Unit consists of one share of the Company’s common stock and a3-year warrant (immediately exercisable) to acquire 0.5 shares of the Company’scommon stock for $2.50 ($5.00 per share). Costs of this sale totaled $52,388.

 

·                  On February 12, 2007,the Company sold 1,707 shares of its common stock to Mr. Scott Smith, adirector of the Company.  The per shareselling price of $4.10 was based on the last selling price prior to this saleas reported on the Over-the-Counter Bulletin Board.  The subscription price was paid by theconversion of a $7,000 loan to the Company from Mr. Smith.

 

·                  On March 21,2007, the Company and the four guarantors of the Company’s Crown Bankpromissory notes (see Note 9) 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 

 

F-31

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its Investment Units to the four guarantors in lieu of $49,911 of accruedinterest.  Each Investment Unitconsists 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).  The 6,240warrants 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 1,100shares of its common stock to Mr. Carlsonand Mr. Smith.  The per shareselling price of $3.00 was based on the last selling price prior to this saleas reported on the Over-the-Counter Bulletin Board.  The subscription price was paid by theconversion of a $3,300 of loans to the Company from Mr. Carlson and Mr. Smith.

** **

***(e)***                      Common Stock and Warrants issued forservices and liabilities

*** ***

·                  In March 2002, the Company granted awarrant to purchase 3,000 shares of common stock to a former director that wasexercisable at $11.33 per share. This warrant vested ratably over a 24-monthperiod ending April 2004 until the resignation of the director on February 9,2004, and expired on February 9, 2005. An aggregate of $12,075 of stock-based compensation related to thiswarrant was recognized in the period from August 17, 1999 (inception) to December 31,2007.

 

·                  In November 2002, the Company granted awarrant to purchase 150 shares of common stock to a consultant, for servicesrendered.  This warrant was exercisableat $23.33 per share, and expired in November 2007.  An aggregate of $490 of stock-basedcompensation related to this warrant was recognized in the period from August 17,1999 (inception) to December 31, 2007.

 

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

 

·                  In June 2003, under the terms of anagreement with a supplier, the Company issued a warrant to purchase 9,215shares of common stock.  This warrant isexercisable at $3.33 per share, and expired in June 2007.  The value of $187,060 related to this warrantwas recognized in the period from August 17, 1999 (inception) to December 31,2007.

 

·                  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, the Company entered into aresearch and development agreement with Artann for the further development ofthe ProUroScanTM system. Under this agreement, warrants for the purchase of 10,000 shares of theCompany’s common stock upon the execution of the agreement and warrants for thepurchase of 20,000 shares of the Company’s common stock in December 2004.The warrants were fully vested, five-year warrants at a per share exerciseprice of $20.00 per share value.  Thetotal value of these warrants computed using the Black-Scholes pricing modelwas $281,086.  The value of the warrantswere recorded as research and development expense.

 

·                  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 a placement agencyagreement with Stonegate Securities Inc. to raise working capital for theCompany.  Pursuant to the agreement, theCompany paid $5,000 and on May 13, 2005 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 grant.Subsequently, the placement agent was unable to raise capital on terms thatwere acceptable to the Company and the agreement was terminated.  Costs incurred in this financing totaling 

 

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$59,696, including thevalue of the common stock issued to the placement agent, were recorded asgeneral and administrative expense in the period from August 17,1999 (inception) to December 31, 2007.

 

**·**                  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 expensed in April 2006.

** **

·                  On September 8, 2006, the Company issued 1,415shares of its common stock to a vendor, as payment for product development workvalued at $8,938.

 

·                  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 12).  The warrants were valued at $72,000 by theBlack-Scholes pricing model and recorded as research and development expense.

 

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

 

***(f)***                         Common Stock and Warrants issued pursuantto loans 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 Company issued warrants to purchase a total of 64,287 shares of common stock at $23.33per share to 9 individuals, including 4,286 shares to DavidKoenig, a Company director, in exchange for their guaranteeing a bank line ofcredit.  An aggregate of $216,112 of debt issuancecost related to these warrants was recorded and amortized over the life of thebank line of credit.  Upon the closing ofthe Company’s 2004 private placement and Merger on April 5, 2004, certainexercise price protections and anti-dilution provisions of these warrantsbecame effective.  Under the terms ofthese provisions, the holders of these warrants became eligible to purchase atotal of 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.

 

·                  In September 2005, theCompany engaged Venture Law Resources, PLLC (“VLR”) to assist with theintroduction of strategic investors to the Company.  Under this agreement, in addition to a $2,500retainer, on September 1, 2005 and February 22, 2006, the Companyissued a total of 5,000 shares of common stock valued at $40,500 on the grantdates to VLR.  Upon the closing of theCompany’s Crown Bank notes on February 16, 2006, the $43,000 aggregatevalue of the shares and initial retainer were recorded as debt issuance costand are being amortized over the term of the notes (see Note 9(a)).

 

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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 $0, $12,977 and $29,000 of expense related to thevalue of the warrants during the years ended December 31, 2007 and 2006,and the period from August 17, 1999 (inception) to December 31, 2007,respectively.

** **

**·**                  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 No. 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, 2007 and 2006, and the period from August 17,1999 (inception) to December 31, 2007, respectively.

** **

**·**                  On October 19, 2005, in connection with commercialguaranties of a $300,000 loan from Venture Bank, the Company issued five-year warrants(immediately exercisable) to Ron Musich and Adrian Johnson to acquire up to7,500 shares (15,000 shares in total) of the Company’s common stock at $5.00per 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 $0, $39,750, and $79,500of expense related to the value of the warrants during the years ended December 31,2007 and 2006, and the period from August 17, 1999 (inception) to December 31,2007, respectively.

** **

**·**                  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 EITF No. 98-5.  The Company recorded $23,000 of expenserelated to the value of the warrants during the year ended December 31,2006.

** **

***·***                  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 Note8).  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 No. 98-5 andsubsequently expensed as interest expense over the 90-day term of the loan.

 

F-34

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***On August 24,2006 the promissory note was amended to mature on the first to occur of: (i) theCompany’s closing of an aggregate of $1 million of net proceeds under itsongoing financing efforts***(see Note 2) or (ii) October 29,2006.  On January 22, 2007, the Companyrepaid $25,000 of the promissory note. On March 20, 2007, the promissory note was amended for a secondtime to extend the due date of the remaining balance until the Company’sclosing on an aggregate of $750,000 or more of additional financing followingthe date of the amendment.  Inconnection with the amendments to the promissory note, following repaymentthereof, the Company is to issue a five-year warrant (immediately exercisable)to Mr. Pauly to acquire 41.7 shares of the Company’s common stock at $5.00per share for each day the promissory note is outstanding after August 30,2006.  As of December 31, 2007, theCompany had accrued for issuance 20,931 warrants related to thisamendment.  The fair value of the warranton the amendment date was estimated using the Black-Scholes pricing model to be$5.40 per share, which is expensed as debt extinguishment expense as thewarrants are earned.  The total debtextinguishment expense recorded for the amended warrants during the year ended December 31,2007 and 2006 was $82,191 and $27,922, respectively.

*** ***

On January 3, 2008,the Company repaid $33,000 of the remaining $50,000 principal amount of thePauly loan (see Note 12).

 

**·**                  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 No. 98-5 and was expensed as interest expense during the yearended 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 discount asdefined in EITF No. 98-5 and was expensed as interest expense during theyear ended December 31, 2006.

*** ***

·                  On November 30, 2006, the Companyborrowed $100,000 from Adron, and in connection therewithissued to Adron a promissory note to mature on January 2, 2007 (see Note8).  Pursuant to the terms of the promissory note,the Company issued five-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 No. 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, $21,838, and $45,000 related to thewarrants issued pursuant to the original agreement during the years ended December 31,2007 and 2006, and the period from August 17, 1999 (inception) to December 31,2007, respectively.

 

F-35

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On March 20, 2007, theCompany amended the promissory note to extend its due date until the first to occur of: (i) theCompany’s closing on an aggregate of $750,000 or more of additional financingfollowing the date of the amendment, or (ii) April 30, 2007.  In connection with the amendment, theCompany issued to Adron’s partners five-year warrants (immediately exercisable)dated February 1, 2007 to acquire 5,000 shares of Company common stock at$5.00 per share, and following repayment of the promissory note issued toAdron, the Company will issue additional five-year warrants (immediatelyexercisable) to Adron’s partners to acquire a total of 166.7 shares of theCompany’s common stock for each day the promissory note issued to Adron isoutstanding on and after March 1, 2007, at $5.00 per share.  On August 8, 2007, the Company furtheramended the promissory note to increase the interest rate to $3,500 per monthbeginning May 1, 2007 and further extend its due date to the first tooccur of: (i) the Company’s closing on $750,000 of new financing or (ii) September 15,2007.  As of December 31, 2007, theCompany had accrued for issuance warrants to acquire 51,010 shares of theCompany’s common stock pursuant to this arrangement.  During the year ended December 31, 2007,the Company expensed as debt extinguishment cost $201,637 related to theissuance of the 5,000 warrants on February 1, 2007 and the accrued 51,010warrants to be issued pursuant to the amended terms of the promissory note.

 

The Company repaid the$100,000 principal amount of the loan in installments of $66,000 and $34,000 onJanuary 4 and January 16, 2008, and on January 16, 2008 issued52,357 warrants pursuant to the terms of the promissory note (see Note 13).

 

·                  On March 14, 2007, upon thetermination of employment of an employee, and in consideration for an agreementto defer payment of accrued salaries until the Company is able to make suchpayments (on the same basis as the payment of deferred salaries of continuingemployees), the Company agreed to extend by three years the expiration date of30,000 warrants beneficially held by the employee.  The modification of the warrant resulted inthe recording of an immediate incremental compensation expense totaling$96,000, computed as the increase in the fair value of the warrant asdetermined under the provisions of SFAS 123R over the fair value so determinedimmediately 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 8). During the year ended December 31, 2007, the Company accrued forissuance warrants to acquire 15,400 shares of the Company’s common stockpursuant to the terms of the promissory note. The warrants, valued at $24,800 using the Black-Scholes pricing model,were expensed as interest expense.

 

·                  On August 29, 2007, October 31,2007, and November 30, 2007, the Company borrowed for working capital needs$50,000, $100,000 and $25,000, respectively, from James Davis (see Note8).  Upon the December 27, 2007conversion of these notes into the convertible debentures of the Company (seeNote 9(c)) 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.

 

·                  On October 15, 2007, the Companyborrowed $600,000 pursuant to a promissory note issued to the Smith Trust (seeNote 9(b)).  In consideration for thisloan, on November 7, 2007 the Company agreed to issue 33,333 shares of itscommon stock to the Smith Trust.  The$66,666 value of this consideration was recorded as debt issuance cost and isbeing amortized over the term of the loan using the straight-line method, whichapproximates the interest method (see Note 1(n)).

