SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



_____________________





FORM 10-QSB





|                                                                                                                                   
|-----------------------------------------------------------------------------------------------------------------------------------
|QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2006





Commission File Number:  0-24635







HYPERTENSION DIAGNOSTICS, INC.

(Exact name of small business issuer as specified in its charter)





|                                   |  |                                                
|---------------------------------- |  | -----------------------------------------------
|MINNESOTA
(State of incorporation) |  | 41-1618036
(I.R.S. Employer Identification No.)





2915 WATERS ROAD, SUITE 108

EAGAN, MINNESOTA 55121-1562

(651) 687-9999

(Address of issuers principal executive offices and telephone number)





|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesx
No  ̈


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



The number of shares of Common Stock outstanding as of October 31, 2006 was 40,157,106.

Transitional Small Business Disclosure Format:


Yes  ̈
No x









1







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|                                                                    |         
|------------------------------------------------------------------- | --------
|HYPERTENSION DIAGNOSTICS, INC.                                      |         
|                                                                    |         
|INDEX TO FORM 10-QSB                                                |         
|                                                                    |         
|                                                                    | Page No.
|                                                                    |         
|PART I.
FINANCIAL INFORMATION:                                      |         
|                                                                    |         
|Item 1.
Financial Statements                                        |         
|                                                                    |         
|Balance Sheets  September 30, 2006 (unaudited)                     |         
|and June 30, 2006                                                   | 3       
|                                                                    |         
|                                                                    |         
|Statements of Operations (unaudited)  Three Months Ended           |         
|September 30, 2006 and 2005                                         | 4       
|                                                                    |         
|                                                                    |         
|Statements of Cash Flows (unaudited)  Three Months Ended           |         
|September 30, 2006 and 2005                                         | 5       
|                                                                    |         
|Notes to Financial Statements                                       | 6       
|                                                                    |         
|Item 2.
Managements Discussion and Analysis of Financial Condition |         
|and Results of Operations                                           | 9       
|                                                                    |         
|Item 3.
Controls and Procedures                                     | 15      
|                                                                    |         
|                                                                    |         
|                                                                    |         
|PART II.
OTHER INFORMATION:                                         |         
|                                                                    |         
|Item 1.
Legal Proceedings                                           | 16      
|                                                                    |         
|Item 6.
Exhibits                                                    | 17      
|                                                                    |         
|SIGNATURES                                                          | 18      
|                                                                    |         
|CERTIFICATIONS                                                      | 19      





























2







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PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Hypertension Diagnostics, Inc.