 

**·**                  On December 27, 2007, the Company closed on the 2007 PrivatePlacement (see Note 9(c)).  At theclosing, the Company issued 2007 Warrants to purchase 210,000 shares of commonstock.  The 2007 Warrants will becomeexercisable upon the earlier of the closing of a public offering or thematurity date of the 2007 Notes, and will remain exercisable until December 31,2012.  The 

 

F-36

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**exercise price will be50 percent of the public offering price, or in the event a public offering isnot completed before the maturity date, at 50 percent of the closing price ofthe Company’s common stock on the maturity date of the 2007 Note.  The 2007 Warrants, valued at $79,621 usingthe Black-Scholes pricing model, were recorded as an original issue discount asdefined in EITF 98-5 against the 2007 Notes and are being amortized as interestexpense over the term of the 2007 Notes.**

** **

**·**                  On December 27, 2007, the Company also converted $150,000 ofexisting loans from James Davis into a note and warrants similar to those ofthe 2007 Private Placement (see Note 9(c)). Pursuant to that conversion, Mr. Davis received warrants topurchase 30,000 shares of the Company’s common stock, which will becomeexercisable upon the earlier of the closing of a public offering or thematurity date of the note, and will remain exercisable until December 31,2012.  The exercise price will be 50percent of the public offering price, or in the event a public offering is notcompleted before the maturity date, at 50 percent of the closing price of theCompany’s common stock on the maturity date of the note.  The warrants, valued at $8,955 using theBlack-Scholes pricing model, were recorded as an original issue discount asdefined in EITF 98-5 against the note and are being amortized as interestexpense over the term of the 2007 Notes.

** **

**·**                  On December 28, 2007, the Company put into escrow with Crown Bankfour months of future interest payments due under the terms of the notes.  Accordingly, the terms and conditions of therenewed Crown Bank notes became effective on that date, and pursuant to theterms of the guaranties the Company issued to the three guarantors an aggregateof 88,889 shares of the Company’s common stock (see Note 9(a)).

*** ***

***(g)***                      Warrants summary

*** ***

Warrant activity is as follows for the years ended December 31:

 
| ** **                     | ** ** | **Warrants** | ** ** | **Weighted-Average Exercise  Price** | ** ** |
|--------------------------------|------------|--------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **2007**     | ** ** | **2006**                                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| Outstanding,  January 1   |       | 215,949      |       | 200,688                                   |       | $ | 14.61 |   | $ | 15.80 |   |
| Granted                        |       | 432,920      |       | 19,796                                    |       | 4.91 |   | 5.00 |   |
| Exercised                      |       | —       |       | —                                    |       | — |   | — |   |
| Expired                        |       | (9,365       | )          | (4,535                                    | )          | 3.62 |   | 23.33 |   |
| Outstanding,  December 31 |       | 639,504      |       | 215,949                                   |       | $ | 9.99 |   | $ | 14.61 |   |

 

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, 2007 and2006 was $3.80 and $5.22, respectively. The expense related to warrants issued to lenders anddebt guarantors was $423,096, $103,247, and $877,455 for the years ended December 312007 and 2006, and the period from August 17, 1999 (inception) to December 31,2007, respectively.  Stock-basedcompensation cost related to warrants issued to the Company’s consultants andsuppliers was $168,000, $0, and $636,636 for the years ended December 31,2007 and 2006, and the period from August 17, 1999 (inception) to December 31,2007, 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, 2007 and2006, and the period from August 17, 1999 (inception) to December 31,2007, respectively.

 

F-37

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***(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.**

** **

·                  InMarch 2002, the Company granted an aggregate of 90,000 employee stockoptions to officers and directors that were exercisable at $11.33 pershare.  The officers’ options vestedratably over a 36-month period through December 2004, while the directors’options vested ratably over a 24-month period through April 2004.  An aggregate $340,435 of stock-basedcompensation related to these options was recognized in the period from August 17,1999 (inception) to December 31, 2007.

 

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 until April 1,2012 (see Note 6(b)).  The Companyrecorded stock-based compensation expense of $103,500 related to the extensionof the exercise date in the year ended December 31, 2007.

 

·                  InApril, 2002, the Company issued a nonqualified stock option to a consultant toacquire 3,000 shares of common stock at $11.33 per share. This option vestedover a 6-month period ended October 2002. At the same time, the Companyalso issued a nonqualified stock option to a consultant, to acquire 3,000shares of common stock at $11.33 per share. This option vested ratably over atwo-year period through April 2004. An aggregate of $25,300 of stock-based compensation related to theseoptions was recognized in the period from August 17, 1999 (inception) to December 31,2007.  In February 2005, one of theconsultants’ engagement with the Company ended and, under the terms of the optionagreement, all of the options expired in February 2006.

 

F-38

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·                  In February 2004, the Company issued45,000 employee stock options to Michael Grossman, our former President andCOO.  These options were valued at $6.70per share, vested ratably over a three year period and are exercisable at$20.00 per share.  The Company expensed$16,811, $101,008, and $303,000 related to these options during the years endedDecember 31, 2007 and 2006 and the period from August 17, 1999(inception) to December 31, 2007, respectively.  Pursuant to a May 11, 2007 separationagreement, the Company extended the date through which Mr. Grossman mayexercise 45,000 options (including options gifted to his children) following hisseparation until February 1, 2012 (see Note 6(b)).  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, the Company issued3,000 nonqualified stock options to a consultant in consideration of servicesrendered.  The options were valued at$6.70 per share, and vested as to 1,500 shares upon issuance and as to theremaining 1,500 shares on January 1, 2005. These options are exercisable at $20.00 per share through February 2014.  The Company expensed $0, $0 and $20,200related to these options during the years ended December 31, 2007 and 2006and the period from August 17, 1999 (inception) to December 31, 2007,respectively.

 

·                  In July 2004, the Company issued 20,000employee stock options to Richard Thon, our CFO, in connection with hisemployment agreement.  These options werevalued at $15.00 per share, vested ratably over a three-year period, and areexercisable at $25.00 per share through July 2014.  The Company expensed $58,314, $100,008, and$300,000 related to these options during the years ended December 31, 2007and 2006 and the period from August 17, 1999 (inception) to December 31,2007, respectively.

 

**·**                  In January 2005,the Company issued 15,000 stock options to Richard Carlson, our CEO and at thetime our Vice President of Marketing and Sales. The options were valued at $16.20 per share, vest ratably over athree-year period, and are exercisable at $23.50 per share through January 2015.  The Company expensed $81,006, $81,006, and$236,268 related to these options during the years ended December 31, 2007and 2006 and the period from August 17, 1999 (inception) to December 31,2007, respectively.

** **

**·**                  In September 2005,the Company issued 15,000 stock options to Alan Haggerty, our former VicePresident of Engineering.  The optionswere valued at $5.30 per share, vest ratably over a three-year period, and wereexercisable at $6.00 per share.  Upon Mr. Haggerty’sdeparture from the Company on April 18, 2006, the options ceased vesting,and one year later they expired unexercised. The Company expensed $0, $8,834 and $15,460 related to these optionsduring the years ended December 31, 2007 and 2006 and the period from August 17,1999 (inception) to December 31, 2007, respectively.

** **

**·**                  On March 1, 2006, the Company issued to five of itsemployees stock options to acquire a total of up to 20,000 shares of commonstock at $7.50 per share.  The five-yearoptions, which vest upon the Company securing FDA approval of its ProUroScanTMsystem, were valued at $5.60 per share and are being expensed over the vestingperiod (estimated by the Company as twenty-nine months) as general andadministrative expense.  The Companyexpensed $33,245 and $48,215 related to these options during the years ended December 31,2007 and 2006, respectively.

** **

·                  On May 30, 2006, the Company issued3,000 nonqualified stock options to Scott Smith, a director, upon hisappointment to the Board of Directors. The options were valued at $5.90 per share, and vest ratably over a24-month period through May 2008. These options are exercisable at $7.00 per 

 

F-39

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share through May 2013.  The Company expensed $ 8,850 and $5,163related to these options during the years ended December 31, 2007 and2006, respectively.

 

·                  On February 1, 2007, the Company grantedto Mr. Richard Carlson, our Chief Executive Officer, a seven-year optionto acquire up to 20,000 shares of the Company’s common stock at a price of$5.00 per share.  The options were valuedat $3.40 per share using the Black-Scholes pricing model and will be expensedover the vesting period as general and administrative expense. ** **The options will vestaccording to the following schedule if the enumerated conditions are satisfied:

 

(a)          5,000 shares vest 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.

 

(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; and

 

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

 

The Company expensed $32,857related to these options during the year ended December 31, 2007.

 

·                  On May 11, 2007, the Company enteredinto an agreement with its former Chief Executive Officer, Maurice Taylor, todefer the payment of his accrued salary further according to an agreed uponschedule.  As consideration for hisagreement to defer payment of his accrued salary, the Company extended theoriginal one-year period that Mr. Taylor may exercise 45,000 of his stockoptions (including options gifted to his children) following his termination ofemployment until April 1, 2012 (see Note 6(b)).  The option extension was valued at $103,500using the Black-Scholes pricing model, and expensed as compensation expense inthe year ended December 31, 2007.

 

·                  On May 11, 2007, the Company enteredinto an agreement with its former President and Chief Operating Officer,Michael Grossman, to defer the payment of his accrued salary further accordingto an agreed upon schedule.  As considerationfor his agreement to defer payment of his accrued salary, the Company extendedthe original one-year period that Mr. Grossman may exercise 45,000 of hisstock options (including options gifted to his children) following histermination of employment until February 1, 2012 (see Note 6(b)).  The option extension was valued at $117,000using the Black-Scholes pricing model, and expensed as compensation expense inthe year ended December 31, 2007.

 

·                  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 $1,800 related to these options during the yearended December 31, 2007.