Balance Sheets

|                                                           |  |   |               |         |           |              |        
|---------------------------------------------------------- |  | - | ------------- | ------- | --------- | ------------ | -------
|                                                           |  |   | September 30, |         | June 30, 
|                                                           |  |   | 2006          |         | 2006     
|                                                           |  |   | (Unaudited)   |         | (Audited)
|Assets                                                     |  |   |               |         |           |              |        
|Current Assets:                                            |  |   |               |         |           |             
|Cash and cash equivalents                                  |  | $ | 1,565,138     |         | $         | 1,722,913   
|Accounts receivable                                        |  |   | 138,189       |         |           | 177,660     
|Inventory                                                  |  |   |               | 299,298 |           |              | 334,963
|Prepaids and other current assets                          |  |   | 28,135        |         |           | 21,854      
|Total Current Assets                                       |  |   | 2,030,760     |         |           | 2,257,390   
|Property and Equipment:                                    |  |   |               |         |           |             
|Leasehold improvements                                     |  |   | 17,202        |         |           | 17,202      
|Furniture and equipment                                    |  |   | 1,178,642     |         |           | 1,193,807   
|Less accumulated depreciation and amortization             |  |   | (1,124,503)   |         |           | (1,128,980) 
|                                                           |  |   |               | 71,341  |           |              | 82,029 
|Other Assets                                               |  |   | 6,530         |         |           | 6,530       
|Total Assets                                               |  | $ | 2,108,631     |         | $         | 2,345,949   
|Liabilities and Shareholders' Equity                       |  |   |               |         |           |             
|Current Liabilities:                                       |  |   |               |         |           |             
|Accounts payable                                           |  | $ | 87,499        |         | $         | 58,895      
|Accrued payroll and payroll taxes                          |  |   | 237,504       |         |           | 398,101     
|Deferred revenue                                           |  |   | 11,854        |         |           | 12,454      
|Other accrued expenses                                     |  |   | 34,006        |         |           | 19,631      
|Total Current Liabilities                                  |  |   | 370,863       |         |           | 489,081     
|Deferred Revenue, less current portion                     |  |   | 14,203        |         |           | 16,454      
|Shareholders' Equity:                                      |  |   |               |         |           |             
|Series A Convertible Preferred Stock, $.01 par value:      |  |   |               |         |           |             
|Authorized shares--5,000,000                               |  |   |               |         |           |             
|Issued and outstanding shares--871,225 at September        |  |   |               |         |           |             
|30, 2006 and June 30, 2006; each share of preferred        |  |   | 8,712         |         |           | 8,712       
|stock convertible into 12 shares of common stock at        |  |   |               |         |           |             
|the option of the holder (aggregate liquidation preference |  |   |               |         |           |             
|$2,869,462 and $2,391,218 at September 30, 2006            |  |   |               |         |           |             
|and June 30, 2006, respectively).                          |  |   |               |         |           |             
|Common Stock, $.01 par value:                              |  |   |               |         |           |             
|Authorized shares--150,000,000                             |  |   |               |         |           |             
|Issued and outstanding shares--40,157,106 at September     |  |   |               |         |           |             
|30, 2006 and June 30, 2006                                 |  |   | 401,571       |         |           | 401,571     
|Additional paid-in capital                                 |  |   | 27,479,682    |         |           | 27,408,450  
|Accumulated deficit                                        |  |   | (26,166,400)  |         |           | (25,978,319)
|Total Shareholders' Equity                                 |  |   | 1,723,565     |         |           | 1,840,414   
|Total Liabilities and Shareholders' Equity                 |  | $ | 2,108,631     |         | $         | 2,345,949   
|See accompanying notes.                                    |  |   |               |         |           |             







3







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Hypertension Diagnostics, Inc.



Statements of Operations

(Unaudited)



|                                             |  |   |                    |         |      |            |        
|-------------------------------------------- |  | - | ------------------ | ------- | ---- | ---------- | -------
|                                             |  |   | Three Months Ended
|                                             |  |   | September 30      
|                                             |  |   | 2006               |         | 2005
|Revenue:                                     |  |   |                    |         |      |            |        
|Equipment sales                              |  | $ | 333,301            |         | $    | 251,922   
|Equipment rental                             |  |   | 75,178             |         |      | 121,530   
|Service/contract income                      |  |   | 14,006             |         |      | 7,464     
|                                             |  |   |                    | 422,485 |      |            | 380,916
|Cost of Sales                                |  |   | 20,245             |         |      | 32,500    
|Gross Profit                                 |  |   | 402,240            |         |      | 348,416   
|Selling, general and administrative expenses |  |   | 612,006            |         |      | 697,109   
|Operating Loss                               |  |   | (209,766)          |         |      | (348,693) 
|Other Income:                                |  |   |                    |         |      |           
|Interest income                              |  |   | 13,586             |         |      | 11,476    
|Gain on sale of property and equipment       |  |   | 8,099              |         |      | -         
|Total Other Income                           |  |   | 21,685             |         |      | 11,476    
|Net Loss                                     |  | $ | (188,081)          |         | $    | (337,217) 
|Basic and Diluted Net Loss per Share         |  | $ | 0.00               |         | $    | (0.01)    
|Weighted Average Shares Outstanding          |  |   | 40,157,106         |         |      | 32,930,909
|See accompanying notes.                      |  |   |                    |         |      |           













4







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Hypertension Diagnostics, Inc.