 

F-40

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

*** ***

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

 
| ** **                     | ** ** | **Options** | ** ** | **Weighted-Average Exercise  Price** | ** ** |
|--------------------------------|------------|-------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **2007**    | ** ** | **2006**                                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| Outstanding,  January 1   |       | 160,417     |       | 155,000                                   |       | $ | 16.17 |   | $ | 16.40 |   |
| Granted                        |       | 23,000      |       | 23,000                                    |       | 4.73 |   | 7.43 |   |
| Exercised                      |       | —      |       | —                                    |       | — |   | — |   |
| Forfeited                      |       | (7,917      | )          | (14,583                                   | )          | 5.37 |   | 6.30 |   |
| Expired                        |       | (3,000      | )          | (3,000                                    | )          | 20.00 |   | 11.33 |   |
| Outstanding,  December 31 |       | 172,500     |       | 160,417                                   |       | $ | 15.07 |   | $ | 16.17 |   |
|                           |       |        |       |                                      |       |   |   |   |   |
| Exercisable,  December 31 |       | 149,210     |       | 128,992                                   |       | $ | 16.47 |   | $ | 16.80 |   |

 

The following table summarizesinformation about stock options outstanding as of December 31, 2007:

 
| ** **        | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **        | ** ** | ** **                   | ** ** | ** **                   | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **        | ** ** | ** **                   | ** ** | **Weighted**                 | ** ** | **Average** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| **Range of** | ** ** | ** **                   | ** ** | **Average**                  | ** ** | **Remaining** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Exercise**      | ** ** | **Number of**           | ** ** | **Exercise**                 | ** ** | **Contractual** | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| **prices**        | ** ** | **Options**                  | ** ** | **Price**                    | ** ** | **life** | ** ** | **Options** | ** ** | **Price** | ** ** |
| $2.90-7.50        |       | 38,500                       |       | $                            | 6.13       |   | 5.4 |   | 15,625 |   | $ | 6.62 |   |
| $11.33            |       | 54,000                       |       | $                            | 11.33      |   | 4.3 |   | 54,000 |   | $ | 11.33 |   |
| $20.00-25.00      |       | 80,000                       |       | $                            | 21.91      |   | 5.3 |   | 79,585 |   | $ | 21.90 |   |
|              |       | 172,500                      |       | $                            | 15.07      |   | 5.0 |   | 149,210 |   | $ | 16.47 |   |

 

The aggregate intrinsic value of the optionsoutstanding and exercisable at December 31, 2007 was both $0.  The average fair value of each option grantedduring the years ended December 31, 2007 and 2006, and the period from August 17,1999 (inception) to December 31, 2007, as determined using theBlack-Scholes pricing model (see Note 1(j)) was $3.27, $5.64, and $6.63,respectively.  The stock-based employee and non-employeecompensation cost related to stock options was $453,384, $344,234, and$1,582,078 for the years ended December 31, 2007 and 2006, and the periodfrom August 17, 1999 (inception) to December 31, 2007, respectively.

 

**(11)**              Related Parties

** **

FromJanuary 2002 through December 15, 2006, the Company sublet officespace serving as the Company’s executive offices, on a month-to-month basis,from a company majority-owned and controlled by one of the Company’s directors,Mr. Taylor. The Company believes the monthly rent incurred was at marketrate for such executive office space in Minneapolis, Minnesota.

 

TheCompany’s executive offices are temporarily located within the offices ofAlexander Nazarenko, a former Company director. Our rental cost for these temporary offices is approximately $2,200 permonth, which we believe is at market for similar office space in Minneapolis,Minnesota.  Mr. Nazarenko hasinformally agreed to defer payment of the rent until we are able to pay.

 

OnJanuary 25, 2006, the Company borrowed $12,500 from each of Mr. Nazarenkoand David F. Koenig, Company directors. In consideration, the Company executedand issued to each of Mr. Nazarenko and Mr. Koenig a $12,500unsecured demand promissory note bearing interest at an annual rate of primeplus one 

 

F-41

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percent.  These notes were satisfied on February 16,2006.

 

OnSeptember 7, 2006, the Company borrowed $7,000 from Scott Smith, adirector of the Company. On February 12, 2007, the Company sold 1,707shares of its common stock to Mr. Smith, the subscription price being paidby the conversion of the $7,000 loan from Mr. Smith.  The per share selling price of $4.10 wasbased on the last selling price prior to this sale as reported on the OTCBulletin Board.

 

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 prime plus one percent, and was repaid on May 8, 2007.  The Company recorded $380 of interest expenserelated to this note.

 

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 ofprime plus one percent.  The Companyrecorded $1,676 of interest expense related to this note.  The principal amounts of these loans wererepaid to Mr. Nazarenko on December 28, 2007.

 

OnJuly 3, 2007, the Company borrowed $10,000 from Mr. Nazarenko.  The unsecured loan bore no interest and wasrepaid on December 28, 2007

 

**On September 28, 2007, theCompany borrowed for working capital purposes $15,000 from Mr. Smith and$10,000 from Robert Rudelius, both directors of the Company.  The unsecured loans bore no interest.  Upon the first closing of the 2007 PrivatePlacement, these loans were converted into units under that offering.**

** **

**(12)**              Development Agreements

** **

***Artann 2004 Development Agreement***

 

In July 2004, the Company entered into adevelopment agreement with Artann and Armen Sarvazyan under which Artann and Dr. Sarvazyandeveloped two working, pre-clinical ProUroScanTM systems.  These systems were delivered to us in late November 2004.  We paid Artann $180,000 for this developmentwork, which was expensed as research and development cost during the year endedDecember 31, 2004.

 

***Artann 2004 Research andDevelopment Agreement***

 

In July 2004, the Company entered into aresearch and development Agreement with Artann for the further development ofthe ProUroScanTM system. Under this agreement, Artann was a research and development partner tothe Company, supporting the further development of the ProUroScanTMsystem.  For its role, Artann received apayment of $50,000 and warrants for the purchase of 10,000 shares of theCompany’s common stock upon the execution of the agreement, and $110,000 and warrantsfor the purchase of 20,000 shares of the Company’s common stock following theshipment of the ProUroScanTM pre-clinical systems in accordance withthe development agreement 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.  All payments and the value of the warrantswere recorded as research and development expense in the year ended December 31,2004.

 

***Artann 2007Cooperation Agreement***

 

On April 16, 2007, the Company entered into an agreement theCooperation Agreement with Artann in which 

 

F-42

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theparties agreed to terminate their existing research and development agreementand to use their best efforts to finalize a new development agreement within areasonable period of time.  TheCooperation Agreement establishes a platform for joint cooperation inestablishing the new development agreement, which will define a process for thejoint development of a next generation prostate mechanical imaging system withenhanced functionalities.  TheCooperation Agreement terminates the research and development agreement, andreleases each party from all undischarged obligations and liabilities underthat 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.

 

***Urologix Joint Development Agreement***

 

On July 27, 2005, the Company entered into a Memorandum of Understanding with Urologix, Inc. (“Urologix”) pursuant to which the parties will co-develop new products utilizing ProUroCare’s electrical impedance tomography (“EIT”) technology. The EIT technology is expected to be assembled into modules that will be compatible with and incorporated into Urologix’ existing thermal therapy systems.  The parties expected the joint development project to involve several phases of research, testing and development, for which they would share equally in the costs of the work performed. After completing Phase I of the development program in September 2006, it was determined that an assessment of certain key factors affecting the compatibility of our EIT technology with Urologix’ equipment would be required before proceeding with Phase II.

 

On March 20, 2007, we executed an amendment to the Urologix agreement to postpone any decision regarding the continuance of the remaining phases contemplated under the agreement, and gave each party the right to abandon the project for any reason with 5 days’ notice to the other.  We plan to conduct research related to the compatibility issues if and when sufficient funding becomes available before a decision is made to move to Phase II of the program.  On March 20, 2007, the Company executed an amendment to the Urologix Memorandum of Understanding. Under the terms of the amendment, Urologix agreed to postpone any decision regarding the continuance of the remaining phases of work, while the Company agreed that the assessments described above will be done and funded solely by the Company.

 

We have temporarily suspended payment of the minimum licensing fees required by the RPI license agreement to maintain exclusive rights to the EIT technology (see Note 5).  If we are unsuccessful in obtaining sufficient funds to continue development of this technology, resolving the key project factors noted above, or negotiating an extension of the RPI license, the development efforts with Urologix may be terminated.

 

***(13)***                          Subsequent Events

*** ***

On January 4,2008, the Company closed on the sale of $80,000 of additional units as part ofthe 2007 Private Placement (see description and terms in Note 9(c)).  Net cash proceeds to the Company were$69,600, after deducting $10,400 of commissions paid to the placementagent.  In total, in the two closings ofthe 2007 Private Placement the Company issued a total of $1,073,500 inprincipal amount of notes and warrants to purchase 226,000 shares of commonstock. The combined net proceeds of the two closings of the 2007 PrivatePlacement will be used to pay certain existing obligations, fund research anddevelopment efforts and for general corporate purposes.

 

F-43

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On January 4, 2008,pursuant to a final separation agreement with a former employee of the Company,the Company issued to the former employee five-year warrants (immediatelyexercisable) to acquire up to 14,500 shares of the Company’s common stock at anexercise price of $5.00 per share, and amended a previously issued warrant toacquire up to 30,000 shares of the Company’s common stock to provide forcashless exercise thereof.

 

On February 13 and February 28,2008, we closed on an aggregate $390,000 of units consisting of unsecured, subordinated,convertible promissory notes and common stock purchase warrants in a privateplacement (the “2008 Private Placement”).  Each unit consists of a note in theprincipal amount of $9,500 and awarrant to purchase 2,000 shares of our common stock.  The purchase price of the warrant portion ofeach unit was $500.  The notes bearinterest at 10 percent per year, mature on August 13, 2009, and willconvert into the securities offered under the public offering at 70 percent ofthe public offering price, including one warrant to purchase one share ofcommon stock for each share of common stock received thereby.  In the event a public offering is notcompleted before the maturity date, the entire principal and unpaid accruedinterest will convert into the Company’s common stock at $0.05 per share.  The Company may, at its option, prepay thenotes anytime on or after February 13, 2009.  The warrants will become exercisable upon theearlier of the closing of this offering or the maturity date of the notes, andwill remain exercisable until December 31, 2012.  The exercise price will be 50 percent of thepublic offering price, or in the event a public offering is not completedbefore the maturity date, at 50 percent of the closing price of the Company’scommon stock on the maturity date.

 

On February 14, 2008, the Company’s one-for-ten reverse stock split was declared effective as of the opening ofthe market.  Concurrent with theeffectiveness of the stock split, NASDAQ has assigned ProUroCare’s common stocka new trading symbol, “PUMD.”  All stockrelated numbers in this filing have been restated retrospectively for the stocksplit.

 

Duringthe year ended December 31, 2006, the Company was party to an employmentagreement with Mr. Taylor, its former Chief Executive Officer. Upon hisretirement from the Company, Mr. Taylor entered into an agreement with theCompany to defer the payment of his unpaid salary according to an agreed uponschedule (see Note 6(b)).  Due to fundinglimitations, the Company only paid $5,000 of the required December 28,2007 payment of $106,017, and paid afurther $5,000 to Mr. Taylor on February 5, 2008.  On February 14, 2008, the Company paidthe remaining $96,017 balance due to Mr. Taylor from the proceeds of theprivate placement.  On February 14,2008, the Company paid $8,316 pursuant to certain late payment clauses in thedeferred payment agreement.  No furtherpayments are due to Mr. Taylor under either his employment agreement orthe deferred payment agreement.

 

**On March 11, 2008, the Company amendedits $600,000 promissory note with the Smith Trust”.  Under the terms of the amendment, interestaccrued pursuant to the promissory note will be payable on the February 28,2009 maturity date, rather than payable monthly.**

** **

**Also on March 11, 2008, the Companyamended its $100,000 promissory note with the Smith Trust.  Under the terms of the amendment, unpaidprincipal and interest will be payable upon the Company’s closing of anaggregate of $500,000 or more of financing following the date of the amendment.**

 

F-44

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**ITEM 8:**                                 CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

** **

None.

 

**ITEM 8A(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, 2007, the end of the periodcovered by this Annual Report on Form 10-KSB, we carried out anevaluation, under the supervision and with the participation of management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures pursuant to Exchange Act Rule 13a-15. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures 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-KSB were prepared by the Company’smanagement, which is responsible for establishing and maintaining adequateinternal control over 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, 2007. 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 31,2007, the Company’s internal control over financial reporting is effective.

 

ThisAnnual Report on Form 10-KSB 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 

 

44

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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-KSB

 

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

 

Duringthe quarter ended December 31, 2007, 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 8B:           OTHER INFORMATION**

 

None.

 

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**PART III**

 

**ITEM 9:**                                 DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE;COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

** **

***Directors and Executive Officers***

 

Thefollowing information sets forth the names of our executive officers anddirectors, their ages and their present positions with the Company as of March 17,2008.  The directors serve for a term ofone year or until the next annual meeting of the shareholders.  Each officer serves at the discretion of theBoard of Directors.

 
| **Name**           | ** ** | **Age** | ** ** | **Position**                                 |
|--------------------|------------|---------|------------|----------------------------------------------|
|               |       |    |       |                                         |
| Richard C. Carlson |       | 56      |       | Chief  Executive Officer and Acting Chairman |
|               |       |    |       |                                         |
| Richard B. Thon    |       | 52      |       | Chief  Financial Officer                     |
|               |       |    |       |                                         |
| David F. Koenig    |       | 67      |       | Director                                     |
|               |       |    |       |                                         |
| Robert J. Rudelius |       | 52      |       | Director                                     |
|               |       |    |       |                                         |
| Scott E. Smith     |       | 52      |       | Director                                     |

 

**Richard C. Carlson** was elected to our Board of Directors in December 2006 and becameActing Chairman in May 2007.  Mr. Carlsonwas hired as our Vice President of Marketing and Sales in January 2005,and was promoted to Chief Executive Officer in November 2006.  Prior to joining ProUroCare, Mr. Carlsonheld several positions with SurModics, Inc., a company that providessurface modification solutions for medical device and biomedical applications,from 1998 to 2004, including Vice President of Marketing and Sales and Vice Presidentof Strategic Planning.

 

**Richard B. Thon**, was engaged as our Chief Financial Officer on a part-time consultingbasis from 2002 until July 2004, when he became employed by the Company inthat position on a full-time basis.  From2001 to 2004, Mr. Thon was also the part-time Chief Financial Officer ofCHdiagnostics, LLC, a marketer of blood glucose diagnostic supplies.

 

**David F. Koenig** served as a director of our predecessor company, PUC, from 1999 until April 2004,when became a director of the Company upon the Merger.  From 1996 to 2005, Mr. Koenig was theExecutive Vice President and Chief Operating Officer of Solar Plastics, Inc.,a manufacturer of custom rotationally molded plastic parts.  Mr. Koenig is Chairman of the Nominatingand Governance Committee, and is a member of the Audit and CompensationCommittees.

 

**Robert J. Rudelius** was elected to the Company’s Board of Directors on June 12,2007.  Since 2003, Mr. Rudelius hasbeen the Managing Director and CEO of Noble Ventures, LLC, a company he founded,providing advising and consulting services to early-stage companies in theinformation technology, renewable energy, and loyalty marketing fields.  Mr. Rudelius is also the ManagingDirector and CEO of Noble Logistics, LLC, a holding company he founded in 2002to create, acquire and grow a variety of businesses in the freight management,logistics and information technology industries.

 

**Scott E. Smith** has been a director of the Company since 2006. He is employed by F-2Intelligence Group (“F-2”), a company engaged in providing critical insights tomultinational corporations and private equity clients on a broad range ofstrategic issues.  From 2002 to 2005, Mr. Smithserved as F2’s Director of Corporate Accounts, and is currently F2’s RegionalDirector for Private Equity.  Mr. Smithis a Certified Public Accountant and a Certified Management Accountant.  Mr. Smith is Chairman of the AuditCommittee.

 

46

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Thereare no family relationships among our executive officers or directors.

 

**Audit Committee**

** **

Our Board of Directors has established a two-memberAudit Committee that currently consists of Messrs. Smith and Koenig.  The Board of Directors has adopted a writtencharter for the Audit Committee, which is available on our website www.prourocare.com.  The Audit Committee wasformed after the effectiveness of the Merger, and prior to the Merger, theCompany had no such Audit Committee.

 

The board of directors has determined that bothmembers of the audit committee, Mr. Smith and Mr. Koenig, are “auditcommittee financial experts” as that term is defined in Item 407(d)(5) ofRegulation S-B 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 relevant experience includes hisservice as the Chief Financial Officer and director of Quadion Corporation, andhis past consulting experience, which involved his oversight and supervision ofthe performance of business enterprises respecting the preparation, audit andevaluation of financial statements.  Bothmembers of the audit committee currently qualify as “independent directors,” assuch term is defined in Section 4200(a)(15) of the NASDAQ listingstandards.  Moreover, the board ofdirectors has determined that each of the Audit Committee members is able toread and understand fundamental financial statements and has past employmentexperience in finance or accounting.

 

**Code of Ethics Disclosure Compliance**

 

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 ourwebsite www.prourocare.com, and we will provide a copy, without charge, toany shareholder upon written request to Dick Thon, ProUroCare Medical Inc.,5500 Wayzata Blvd., Suite 310, Golden Valley, MN  55416.

 

**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 2007, except as follows:

 
| **Name**        | ** ** | **Number of Late  Reports** | ** ** | **Number of**

**Transactions Reported  Late** |
|-----------------|------------|---------------------------------------|------------|----------------------------------------------------------|
|            |       |                                  |       |                                                     |
| Robert Rudelius |       | 2                                     |       | 1                                                        |

 

**ITEM 10:            EXECUTIVE COMPENSATION**

 

***Summary Compensation Table***

 

Thefollowing table sets forth the compensation earned for services rendered in allcapacities by our Chief Executive Officer and the other highest-paid executiveofficers serving as such at the end of fiscal year 2007 whose compensation forthat fiscal year was in excess of $100,000. The individuals named in the table will be hereinafter referred to asthe “Named Executive Officers.”

 

47

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**Summary Compensation Table**

 
| **Name and Position**                                                            | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)** | ** ** | **Option  Awards  ($)(5)** | ** ** | **All Other  Compensation  ($)(6)** | ** ** | **Total  ($)** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------|------------|-----------------|------------|----------------|------------|----------------------------|------------|------------------------------------------|------------|----------------|------------|
|                                                                                       |       |     |       |            |       |           |       |                       |       |                                     |       |           |       |   |   |   |   |   |
| Richard C.  Carlson(1)  Chief Executive Officer and Acting  Chairman of the Board          |       | 2007     |       | $               | 150,000    |           | $          | —                     |       | $                                        | 120,898    |           | $          | — |   | $ | 270,898 |   |
|                                                                                       |       | 2006     |       | $               | 125,000    |           | $          | —                     |       | $                                        | 94,782     |           | $          | — |   | $ | 219,782 |   |
|                                                                                       |       |     |       |            |       |           |       |                       |       |                                     |       |           |       |
| Richard B. Thon  (2)  Chief Financial Officer                                              |       | 2007     |       | $               | 140,000    |           | $          | —                     |       | $                                        | 65,348     |           | $          | 1,200 |   | $ | 206,548 |   |
|                                                                                       |       | 2006     |       | $               | 140,000    |           | $          | 18,900                     |       | $                                        | 113,784    |           | $          | 1,200 |   | $ | 273,884 |   |
|                                                                                       |       |     |       |            |       |           |       |                       |       |                                     |       |           |       |
| Maurice R.  Taylor, II(3)  Former Chief Executive Officer and former Director         |       | 2007     |       | $               | 38,100     |           | $          | —                     |       | $                                        | 103,500    |           | $          | — |   | $ | 141,600 |   |
|                                                                                       |       | 2006     |       | $               | 190,000    |           | $          | —                     |       | $                                        | —     |           | $          | 1,838 |   | $ | 191,838 |   |
|                                                                                       |       |     |       |            |       |           |       |                       |       |                                     |       |           |       |
| Michael P.  Grossman(4)  Former President and Chief Operating Officer, and former Director |       | 2007     |       | $               | 14,583     |           | $          | —                     |       | $                                        | 146,635    |           | $          | — |   | $ | 161,228 |   |
|                                                                                       |       | 2006     |       | $               | 175,000    |           | $          | —                     |       | $                                        | 114,784    |           | $          | 1,080 |   | $ | 290,864 |   |

 

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(1)                   Mr. Carlson joined the Company on January 3,2005 as Vice President of Marketing and Sales. He was promoted to the position of Chief Executive Officer on November 1,2006.  Mr. Carlson was appointed tofill a vacancy on the Board of Directors in December 2006, and wasappointed as acting Chairman upon Mr. Taylor’s stepping down from thatposition effective May 3, 2007. All compensation Mr. Carlson earnedis related to his duties as an officer. Due to funding limitations, $146,635 of Mr. Carlson’s salary earnedin 2006 and 2007 was unpaid as of December 31, 2007.

 

(2)                   Due to funding limitations, $166,259 of Mr. Thon’ssalary and bonus earned in 2006 and 2007 was unpaid as of December 31,2007.

 

(3)                   Mr. Taylor was Chief Executive Officerof the Company until his retirement from that position on October 31,2006.  Mr. Taylor continued to beemployed by the Company in a transition role through March 31, 2007.  Mr. Taylor continued to serve as theChairman of the Company until stepping down from that position effective May 2,2007.  All compensation Mr. Taylorearned related to his duties as an employee of the Company.  Due to funding limitations, $141,017 of Mr. Taylor’ssalary earned during 2006 and 2007 was unpaid at the time of his departure fromthe Company.  As consideration for hisagreement to defer payment of his accrued salary, pursuant to a deferredpayment agreement *(see “Employment Agreements,” below)*,the Company extended the original one-year period that Mr. Taylor mayexercise 45,000 of his stock options (including options gifted to his children)following his termination of employment until April 1, 2012.  The option extension was valued at $103,500using the Black-Scholes pricing model. As of December 31, 2007, $101,017 of Mr. Taylor’s accruedsalary remained unpaid, but was subsequently paid in February, 2008.

 

(4)                   Mr. Grossman served asa director of the Company until his resignation from the Board in December 2006.  The contract term of Mr. Grossman’semployment agreement ended effective January 31, 2007.  The Company elected not to renew Mr. Grossman’semployment agreement and effective February 1, 2007.  Due to funding limitations, $103,990 of Mr. Grossman’ssalary earned during 2006 and 2007 was unpaid at the time of his departure fromthe Company.  As consideration for hisagreement to defer payment of his accrued salary, , pursuant to a separationagreement *(see “Employment Agreements,” below),*the Company extended the original one-year period that Mr. Grossman mayexercise 45,000 of his stock options (including options gifted to his 

 

48

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children) following histermination of employment until February 1, 2012.  The option extension was valued at $117,000using the Black-Scholes pricing model. As of December 31, 2007, all of Mr. Grossman’saccrued salary had been paid.