Statements of Cash Flows

(Unaudited)



|                                                                            |  |   |                    |           |      |           |          
|--------------------------------------------------------------------------- |  | - | ------------------ | --------- | ---- | --------- | ---------
|                                                                            |  |   | Three Months Ended
|                                                                            |  |   | September 30      
|                                                                            |  |   | 2006               |           | 2005
|Operating Activities:                                                       |  |   |                    |           |      |          
|Net loss                                                                    |  |   | $                  | (188,081) |      | $         | (337,217)
|Adjustments to reconcile net loss to net cash used in operating activities: |  |   |                    |           |      |          
|Expensing of fair value of stock options vested                             |  |   | 71,232             |           |      | -        
|Depreciation                                                                |  |   | 15,315             |           |      | 36,359   
|Net book value of disposed rental assets                                    |  |   | 659                |           |      | 6,897    
|Gain on sale of property and equipment                                      |  |   | (8,099)            |           |      | -        
|Change in operating assets and liabilities:                                 |  |   |                    |           |      |          
|Accounts receivable                                                         |  |   | 39,471             |           |      | (52,936) 
|Inventory                                                                   |  |   | 35,665             |           |      | 10,346   
|Prepaids and other current assets                                           |  |   | (6,281)            |           |      | (7,795)  
|Accounts payable                                                            |  |   | 28,604             |           |      | 16,760   
|Accrued payroll and payroll taxes                                           |  |   | (160,597)          |           |      | (27,833) 
|Deferred revenue                                                            |  |   | (2,851)            |           |      | (2,475)  
|Other accrued expenses                                                      |  |   | 14,375             |           |      | 1,682    
|Net cash used in operating activities                                       |  |   | (160,588)          |           |      | (356,212)
|Investing Activities:                                                       |  |   |                    |           |      |          
|Purchase of property and equipment                                          |  |   | (5,286)            |           |      | -        
|Proceeds from disposal of property and equipment                            |  |   | 8,099              |           |      | -        
|Net cash provided by investing activities                                   |  |   | 2,813              |           |      | -        
|Net (decrease) in cash and cash equivalents                                 |  |   | (157,775)          |           |      | (356,212)
|Cash and cash equivalents at beginning of period                            |  |   | 1,722,913          |           |      | 1,525,865
|Cash and cash equivalents at end of period                                  |  | $ | 1,565,138          |           | $    | 1,169,653
|See accompanying notes.                                                     |  |   |                    |           |      |          



















5







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Hypertension Diagnostics, Inc.

Notes to Financial Statements

September 30, 2006





1.

Interim Financial Information



The accompanying unaudited financial statements have been prepared in accordance with the instructions to Form 10-QSB and do not include all the information and notes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, these unaudited financial statements reflect all adjustments, consisting only of normal and recurring adjustments necessary for a fair presentation of the financial statements.  The results of operations for the three months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the full year ending June 30, 2007.  The June 30, 2006 balance sheet was derived from audited financial statements.  For further information, refer to the financial statements and notes included in the Companys Annual Report on Form 10-KSB for the fiscal year ended June 30, 2006.  The policies described in that report are used for preparing quarterly reports.



2. Litigation



On March 17, 2004, the Company received a letter from counsel for one of its employees alleging that the Companys reimbursement practices were illegal and unethical and also alleging violation of applicable whistleblower statutes.  On March 18, 2004, the Company received a letter from counsel for one of its former employees alleging that the Company failed to pay for accrued vacation time and also alleging violation of applicable whistleblower statutes.  On August 25, 2004, the Company entered into a binding memorandum of understanding with these individuals agreeing to settle these disputes.  As settlement in full of these employees claims, the Company agreed to pay the individuals an aggregate amount of $130,000 in cash and to issue shares of unrestricted Company common stock with a market value of $100,000.  The Company also retained a reimbursement consultant to investigate the whistleblower claims, and such consultant indicated its belief that such claims lack merit.



In May 2005, plaintiffs filed a motion to enforce the memorandum of understanding.  The Company filed a counter-motion seeking to enforce the return of property provisions in the memorandum of understanding.  On September 9, 2005, the Hennepin County District Court (the Court) ruled in favor of plaintiffs.  Pursuant to the Order, on September 30, 2005, the Company provided the Court with a check for deposit in the Courts account in the amount of $138,382 ($130,000 for the cash portion of the mediated settlement, and $8,382 for court and administrative costs and interest) to secure the judgment pending post-Order motions seeking further relief.  The Company filed a Notice of Appeal of the Courts decision on November 7, 2005.  On December 14, 2005, the Court denied plaintiffs motion for a supersedeas bond and instead ordered the defendants to deliver to the Hennepin County Court Administrator a stock certificate for 714,286 shares of the Companys common stock.  Additionally, the Court ordered that the $138,382 in funds on deposit with the Court remain on deposit with the Court for the duration of the parties appeal process.  On August 8, 2006, the Minnesota State Court of Appeals affirmed the decision of the Hennepin County District Court.  The Company has decided not to appeal the Court of Appeals decision to the Minnesota State Supreme Court and has attempted to negotiate a cash settlement in lieu of payment of 714,286 shares of common stock which, under the terms of the memorandum of understanding, would require registration with the U.S. Securities and Exchange Commission.  As of June 30, 2006 and September 30, 2006, there is no amount accrued regarding this matter as all claims have been settled in full by payment of cash and common stock. On October 13, 2006, the Company paid an additional $3,000 to Mansfield, Tanick & Cohen, P.A for interest in connection with the cash settlement in this matter.







6







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Hypertension Diagnostics, Inc.

Notes to Financial Statements

September 30, 2006





2.         Litigation (continued)



The Company is involved in various other legal actions in the ordinary course of its business.  Although the outcome of any such legal actions cannot be predicted, management believes that there are no pending legal proceedings against or involving the Company for which the outcome is likely to have a material adverse effect upon the Companys financial position or results of operations.



3.

Stock-Based Compensation

The Company regularly grants options to individuals under various plans as described in Note 4 of the Companys Annual Report on Form 10-KSB for the year ended June 30, 2006.  In December 2004, FASB published FASB Statement No. 123 (revised 2004), Share-Based Payment (FAS 123(R) or the Statement).  FAS 123(R) requires that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements.  That cost will be measured based on the fair value of the equity or liability instruments issued.  FAS 123(R) covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans.  FAS 123(R) is a replacement of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretive guidance.  The effect of the Statement is to require entities to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award.  FAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement.  The Company implemented FAS 123(R) on July 1, 2006, using the modified prospective transition method.



During the three months ended September 30, 2006, there were 575,000 options granted.  The fair value of option grants is determined at grant-date, using a Black-Scholes option pricing model.  The volatility factor used in the Black-Scholes option pricing model is based on historical stock price fluctuations.  Based on these valuations, the Company recognized compensation expense of $71,232 (earnings per share is zero) for the three months ending September 30, 2006, related to the options granted during this quarter.  The Company estimates the expense for the remainder of fiscal year 2007 to be approximately $9,668 based on the value of options outstanding on September 30, 2006 that will vest during the remainder of fiscal year 2007.  This estimate does not include any expense for options that may be granted and vest during the remainder of fiscal year 2007.



Had compensation cost for all employee stock-based compensation grants and warrants issued been determined based on the fair values at the grant-date consistent with the provisions of SFAS No. 123 for the three months ending September 30, 2005, net loss and basic and diluted net loss per share would have been as indicated below:





















7







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Hypertension Diagnostics, Inc.

Notes to Financial Statements

September 30, 2006





3.