 

(5)                   Options awards are valued in accordance withStatement of Financial Accounting Standards (“SFAS”) No. 123 (revised2004), “Share-Based Payment” (“SFAS 123R”). See Notes 1(j) and 10(h) to the Consolidated FinancialStatements for the fiscal year ended December 31, 2007 in this AnnualReport on Form 10-KSB for the material terms of stock option grants.

 

(6)                   Other compensation represents insurancepremiums paid by the Company with respect to term life insurance polices forthe benefit of the executive.  There isno cash surrender value associated with the policies.

 

***Outstanding Equity Awards at December 31,2007***

 

Nostock options or stock-appreciation rights were exercised during fiscal year2007, and no stock-appreciation rights were outstanding at the end of suchfiscal year.  The table below sets forthoutstanding but unexercised options of the Named Executive Officers as of December 31,2007.

 
| **Name(1)**          | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#) Exercisable** | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#)  Unexercisable** | ** ** | **Equity Incentive  Plan Awards:  Number of  Securities  Underlying  Unexercised  Unearned Options  (#)** | ** ** | **Option  Exercise Price** | ** ** | **Option**

**Expiration Date** | ** **            |
|----------------------|------------|----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|--------------------------------------|-----------------------|
|                 |       |                                                                                   |       |                                                                                 |       |                                                                                                                          |       |                            |       |                                 |                  |   |
| Richard C.  Carlson  |       | —                                                                                 |       | —                                                                               |       | 5,000                                                                                                                         | (2)        | $                               | 7.50       |                                 | March 1, 2011    |   |
|                 |       | 14,585                                                                                 |       | 416                                                                                  | (3)        | —                                                                                                                        |       | $                               | 23.50      |                                 | January 3, 2015  |   |
|                 |       | 5,000                                                                                  |       | 5,000                                                                                | (4)        | 5,000                                                                                                                         | (5)        | $                               | 5.00       |                                 | February 1, 2017 |   |
|                 |       |                                                                                   |       |                                                                                 |       |                                                                                                                          |       |                            |       |                                 |                  |
| Richard B. Thon      |       | —                                                                                 |       | —                                                                               |       | 5,000                                                                                                                         | (2)        | $                               | 7.50       |                                 | March 1, 2011    |   |
|                 |       | 3,000                                                                                  |       | —                                                                               |       | —                                                                                                                        |       | $                               | 11.33      |                                 | April 18, 2012   |   |
|                 |       | 20,000                                                                                 |       | —                                                                               |       | —                                                                                                                        |       | $                               | 25.00      |                                 | July 21, 2014    |   |
|                 |       |                                                                                   |       |                                                                                 |       |                                                                                                                          |       |                            |       |                                 |                  |
| Maurice R.  Taylor   |       | 18,600                                                                                 |       | —                                                                               |       | —                                                                                                                        |       | $                               | 11.33      |                                 | April 1, 2012    |   |
|                 |       |                                                                                   |       |                                                                                 |       |                                                                                                                          |       |                            |       |                                 |                  |
| Michael P.  Grossman |       | 38,000                                                                                 |       | —                                                                               |       | —                                                                                                                        |       | $                               | 20.00      |                                 | February 1, 2012 |   |

 

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(1)                      See Notes 1(j) and 10(h) to theConsolidated Financial Statements for the fiscal year ended December 31,2007 in this Annual Report on Form 10-KSB for the material terms of stockoption grants.

 

(2)                      Equity Incentive Plan Awards vest upon theCompany securing FDA approval of its ProUroScanTMsystem.

 

(3)                      Options vest ratably in monthly installmentsthrough January 3, 2008.

 

(4)                      Options vest on December 31, 2008.

 

(5)                      Equity Incentive Plan Award vests upon theCompany recording at least $1 million in revenue in 2008.

 

***Director Compensation***

 

OurBoard of Directors has established a policy that each of our non-employeedirectors receives an annual cash payment of $5,000 for annual services to theCompany, and that the chairpersons of our Compensation, Audit, and 

 

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Nominatingand Governance committees receive an additional annual payment of $2,500.  In addition, we have also agreed to grant toall non-employee directors a one-time non-qualified stock option upon electionor appointment to the Board of Directors to purchase 3,000 shares of our commonstock at fair market value.  Thesedirector options vest ratably over two years of service.  Mr. Nazarenko’s and Mr. Koenig’soptions have a ten-year term, and Mr. Smith’s and Mr. Rudelius’options have a seven-year term.  Alldirectors shall be reimbursed for travel and other out-of-pocket expensesincurred in connection with attendance at meetings of the Board of Directorsand its Committees.

 
| ** **              | ** ** | **(b)**                      | ** ** | ** **            | ** ** | **(d)**       | ** ** | ** ** | ** ** |
|-------------------------|------------|------------------------------|------------|-----------------------|------------|---------------|------------|------------|------------|
| **(a)**                 | ** ** | **Fees Earned or** | ** ** | **(c)**               | ** ** | **Option**    | ** ** | **(e)**    | ** ** |
| **Name**                | ** ** | **Paid in Cash**   | ** ** | **Stock Awards** | ** ** | **Awards(5)** | ** ** | **Total**  | ** ** |
| ** **              | ** ** | **($)**                      | ** ** | **($)**               | ** ** | **($)**       | ** ** | **($)**    | ** ** |
| David Koenig(1)         |       | $                            | 7,500      |                  | —     |          | —     |       | $          | 7,500 |   |
|                    |       |                         |       |                  |       |          |       |       |       |   |   |
| Alexander  Nazarenko(2) |       | $                            | 7,500      |                  | —     |          | —     |       | $          | 7,500 |   |
|                    |       |                         |       |                  |       |          |       |       |       |   |   |
| Scott Smith(3)          |       | $                            | 7,500      |                  | —     |          | $          | 8,850      |       | $ | 16,350 |   |
|                    |       |                         |       |                  |       |          |       |       |       |   |   |   |
| Robert  Rudelius(4)     |       | $                            | 2,917      |                  | —     |          | $          | 1,800      |       | $ | 4,717 |   |

 

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(1)                    Chairman of the Compensation Committee as of March 14,2008.  During 2007 and until March 17,2008, Mr. Koenig was Chairman of the Nominating and Governance Committee.

 

(2)                    Chairman of the Compensation Committee untilhis resignation from the Board of Directors on March 11, 2008.

 

(3)                    Chairman of the Audit Committee.

 

(4)                    Elected to the Board of Directors on June 14,2007.  The 3,000 options awarded in 2007vest ratably in monthly installments through June 14, 2009.  Chairman of the Nominating and GovernanceCommittee of March 14, 2008.

 

(5)                    Each outside director held options to acquire3,000 shares at December 31, 2007. Options awarded during the fiscal year are valued in accordance withSFAS 123R.  See Notes 1(j) and 10(h) tothe Consolidated Financial Statements for the fiscal year ended December 31,2007 for the material terms of stock option grants.

 

***Employment Agreements***

 

OnJuly 21, 2007, PUC entered into an employment agreement with its ChiefFinancial Officer, Richard Thon.  Theagreement extends through September 30, 2009. The agreement provides for aminimum annual salary of $140,000, a cash incentive bonus potential of up to 30percent of Mr. Thon’s base pay and eligibility to participate in an annualgrant of options to purchase shares of common stock, as determined by theCompany’s Board of Directors.  Theagreement provides for severance payments if the Company terminates Mr. Thonwithout cause or if Mr. Thon terminates the agreement for good reason,including four months of base salary plus one month of base salary for eachyear of service (up to a maximum of nine months of base salary), payment ofearned bonuses, continued payment of existing health and life insurancebenefits for a period of four months and immediate vesting of all unvestedstock options then held by Mr. Thon. In addition, within a one-year period following a “change in control” ofthe Company, upon termination without cause, unacceptable demotion or reductionin responsibilities, 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), andimmediate vesting of all unvested stock options then held by Mr. Thon.  The agreement prohibits Mr. Thon fromdirectly or indirectly participating in the ownership, management, operation orcontrol of a competitive business for a period of one year after his employmentwith the Company terminates.

 

50

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Duringthe year ended December 31, 2006, the Company was also party to anemployment agreement with Mr. Taylor, its former Chief Executive Officer,which terminated with his retirement from that position effective November 1,2006.  Mr. Taylor continued to beemployed by the Company in a transition role until March 31, 2007.  The employment agreement with Mr. Taylorprovided for an annual salary of $190,000 and maximum bonus potential of 75 percentof his base pay.  Due to fundinglimitations, the Company was unable to pay Mr. Taylor’s salary between June 15,2006 and March 31, 2007.  On May 11,2007, the Company entered into an agreement with Mr. Taylor to defer thepayment of his accrued salary further according to an agreed uponschedule.  Under the terms of theagreement, the Company agreed to pay Mr. Taylor’s accrued salary totaling$141,017 in installments of $5,000 per month from June 1, 2007 through December 1,2007, with the $106,017 balance to be paid prior to December 28,2007.  On February 14, 2008, the Company paid the balance of the accruedsalary plus $8,316 pursuant to certain late payment clauses in the deferredpayment agreement.  No further paymentsare due to Mr. Taylor under either his employment agreement or thedeferred payment agreement.  Asconsideration for his agreement to defer payment of his accrued salary, theCompany extended the original one-year period that Mr. Taylor may exercise45,000 of his stock options (including options gifted to his children)following his termination of employment until April 1, 2012.

 

Alsoduring the year ended December 31, 2006, the Company was party to anemployment agreement with Mr. Grossman, its former President and ChiefOperating Officer, that expired on January 31, 2007.  The Company elected not to renew theemployment agreement.  Mr. Grossman’sagreement provided for an annual salary of $175,000 with a maximum bonuspotential of 50 percent of his base pay. Due to funding limitations, the Company was unable to pay Mr. Grossman’ssalary between June 15, 2006 and January 23, 2007.  On May 11, 2007, the Company enteredinto an agreement with Mr. Grossman to defer the payment of his accruedsalary further according to an agreed upon schedule.  The parties also agreed to release and waiveeach other from all damages, actions, lawsuits, or claims the other party mayhave arising out of the employment of Mr. Grossman and the conclusion ofthat employment.  The Company paid Mr. Grossman’saccrued salary totaling $103,990 in installments of $4,000 on May 15,2007, $6,000 on June 1, 2007, and $8,000 per month from June 1, 2007through December 1, 2007, with the $45,990 balance paid out of theproceeds of the 2007 Private Placement on December 28, 2007.  As consideration for his agreement to deferpayment of his accrued salary, the Company extended the original one-yearperiod that Mr. Grossman may exercise 45,000 of his stock options(including options gifted to his children) following his termination ofemployment until February 1, 2012.

 

From June 2006 through the first closing of the2007 Private Placement, the Company deferred payment of the majority of ourremaining executive team’s compensation. We expect to paythe balance of the deferred compensation out of the proceeds of futurefinancings.  As of December 31, 2007,approximately $313,000 of our remaining executive team’s compensation had notbeen paid, and was recorded as an accrued liability.