Stock-Based Compensation  (continued)

|                                      |                    |          
|------------------------------------- | ------------------ | ---------
|                                      | Three Months      
|                                      | Ended             
|                                      | September 30, 2005
|Net Loss:                             |                    |          
|As Reported                           | $                  | (337,217)
|Fair Value compensation expense       |                    | (53,497) 
|Proforma                              | $                  | (390,714)
|                                      |                    |          
|Basic and Diluted Net Loss per Share: |                    |          
|As Reported                           | $                  | (0.01)   
|Fair Value compensation expense       |                    | -        
|Proforma                              | $                  | (0.01)   
|                                      |                    |          
|Stock Based Compensation:             |                    |          
|As Reported                           | $                  | -        
|Fair Value compensation expense       |                    | (53,497) 
|Proforma                              | $                  | (53,497) 



The fair value of the options granted during the three months ended September 30, 2006 and September 30, 2005 was estimated using the Black-Scholes option pricing model with the following weighted average assumptions:

|                   |               |                |             |           
|------------------ | ------------- | -------------- | ----------- | ----------
|                   |               | Expected       | Expected    | Expected  
|Three Months Ended | Interest Rate | Dividend Yield | Life        | Volatility
|September 30, 2006 | 4.50%         | None           | 2 - 5 years | 138.07%   
|September 30, 2005 | 4.25%         | None           | 5 years     | 112.00%   

.

The Company has entered into an employment agreement with its CEO, Mark N. Schwartz, whereby the Company will grant 175,000 phantom shares of its common stock to its CEO for every month of employment for the period January 1, 2006 through December 31, 2006.  A cash payment will be made to the CEO equal to the price per share of the Companys common stock times the number of phantom shares accrued at the earliest of certain Event Dates (as defined in the employment agreement).  Accordingly, the Company has accrued a compensation liability of $133,875 at September 30, 2006, which is the fair market value of 1,575,000 shares granted as of September 30, 2006 pursuant to this provision.  Due to the changes in the price of the Companys common stock, the Company recorded a benefit of $133,875 in compensation cost for the quarter ended September 30, 2006.







8







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4.         Net Loss Per Share



Basic net loss per share is computed using the weighted average number of common shares outstanding during each period.  Diluted net loss per share would normally include the dilutive effect of common shares potentially issuable upon the exercise of stock options, warrants, or the conversion of preferred stock.  However, since the Company reported losses for all periods presented, all potential common shares have been excluded from the calculation of diluted net loss per share, as the effect would have been anti-dilutive.



Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations



Forward-Looking Statements



This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934.  In addition, we may make forward-looking statements orally in the future by or on behalf of the Company.  When used, the words believe, expect, will, can, estimate, anticipate and similar expressions are intended to identify forward-looking statements.  We caution readers not to place undue reliance on any forward-looking statements and to recognize that the statements are not predictions of actual future results.  Actual results could differ materially from those anticipated in the forward-looking statements due to the risks and uncertainties set forth in our 2006 Annual Report on Form 10-KSB under the caption Risk Factors, as well as others not now anticipated.  These risks and uncertainties include, without limitation: our ability to develop a business model to timely generate acceptable levels of revenues; the control exercised by the Schwartz Group; negative effect on our stock price resulting from available securities for sale; our need for additional capital; our dependence on our CVProfilor® DO-2020; the availability of third-party reimbursements for the use of our products; increased market acceptance of our products; our marketing strategy potentially resulting in lower revenues; the illiquidity of our securities on the OTC Bulletin Board and the related restrictions on our securities relating to penny stocks; potential violations by us of federal and state securities laws; the availability of integral components for our products; our ability to develop distribution channels; increased competition; changes in government regulation; health care reforms; exposure to potential product liability; our ability to protect our proprietary technology; regulatory restrictions pertaining to data privacy issues in utilizing our Central Data Management Facility; and the ability to manufacture our products on a commercial scale and in compliance with regulatory requirements.  We undertake no responsibility to update any forward-looking statement. These forward-looking statements are only made as of the date of this report.  In addition to the risks we have articulated above, changes in market conditions, changes in our business and other factors may result in different or increased risks to our business in the future that are not foreseeable at this time.



Overview



We are engaged in the design, development, manufacture and marketing of proprietary medical devices that we believe non-invasively detect subtle changes in the elasticity of both large and small arteries.  We are currently marketing three products: the HDI/PulseWaveTM CR-2000 Research CardioVascular Profiling System, the CVProfilor® DO-2020 CardioVascular Profiling System and the CVProfilor® MD-3000 CardioVascular Profiling System.



·

The CR-2000 Research System is being marketed worldwide for research purposes only to clinical research investigators for the purpose of collecting data in cardiovascular studies. Because the CR-2000 Research System bears the CE Mark (CE0123 ) and meets the European Union Medical Device Directive, physicians may use the CR-2000 Research System with patients in a clinical setting in the European Union.



9







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·

In the U.S., the CVProfilor® DO-2020 System is being marketed to primary care physicians and other health care professionals on a per-patient-tested rental basis.  It can also be purchased or leased.  Utilizing our Central Data Management Facility, we are able to track utilization of the CVProfilor® DO-2020 System in each physicians office and medical clinic and to invoice our physician customers on the number of CardioVascular Profile Reports (CVProfileTM Reports) which they generate each month.  In the fourth quarter of fiscal year 2005, we implemented a new rent-to-own program that allows rental customers to credit a portion of their payments toward the purchase of their CVProfilor® DO-2020 System.  Acquisition options were enhanced with the assistance of a third-party leasing company, which the physicians can use to acquire their CVProfilor.



·

The CVProfilor® MD-3000 System is being marketed through distributors to physicians outside the United States.  These distributors purchase the product from us and then re-sell it to end-user physicians in their territory.  The CVProfilor® MD-3000 System has a CE Mark that allows it to be marketed within European Union countries.  The CVProfilor® MD-3000 may require certain regulatory approval for it to be marketed in other countries throughout the world.





Critical Accounting Policies



The financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which requires us to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related footnotes.  In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality.  We do not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below.  However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.



Revenue Recognition.  We recognize revenue in accordance with U.S. Securities and Exchange Commissions Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition.  Pursuant to SAB No. 104, the Company recognizes revenue from the sale of equipment at the time of shipment to a customer or distributor.  Shipment occurs only after receipt of a valid purchase order.  Payments from customers and distributors are either made in advance of shipment or within a short time frame after shipment.  In the case of sales to distributors, such payment is not contingent upon resale of the product to end users.  Shipping and handling costs are included as cost of equipment sales.  At the time of shipment, all of the criteria for recognition set forth in SAB No. 104 have been met:  persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.



Equipment rental revenue, whether from the minimum monthly fee or from the per-patient-tested fee, is recognized when collection is probable, which is currently upon cash receipt.   At the time of receipt of rental revenues, all of the criteria for recognition set forth in SAB No. 104 have been met:  persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.



In the case of either a sale or rental of our product, there are no post-shipment obligations which affect the timing of revenue recognition.  Neither customers nor distributors have a right to return or



10







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exchange our product.  Warranty repairs on all of the above are handled on a repair or replacement basis, at our discretion.  Further, there is no installation of our product; it is ready to use when plugged into an electrical outlet and no specialized knowledge is required to ready it for use.  For these reasons, we have concluded that our revenue recognition policy is appropriate and in accordance with SAB No. 104.



Allowance for Doubtful Accounts.  Accounts receivable are reviewed to determine the need for an allowance for amounts that may become uncollectible in the future.  The necessity of an allowance is based on managements review of accounts receivable balances and historical write-offs.  As of September 30, 2006 and June 30, 2006, there is no allowance for doubtful accounts.



Inventories and Related Allowance for Excess and Obsolete Inventory.  Inventories are valued at the lower of cost or market and reviewed to determine the need for an allowance for excess and obsolete inventories.  The need for an allowance is based on managements review of inventories on hand compared to estimated future usage and sales.  As of September 30, 2006 and June 30, 2006, there is an inventory reserve allowance.



Research and Development.  For the three months ended September 30, 2006, we incurred research and development costs of $31,505.  We did not incur any research and development costs for the three months ended September 30, 2005.