 

**ITEM 11:****                    ****SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Thefollowing table sets forth certain information regarding beneficial ownershipof our common stock as of March 17,2008, by (i) each person known by us to be the beneficial owner ofmore than five percent of the outstanding common stock, (ii) each directorof the Company, (iii) each executive officer of the Company and (iv) allexecutive officers and directors as a group.

 

Thenumber of shares beneficially owned is determined under rules promulgatedby the SEC and the information is not necessarily indicative of beneficialownership for any other purpose.  Thedefinition of beneficial ownership for proxy statement purposes includes sharesover which a person has sole or shared voting power or dispositive power,whether or not a person has any economic interest in the shares. The definitionalso includes shares that a person has a right to acquire currently or within60 days of March 17, 2008.  Including those shares in the tables doesnot, however, constitute 

 

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anadmission that the named stockholder is a direct or indirect beneficial ownerof those shares.  Unless otherwiseindicated, each person or entity named in the table has sole voting power andinvestment power (or shares that power with that person’s spouse) with respectto all shares of common stock listed as owned by that person or entity.  Unless otherwise indicated, the address ofeach of the following persons is 5500 Wayzata Boulevard, Suite 310, GoldenValley, MN  55416.

 
| **Name**                                                                                          | ** ** | **Shares  Beneficially Owned** | ** ** | **Percent of Class** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|
|                                                                                              |       |                                |       |                           |       |
| Richard C.  Carlson(1)                                                                            |       | 20,850                              |       | 1.2                            |       |
|                                                                                              |       |                                |       |                           |       |
| David F.  Koenig(2)                                                                               |       | 61,035                              |       | 3.5                            |       |
|                                                                                              |       |                                |       |                           |       |
| Robert  J. Rudelius(3)                                                                            |       | 1,792                               |       | *                              |       |
|                                                                                              |       |                                |       |                           |       |
| Scott E.  Smith(4)                                                                                |       | 20,771                              |       | 1.2                            |       |
|                                                                                              |       |                                |       |                           |       |
| Richard B.  Thon(5)                                                                               |       | 23,000                              |       | 1.3                            |       |
|                                                                                              |       |                                |       |                           |       |
| **All  directors and officers as a group (5 total)(6)**                                           | ** ** | **127,448**                         | ** ** | **7.1**                        | ** ** |
| ** **                                                                                        | ** ** | ** **                          | ** ** | ** **                     | ** ** |
| Alex  Nazarenko(7)                                                                                |       | 272,191                             |       | 15.7                           |       |
|                                                                                              |       |                                |       |                           |       |
| Clement Nelson(8)  5644 Heather Ridge Court  Shoreview, MN 55126                                  |       | 212,750                             |       | 12.3                           |       |
|                                                                                              |       |                                |       |                           |       |
| CS Medical Technologies, LLC(9)  2277 West Highway 36, Suite 254  Roseville, Minnesota 55113 |       | 194,750                             |       | 11.3                           |       |
|                                                                                              |       |                                |       |                           |       |
| James Davis (10)  6446 Flying Cloud Dr.  Eden Prairie, MN 55344                                   |       | 164,530                             |       | 9.4                            |       |
|                                                                                              |       |                                |       |                           |       |
| Phillip W. Smith Family Trust (11)  7501 North Ironwood Drive  Paradise Valley, AZ 85253          |       | 151,980                             |       | 8.7                            |       |
|                                                                                              |       |                                |       |                           |       |
| William Reiling (11)  200 University Avenue W., Suite 200  St. Paul, MN 55103                |       | 151,980                             |       | 8.7                            |       |
|                                                                                              |       |                                |       |                           |       |
| Bruce Culver (12)  1856 Dawn Meadow Street  Westlake Village, CA 91362                            |       | 118,077                             |       | 6.8                            |       |
|                                                                                              |       |                                |       |                           |       |
| Maurice R. Taylor(13)  One Carlson Parkway, Suite 124  Plymouth, MN 55447                    |       | 112,501                             |       | 6.4                            |       |
|                                                                                              |       |                                |       |                           |       |
| Profile, L.L.C. (14)  2700 Corporate Drive, Suite 120  Birmingham, Alabama 35242             |       | 102,430                             |       | 5.9                            |       |

 

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*Less than one percent.

 

(1)                    Includes 850 shares held directly and options topurchase up to 20,000 shares of common stock which are currently exercisable orexercisable within 60 days.  Of Mr. Carlson’soptions, 15,000 are exercisable at $23.50 per share, and 5,000 are exercisableat $5.00 per share.

 

(2)                    Includes 1,875 shares held by Clinical Network, LLC,and 26,571 shares held by Clinical Network, Inc., with respect to each ofwhich Mr. Koenig is an officer and minority owner.  Also includes 22,803 shares of common stockheld directly, options to purchase up to 3,000 shares of common stock which arecurrently exercisable or exercisable within 60 days at $11.33 per share, andimmediately exercisable warrants to purchase 6,786 shares at $16.67 per share.

 

(3)                    Includes 417 shares held directly and options topurchase up to 1,375 shares of common stock which are currently exercisable orexercisable within 60 days at $2.90 per share.

 

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(4)                    Includes 17,896 shares held directly and options topurchase up to 2,875 shares of common stock which are currently exercisable orexercisable within 60 days at $7.00 per share.

 

(5)                    Includes options to purchase up to 23,000 shares ofcommon stock which are currently exercisable or exercisable within 60days.  Of Mr. Thon’s options, 3,000are exercisable at $11.33 per share, and 20,000 are exercisable at $25.00 pershare.

 

(6)                    Includes Messrs. Carlson, Koenig, Rudelius, Smithand Thon.

 

(7)                    Includes 194,750 shares held by CS MedicalTechnologies, LLC, of which Mr. Nazarenko is a managing officer andmember.  Also includes 74,441 shares ofcommon stock held directly and options to purchase up to 3,000 shares of commonstock which are currently exercisable or exercisable within 60 days at $11.33per share.  Mr. Nazarenko is aformer director of the Company who resigned from our Board of Directors on March 11,2008.

 

(8)                    Includes 194,750 shares held by CS MedicalTechnologies, LLC, of which Mr. Nelson is a managing officer and member,and 18,000 shares held directly.

 

(9)                    The beneficial owners of CS Medical Technologies, LLCare Clement Nelson and Alex Nazarenko (a director of the Company).

 

(10)              Includes 67,986 shares held directly, immediatelyexercisable warrants to purchase 29,877 shares at $5.00 per share andconvertible debentures convertible into 66,667 shares within 60 days at $3.00per share.

 

(11)              Includes 67,986 shares held directly, immediatelyexercisable warrants to purchase 17,327 shares at $5.00 per share andconvertible debentures convertible into 66,667 shares within 60 days at $3.00per share.

 

(12)              Reporting person also holds certain unitsconsisting of unsecured, subordinated, convertible promissory notes and relatedwarrants to purchase common stock.  The10,000 shares of common stock underlying the warrants and the equity securitiesissuable upon conversion of the $47,500 in principal amount of the notes arenot included in the above calculation of shares because the conversion of thenotes and exercise of the warrants are contingent upon future events.

 

(13)              Includes 56,875 shares held directly, immediatelyexercisable warrants to purchase 16,759 shares at $5.00 per share andconvertible debentures convertible into 44,443 shares within 60 days at $3.00per share.

 

(14)              Includes 1,875 shares of common stock held by ClinicalNetwork, LLC, and 26,571 shares held by Clinical Network, Inc., withrespect to each of which Mr. Taylor is a managing officer and majorityowner.  Also includes 65,205 shares ofcommon stock held directly, 250 shares held by his spouse, and options topurchase 18,600 shares of common stock which are currently exercisable at$11.33 per share.  Of Mr. Taylor’sdirectly held shares, 57,648 shares are pledged as security on a bankloan.  Mr. Taylor is a former ChiefExecutive Officer and Chairman of the Board of Directors of the Company, whoresigned from employment by the Company effective March 31, 2007.  Pursuant to a separation of employmentagreement, the Company has agreed to allow Mr. Taylor to exercise hisoptions through April 1, 2012.

 

(15)              The managers of Profile, LLC are T.Forcht Dagi and Stanley L. Graves, who share voting and investment power overthe securities held by Profile, LLC. Cordova Technology Partners, LP, (“*Cordova*”),is a member of Profile and has a 39.75 percent equity interest in Profile. As aresult of its equity interest in Profile, Cordova has an indirect pecuniaryinterest in 40,716 shares, or approximately 2.4 percent, of the common stockoutstanding.  Cordova’s business addressis 2500 Northwinds Parkway #475, Alpharetta, Georgia 30004. The managementcommittee of Cordova Technologies, LLC, of which T. Forcht Dagi is a member,exercises voting and investment power over the securities held by CordovaTechnology Partners, L.P.

 

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**SecuritiesAuthorized for Issuance under Equity Compensation Plans as of Last Fiscal Year(December 31, 2007)**

 
| ** **                                                  | ** ** | **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)     |       | 172,500                                                                                                                                              |       | $                                                                                                           | 15.07      |                                                                                                                                                                                             | 127,500    |   |
|                                                        |       |                                                                                                                                                 |       |                                                                                                        |       |                                                                                                                                                                                             |       |   |
| Equity compensation plans not approved by  stockholders (2) |       | 337,004                                                                                                                                              |       | $                                                                                                           | 11.14      |                                                                                                                                                                                             | —     |   |
|                                                        |       |                                                                                                                                                 |       |                                                                                                        |       |                                                                                                                                                                                             |       |   |
| Total                                                       |       | 509,504                                                                                                                                              |       | $                                                                                                           | 12.47      |                                                                                                                                                                                             | 127,500    |   |

 

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(1)                      Includes shares of our common stockissuable under options issued under our 2002 and 2004 Plans (as defined below).

 

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

 

The Board of Directors adopted the 2002 and 2004 Plansto provide a means by which our employees, directors, officers and consultantsmay be given an opportunity to purchase our stock, to assist in retaining theservices of such persons, to secure and retain the services of persons capableof filling such positions and to provide incentives for such persons to exertmaximum efforts for our success.  Underthe 2002 and 2004 Plans, we are able to grant incentive and non-statutoryoptions, stock appreciation rights, stock awards, restricted stock awards, andperformance shares.  Incentive stockoptions granted under the 2002 and 2004 Plan are intended to qualify as “incentivestock options” within the meaning of Section 422 of the Internal RevenueCode of 1986, as amended (the “Code”). Non-statutory 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 and 2004 Plans on acase-by-case basis.  In accordance withSFAS No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 123R,“Share-Based Payment” we have elected to utilize the fair-value method ofaccounting for these options.  Anaggregate of $453,384, $344,234, and $1,582,078 of stock-based compensationrelated to these options was recognized in the years ended December 31,2007, 2006 and the period from August 17, 1999 to December 31, 2007,respectively.