Results of Operations



As of September 30, 2006, we had an accumulated deficit of $26,166,400, attributable primarily to selling, general and administrative expenses.  Until we are able to generate significant revenue from our activities, we expect to continue to incur operating losses.  As of September 30, 2006, we had cash and cash equivalents of $1,565,138.  We anticipate that these funds, in conjunction with revenue anticipated to be earned from placements and sales of our CVProfilor® DO-2020 Systems, anticipated sales of our CR-2000 Research Systems, anticipated operating cost reductions, as well as anticipated proceeds from the exercise by holders of stock purchase warrants to purchase our common stock and Series A Preferred Stock, will allow us to pursue our business development strategy for at least the next twelve months following September 30, 2006.



Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005



The following is a summary of our Revenue and Cost of Sales for the three months ended September 30, 2006 and 2005, respectively:

|              |                                       |         |       |           |         |           |          |          |  |   |       
|------------- | ------------------------------------- | ------- | ----- | --------- | ------- | --------- | -------- | -------- |  | - | ------
|              | Three Months Ended September 30, 2006
|              |                                       |         |       | Equipment |         | Equipment |          | Service/
|              | Total                                 |         | Sales |           | Rental  |           | Contract
|Revenue       | $                                     | 422,485 |       | $         | 333,301 |           | $        | 75,178   |  | $ | 14,006
|Cost of Sales |                                       | 20,245  |       |           | 7,162   |           |          | 11,906   |  |   | 1,177 
|Gross Profit  | $                                     | 402,240 |       | $         | 326,139 |           | $        | 63,272   |  | $ | 12,829
|              |                                       |         |       |           |         |           |          |          |  |   |       
|              | Three Months Ended September 30, 2005
|              |                                       |         |       | Equipment |         | Equipment |          | Service/
|              | Total                                 |         | Sales |           | Rental  |           | Contract
|Revenue       | $                                     | 380,916 |       | $         | 251,922 |           | $        | 121,530  |  | $ | 7,464 
|Cost of Sales |                                       | 32,500  |       |           | 7,562   |           |          | 24,797   |  |   | 141   
|Gross Profit  | $                                     | 348,416 |       | $         | 244,360 |           | $        | 96,733   |  | $ | 7,323 





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Revenue.  Total Equipment Sales Revenue for the three months ended September 30, 2006 was $333,301, compared to $251,922 for the three months ended September 30, 2005, a 32% increase.  This increase was due in part to the expansion of our sales force over the period January 2006 through September 2006. Revenue relating to international equipment sales was $24,500 for the three months ended September 30, 2006 and $50,225 for the three months ended September 30, 2005, a 52% decrease.



Placements of the CVProfilor® DO-2020 System, and satisfactory utilization by physicians of those systems placed, has taken more time and resources than originally anticipated due to delays in obtaining consistent and satisfactory levels of third party reimbursements to physicians utilizing the CVProfilor® DO-2020 System and delays in integrating the CVProfilor® DO-2020 System into the clinic operations in which they are placed.  We have commenced focusing our resources on specific regional markets that we believe are more likely to generate higher levels of acceptance of the CVProfilor® DO-2020 System by physicians and a greater amount of reimbursements by third party payors to such physicians.  We believe this approach is the most effective method of both increasing placements of the CVProfilor® DO-2020 System and increasing the physician utilizations of such systems placed.  Our current marketing strategy focuses on marketing the CVProfilor® DO-2020 System to physicians who treat patients with diabetes and hypertension.  We believe these physicians have the greatest interest in, and use for, our product.  Therefore, the most critical factor in our ability to increase rental revenue rests in our ability to expand our marketing and distribution network to increase placements and utilization of our CVProfilor® DO-2020 System.



Further, the existence, timing and extent of reimbursement of physicians for the use of our CVProfilor® DO-2020 System affects the availability of our working capital.  Reimbursement will always vary considerably by the patients medical necessity, by physician, by provider, by geography and by provider coverage plans, making the process of obtaining reimbursement for the CVProfilor® DO-2020 System by current physician customers an important component of our products success.  To the extent that reimbursement is unavailable or inadequate, physicians will be less likely to use the CVProfilor® DO-2020 System.