** **

***2002 Plan***

** **

In April 2002, PUC adopted the ProUroCare Inc.2002 Stock Plan (the “2002 Plan”), pursuant to which PUC granted options toofficers, 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 ofoptions granted 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 the recently implemented Section 409Aof the Code.  Following the amendment,the plan was restated to include the amendment and to reflect the effects ofthe April, 2004 reverse merger and the February, 2008 reverse stock split, andrenamed as the “Amended and Restated 2002 Stock Plan.”

 

As of December 31, 2007 there were options topurchase 116,500 shares of our common stock outstanding under the 2002 Planthat are exercisable at prices ranging from $7.50 to $20.00.  All of these options are held by Companyofficers, consultants and directors.

 

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***2004 Plan***

** **

On July 12, 2005, our stockholders approved aresolution adopting the ProUroCare Medical Inc. 2004 Stock Option Plan (the “2004Plan”).  On March 27, 2008, ourboard of directors approved an amendment to the 2004 Plan that made certaintechnical changes make it compliant with the recently implemented Section 409Aof the Code.  Following the amendment,the plan was restated to include the amendment and to reflect the effects ofthe April, 2004 reverse merger and the February, 2008 reverse stock split, andrenamed as the “Amended and Restated 2004 Stock Option Plan.”

 

We have reserved 150,000 shares of common stock forissuance under the 2004 Plan.  As of December 31,2007, there were options to purchase 56,000 shares of our common stockoutstanding under the 2004 Plan that are exercisable at prices ranging from$2.90 to $25.00 per share. All of these options have been issued to Companyofficers and directors.

 

**ITEM 12:****                          ****CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, ANDDIRECTOR INDEPENDENCE**

 

***Loan Transactions***

 

Fromtime to time since January 2006, certain directors and other affiliates ofthe Company have made personal loans and advances to the Company for short-termworking capital needs.  Most such loansand advances were made on a “good faith” basis, not bearing interest and notevidenced by a note.  Certain larger suchloans were made pursuant to simple promissory notes.

 

OnJanuary 25, 2006, the Company borrowed $12,500 from each of AlexanderNazarenko and David F. Koenig, Company directors. In consideration, the Companyexecuted and issued to each of Mr. Nazarenko and Mr. Koenig a $12,500unsecured demand promissory note bearing interest at an annual rate of primeplus one percent.  These notes weresatisfied on February 16, 2006.

 

OnSeptember 7, 2006, the Company borrowed $7,000 from Scott Smith, adirector of the Company.  The loan boreno interest.  On February 12, 2007,the Company sold 1,707 shares of its common stock to Mr. Smith, thesubscription price being paid by the conversion of the $7,000 loan from Mr. Smith.  The per share selling price of $4.10 wasbased on the last selling price prior to this sale as reported on the OTCBB.

 

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 prime plus one percent, and was repaid on May 8, 2007.

 

OnJune 12, 2007, the Company borrowed $5,000 from Mr. Koenig.  The loan bears no interest.  $3,500 was repaid to Mr. Koenig on January 2,2008, with the remainder to be repaid as soon as the Company is able to do so.

 

Alsoon June 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 ofprime plus one percent.  The principalamounts of these loans were repaid to Mr. Nazarenko on December 28,2007.

 

OnJuly 3, 2007, the Company borrowed $10,000 from Mr. Nazarenko.  The unsecured loan bore no interest and wasrepaid on December 28, 2007

 

OnJuly 31, 2007, we borrowed $100,000 from the Phillips W. Smith FamilyTrust, a five percent shareholder of the 

 

55

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Company,pursuant to a promissory note.  The notebears interest at the prime rate, and is payable on the first to occur of (1) theCompany’s closing on $500,000 of new financing or (2) September 15,2007 (see “Other Transactions” below). Under the terms of the promissory note, we will issue to the SmithFamily Trust five-year warrants (immediately exercisable) to acquire 100 sharesof our common stock for each day the promissory note is outstanding (to beprorated if a portion of the loan is repaid), at $5.00 per share.  On January 3, 2008, we repaid $66,000 ofthis note.

 

On August 29, 2007 and October 31,2007, the Company borrowed for working capital purposes $50,000 and $100,000,respectively, from James Davis, a five percent shareholder of the Company, pursuantto two promissory notes.  The notes boreinterest at the prime rate.  In addition, for each day that thenotes remained outstanding, the Company agreed to grant to Mr. Davisfive-year warrants (immediately exercisable) to purchase 50 and 100 shares ofour common stock at an exercise price of 5.00 per share, respectively. Concurrently with the close of the 2007 Private Placement, we convertedthe $150,000 of short-term notes into a note in the aggregate principal amountof $142,500 and a warrant to purchase 30,000 shares of our common stock onsubstantially the same terms and conditions as the notes and warrants in the2007 Private Placement.  At the sametime, we issued to Mr. Davis the 11,850 warrants accrued pursuant to thepromissory notes as of December 27,2007.

 

On September 10, 2007, theCompany issued a total of 1,100 shares of its common stock to Mr. Carlsonand Mr. Smith as repayment for $3,330 of outstanding loans to the Company.

 

On September 28, 2007, the Company borrowed for workingcapital purposes $15,000 from Mr. Smith and $10,000 from Robert J.Rudelius, both directors of the Company. The unsecured loans bore no interest. Upon the first closing of the 2007 Private Placement, these loans wereconverted into units under that offering.

 

On November 30, 2007, theCompany borrowed for working capital purposes $25,000 from Mr. Davis.  This loan bore interest at the primerate computed on the basis of the actual number of days elapsed in the paymentperiod and a 365-day year.  In addition, for each day that theloan remained outstanding, the Company agreed to grant to Mr. Davisfive-year warrants (immediately exercisable) to purchase 25 shares of ourcommon stock at an exercise price of $5.00 per share.  We converted the principalamount of this short-term loan into units under the 2007 Private Placement, andissued the 700 warrants accrued as of December 27, 2007.

 

***Other Transactions***

 

FromJanuary 2002 through December 15, 2006, the Company sublet officespace serving as the Company’s executive offices, on a month-to-month basis,from a company majority-owned and controlled by one of the Company’s directors,Mr. Taylor. The Company believes the monthly rent incurred was at marketrate for such executive office space in Minneapolis, Minnesota.

 

TheCompany’s executive offices are temporarily located within the offices of Mr. Nazarenko.  Our rental cost for these temporary officesis approximately $2,200 per month, which we believe is at market for similaroffice space in Minneapolis, Minnesota.  Mr. Nazarenkohas informally agreed to defer payment of the rent until we are able to pay.

 

In connection with the renewal ofour Crown Bank notes to, among other things, extend the maturity date of suchnotes to February 28, 2009, we borrowed $600,000 from the Phillips W.Smith Family Trust, pursuant to a promissory note and used the proceeds toretire $600,000 of the original Crown Bank loan obligation.  The promissory note matures on February 28,2009, bears interest at 1.0 percent over the prime rate and has a subordinatedsecurity interest in all of the Company’s assets.  As consideration to the Smith Family Trust for lendingfunds to us and to James Davis, Bruce Culver and William Reiling, each fivepercent shareholders of the Company and the three remaining guarantors of theCrown Bank promissory notes, forextending their guarantees through February 28, 2009, we issued to them anaggregate amount of 122,222 shares of our common stock on December 28,2007.  We also agreed to issue to them (1) anaggregate amount of 24,445 shares of our common stock if the Crown Bankpromissory notes and 

 

56

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$600,000promissory note remain outstanding on October 31, 2008 and (2) five-yearwarrants to acquire a maximum aggregate of 61,112 shares of our common stock atan exercise price of $2.00.  The warrantswill be issued on the earlier of a closing of an underwritten public offeringor October 31, 2008, and will be exercisable beginning on the one-yearanniversary of that date.

 

Duringthe year ended December 31, 2007, the Company sold 125,000 of the Company’sinvestment units, consisting of one share of our common stock and a 3-yearwarrant (immediately exercisable) to acquire 0.5 shares of our common stock for$2.50($5.00 per share), at a price of $4.00 per unit, with total proceeds of$500,000.  The investment units were soldin tranches of 31,250 units each (on January 18, January 23, February 28and May 1) to James Davis, Bruce Culver, William Reiling and the Phillips W. Smith Family Trust.

 

On March 21, 2007, we amendedthe terms of four 10% unsecured convertible subordinated debentures in theaggregate amount of $733,344 issued by us to James L. Davis, BruceCulver, William S. Reiling and thePhillips W. Smith Family Trust.  Underthe amendment, each debenture holder agreed to accept as payment for interestdue on the debenture the following:

 

·                  cash paid forinterest from inception through May 31, 2006;

 

·                  investment units,consisting of one share of stock and a three-year warrant to acquire 0.5 sharesof Company common stock at $2.50 ($5.00 per share), for interest accrued from June 1,2006 through January 31, 2007, with such accrued interest converted intoinvestment units at a price of $4.00 per unit; and

 

·                  cash or shares ofour common stock (converted on the basis of $5.00 per share), at the option ofthe Company, for interest accrued from February 1, 2007 through settlementof the debenture.

 

Accordingly, on March 21, 2007, the Company issueda total of 12,478 shares of its common stock and three-year warrants(immediately exercisable) to acquire up to 6,239 shares of its common stock at5.00 per share to the four debenture holders.

 

On December 27, 2007, wefurther amended the terms of the four 10% unsecured convertible subordinateddebentures in the aggregate amount of $733,344 issued by us to JamesDavis, Bruce Culver, William Reiling and the Phillips W. Smith Family Trust, each guarantors of our Crown Bank promissory notes, so thatthe Debentures will automatically convert into shares of our common stock atthe closing of the public offering at $3.00 per share.

 

On December 27, 2007,the Company held a closing of its 2007 Private Placement.  In addition to the conversion of existingloans into units offered in the 2007 Private Placement, Robert Rudelius andJames Davis invested $10,000 and $200,000 in 2007 Private Placement units,respectively.  Jeanne Rudelius, sister ofRobert Rudelius and Jason Davis, son of James Davis, invested $20,000 and$30,000 in 2007 Private Placement units, respectively.

 

**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.  Prior to his resignation as director on March 11,2008, Mr. Nazarenko also qualified as an “independent director.”  As an executive officer of the Company, Mr. Carlsondoes not qualify as an “independent director.”

 

57

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**ITEM 13: EXHIBITS**

 
| **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).                          |
| 2.2                  |       | 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 warrants issued  to ProUroCare Inc. guarantors of lines of credit, issued between March 1  and December 22, 2003 (incorporated by reference to Exhibit 4.5 to  Registration Statement on Form SB-2 filed August 3, 2004).                                                                                                        |
| 4.3                  |       | Form of Warrant to  acquire a total of 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). |
| 4.4                  |       | 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).                                                                                                                         |
| 4.5                  |       | Form of Convertible  Subordinated Debenture issued in favor of William Reiling and James Davis  dated February 17, 2006 and issued in favor of the Phillips W. Smith  Family Trust and Bruce Culver dated February 28, 2006 (incorporated by  reference to Exhibit 4.6 to Current Report on Form 8-K filed  February 23, 2006).          |
| 4.6                  |       | 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).                                                                                             |
| 4.7                  |       | 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).                                                                                                                  |
| 4.8                  |       | 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).                                                                                                                                                          |
| 4.9                  |       | 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).                                                                                                                                                 |
| 4.10                 |       | 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).                                                                                            |
| 4.11                 |       | 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).                                    |
| 4.12                 |       | 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)                         |

 

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| 4.13  |   | 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). |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.14  |   | 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 (filed herewith).                                                                                                                                                                |
| 4.15  |   | 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 (filed herewith).                                                                                                                                                                 |
| 4.16  |   | Form of warrant  issued pursuant to the Company’s 2007 Private Placement dated  December 27, 2007 (filed herewith).                                                                                                                                                                                                                                                       |
| 4.17  |   | Warrant issued to James  Davis dated December 27, 2007 (filed herewith).                                                                                                                                                                                                                                                                                                            |
| 4.18  |   | Form of warrant  issued pursuant to the Company’s 2008 Private Placement dated February 13,  2008 (filed herewith).                                                                                                                                                                                                                                                       |
| 4.19* |   | 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).                                                                                                                                                                                                    |
| 4.20* |   | 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).                                                                                                                                                                                             |
| 10.1  |   | License Agreement by and  between CS Medical Technologies, LLC and ProUroCare Inc., dated July 6,  2001 (incorporated by reference to Exhibit 10.10 to Registration  Statement on Form SB-2/A filed October 1, 2004).                                                                                                                                                |
| 10.2  |   | License Agreement by and  between Rensselaer Polytechnic Institute and ProUroCare Inc., dated  July 13, 2001 (incorporated by reference to Exhibit 10.11 to  Registration Statement on Form SB-2/A filed October 1, 2004).                                                                                                                                           |
| 10.3  |   | License Agreement by and  between Profile, LLC and ProUroCare Inc., dated January 14, 2002, as  amended on March 22, 2002 (incorporated by reference to Exhibit 10.1  to Current Report on Form 8-K filed April 20, 2004).                                                                                                                                      |
| 10.4  |   | Letter of Understanding by  and between Profile LLC and ProUroCare Inc., dated March 23, 2004  (incorporated by reference to Exhibit 10.4 to Registration Statement on  Form SB-2 filed August 3, 2004).                                                                                                                                                             |
| 10.5  |   | Research and Development  Agreement by and among ProUroCare Medical Inc., Artann  Laboratories, Inc. and Armen Sarvazyan, dated July 15, 2004  (incorporated by reference to Exhibit 10.1 to Quarterly Report on  Form 10-QSB filed August 3, 2004).                                                                                                            |
| 10.6  |   | Development Agreement by  and among ProUroCare Medical Inc., Artann Laboratories, Inc. and Armen  Sarvazyan, dated July 15, 2004 (incorporated by reference to  Exhibit 10.2 to Quarterly Report on Form 10-QSB filed  August 3, 2004).                                                                                                                         |
| 10.7  |   | Memorandum of  Understanding between ProUroCare Inc. and Urologix, Inc., dated  July 27, 2005 (incorporated by reference to Exhibit 10.1 to Current  Report on Form 8-K filed August 2, 2005).                                                                                                                                                                  |
| 10.8  |   | Sublicense agreement  between ProUroCare Inc. and Urologix, Inc., dated July 27, 2005  (incorporated by reference to Exhibit 10.2 to Current Report on  Form 8-K filed August 2, 2005).                                                                                                                                                                         |
| 10.9  |   | Amendment #1 to License  Agreement by and between ProUroCare Inc. and Rensselaer Polytechnic Institute  Dated July 13, 2001, dated July 27, 2005 (incorporated by reference  to Exhibit 10.3 to Current Report on Form 8-K filed August 2,  2005).                                                                                                              |
| 10.10 |   | Demand Promissory Note  issued in favor of Alexander Nazarenko, dated January 25, 2006  (incorporated by reference to Exhibit 10.1 to Current Report on  Form 8-K filed January 31, 2006).                                                                                                                                                                           |
| 10.11 |   | Demand Promissory Note  issued in favor of David Koenig, dated January 25, 2006 (incorporated by  reference to Exhibit 10.2 to Current Report on Form 8-K filed  January 31, 2006).                                                                                                                                                                                  |
| 10.12 |   | Loan Agreement by and among  Adron Holdings, LLC, ProUroCare Inc., Maurice Taylor II and David Koenig,  dated January 25, 2006 (incorporated by reference to Exhibit 10.3  to Current Report on Form 8-K filed January 31, 2006).                                                                                                                                    |

 

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| 10.13  |   | Promissory Note issued in  favor of Adron Holdings, LLC, dated January 25, 2006 (incorporated by  reference to Exhibit 10.4 to Current Report on Form 8-K filed  January 31, 2006).                                                                                 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14  |   | Promissory Note issued in  favor of Crown Bank, executed February 16, 2006 and effective  January 11, 2006 (incorporated by reference to Exhibit 4.1 to  Current Report on Form 8-K filed February 23, 2006).                                                  |
| 10.15  |   | 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).                                                                    |
| 10.16  |   | 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).                                                                       |
| 10.17  |   | Assignment of CS Medical  Technologies LLC License Agreement between ProUroCare Inc. and Crown Bank,  dated January 11, 2006 and executed February 16, 2006 (incorporated  by reference to Exhibit 4.3 to Current Report on Form 8-K filed  February 23, 2006) |
| 10.18  |   | Assignment of Profile LLC  License Agreement between ProUroCare Inc. and Crown Bank, dated  January 11, 2006 and executed February 16, 2006 (incorporated by  reference to Exhibit 4.2 to Current Report on Form 8-K filed  February 23, 2006).                |
| 10.19  |   | 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).                                                                                             |
| 10.20  |   | Final Settlement Agreement  and Unconditional Release between Todd E. Leonard, and ProUroCare, Inc.,  dated March 3, 2006 (incorporated by reference to Exhibit 10.1 to  Current Report on Form 8-K filed March 3, 2006).                                      |
| 10.21  |   | 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).                                                                                                 |
| 10.22  |   | 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).                                           |
| 10.23  |   | 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).                                               |
| 10.24  |   | 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).                                                  |
| 10.25  |   | Amendment to MOU between  ProUroCare Inc. and Urologix Inc., dated March 21, 2007 (incorporated by  reference to Exhibit 10.39 to Annual Report on Form 10-KSB filed  March 30, 2007).                                                                              |
| 10.26  |   | 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).              |
| 10.27  |   | 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).                                                                                  |
| 10.28  |   | 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).                                                                                |
| 10.29  |   | 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).                                                                                                |
| 10.30  |   | 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).                                                                                |
| 10.31* |   | 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).                                                               |
| 10.32  |   | Promissory Note issued in  favor of Phillips W. Smith, dated July 31, 2007 (incorporated by  reference to Exhibit 10.4 to Quarterly Report on Form 10-QSB filed  August 14, 2007).                                                                                  |
| 10.33  |   | 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).                                   |

 

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| 10.34 |   | 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).           |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.35 |   | Promissory Note issued in  favor of the Phillips W. Smith Family Trust, executed on October 31, 2007  effective as of October 15, 2007 (filed herewith).                                             |
| 10.36 |   | Security Agreement issued  in favor of the Phillips W. Smith Family Trust, executed on October 31,  2007 effective as of October 15, 2007 (filed herewith).                                          |
| 10.37 |   | $400,000 Promissory Note  issued in favor of Crown Bank, executed October 31, 2007(filed  herewith).                                                                                                      |
| 10.38 |   | $1,200,000 Promissory Note  issued in favor of Crown Bank, executed October 31 2007 (filed  herewith).                                                                                                    |
| 10.39 |   | Commercial Loan and  Security Agreement with Crown Bank, executed October 31, 2007 and  effective as of December 28, 2007 (filed herewith).                                                          |
| 10.40 |   | Guaranty provided to Crown  Bank on behalf of ProUroCare Medical Inc. by Bruce Culver dated  October XX, 2007 (filed herewith).                                                                           |
| 10.41 |   | Guaranty provided to Crown  Bank on behalf of ProUroCare Medical Inc. by James Davis dated  October XX, 2007 (filed herewith).                                                                            |
| 10.42 |   | Guaranty provided to Crown  Bank on behalf of ProUroCare Medical Inc. by Phil Smith dated  October XX, 2007 (filed herewith).                                                                             |
| 10.43 |   | Promissory Note issued in  favor of James Davis, dated October 31, 2007 (filed herewith).                                                                                                                 |
| 10.44 |   | Promissory Note issued in  favor of James Davis, dated November 30, 2007 (filed herewith).                                                                                                                |
| 10.45 |   | Form of Convertible  Note issued pursuant to the Company’s 2007 Private Placement dated  December 27, 2007 (filed herewith).                                                                    |
| 10.46 |   | Convertible Note issued to  James Davis dated December 27, 2007 (filed herewith).                                                                                                                         |
| 10.47 |   | Form of Convertible  Note issued pursuant to the Company’s 2008 Private Placement dated  February 13, 2008 (filed herewith).                                                                    |
| 10.48 |   | Amendment #1 to Promissory  Note dated July 31, 2007 between ProUroCare Medical, Inc. and The  Phillips W. Smith Family Trust, Dated March 11, 2008 (filed herewith).                           |
| 10.49 |   | 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 (filed  herewith).              |
| 14.1  |   | Code of Ethics  (incorporated by reference to Exhibit 14.1 to Annual Report on Form 10KSB  filed March 31, 2005).                                                                                              |
| 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).                                                     |
| 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:                                     In order that share data agree with theunderlying documents, no share data in this list of Exhibits have been restatedto reflect the Company’s one-for-ten effect of the February, 2008 reverse stocksplit

 

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**ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

**Principal Accountant Fees andServices**

 

Thefollowing is a summary of the fees billed to the Company by Virchow Krause &Company, LLP for professional services rendered for the calendar years ended December 31,2007 and 2006, respectively:

 
| **Fee Category** | ** ** | **Fiscal 2007 Fees** | ** ** | **Fiscal 2006 Fees** | ** ** |
|-----------------------|------------|--------------------------------|------------|--------------------------------|------------|
|                  |       |                           |       |                           |       |
| Audit Fees            |       | $                              | 72,243     |                           | $          | 60,938 |   |
| Audit-related  Fees   |       | 3,750                          |       | —                         |       |
| Tax Fees              |       | —                         |       | 890                            |       |
| All Other Fees        |       | 9,825                          |       | —                         |       |
| Total Fees            | ** ** | **$**                          | **85,818** | ** **                     | **$**      | **61,828** | ** ** |

 

*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 memorandums.

 

**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 minimis 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 Securities Exchange Act of 1934.  100percent of the fees 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.

 

62

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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 31, 2008 |   |

 

Pursuant to the requirements of the Securities Act of1934, this Annual Report has been signed as of the 31st day of March, 2008, bythe 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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