In addition, because our CVProfilor® DO-2020 System is being marketed on a per-patient-tested basis, we have a delay in the cost recovery of our working assets.  Although our per-patient-tested marketing approach reduces the risk and thereby increases the potential rate of acceptance for physician customers willing to use the CVProfilor® DO-2020 System as compared to a capital acquisition approach, it also delays our cash flow recovery of product costs.  Physician payments for use of the CVProfilor® DO-2020 System follow actual utilization by some 60-90 days; utilization in one month is invoiced in the following month and payment is generally received within 30 to 60 days of invoicing.  This delay in payment, therefore, requires six to twelve months to fully recover product costs. These cash flow delays mean that we will generate little, if any, cash during the initial placement of the product and will require cash from other sources to support our operations during this period.



For the three months ended September 30, 2006, we recognized Revenue for the CVProfilor® DO-2020 System per-patient-tested rental program of $75,178, compared to $121,530 for the three months ended September 30, 2005, a 38% decrease.  We believe that a significant reason for this decrease is due to our business model;  we use the rental model primarily as a means of generating a trial with a hopeful move to a sale, and accordingly, a number of our renters will not remain in the rental mode as long as previous, ultimately resulting in lower rental revenues.



For the three months ended September 30, 2006, Service/Contract Income was $14,006,  compared to $7,464 for the three months ended September 30, 2005, an 88% increase.  This increase is due mainly to our increase in warranty service agreements.





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Expenses.  Total selling, general and administrative expenses for the three months ended September 30, 2006 were $612,006, compared to $697,109 for the three months ended September 30, 2005, a 12% decrease.  The following is a summary of the major categories included in selling, general and administrative expenses:



|                                                             |                    |          |      |   |        
|------------------------------------------------------------ | ------------------ | -------- | ---- | - | -------
|                                                             | Three Months Ended
|                                                             | September 30      
|                                                             | 2006               |          | 2005
|Wages, related expenses and benefits                         | $                  | (10,941) |      | $ | 228,320
|Patents and related expenses                                 |                    | -        |      |   | 1,048  
|Outside consultants                                          |                    | 29,853   |      |   | 88,861 
|Rent (building/equipment) and utilities                      |                    | 25,410   |      |   | 25,046 
|Insurance-general and directors/officers liability           |                    | 14,856   |      |   | 17,186 
|Selling, marketing and promotion, including applicable wages |                    | 291,240  |      |   | 215,514
|Legal and audit/accounting fees                              |                    | 74,232   |      |   | 53,992 
|Royalties                                                    |                    | 8,249    |      |   | 11,203 
|Depreciation and amortization                                |                    | 3,408    |      |   | 11,562 
|Research and development                                     |                    | 31,505   |      |   | -      
|Stock option expense                                         |                    | 71,232   |      |   | -      
|Other-general and administrative                             |                    | 72,962   |      |   | 44,377 
|Total selling, general and administrative expenses           | $                  | 612,006  |      | $ | 697,109



Wages, related expenses and benefits decreased from $228,320 to ($10,941) for the three months ended September 30, 2005 and September 30, 2006, respectively.  The ($10,941) was caused, in part, by a decrease in the price of our common stock during the quarter ended September 30, 2006.  Our CEO, Mark N. Schwartzs compensation has a component tied to the price of our common stock (see Note 3).  Included in the ($10,941) expense amount for the three months ended September 30, 2006 is a non-cash charge of ($133,875) that relates to this part of his compensation for services provided to us.  For the three months ended September 30, 2005, $131,250 of the $228,320 expense amount related to a similar non-cash charge.



Outside consultants expense decreased from $88,861 for the three months ended September 30, 2005 to $29,853 for the three months ended September 30, 2006, a 66% decrease.  This decrease is substantially the result of our decision in fiscal year 2005 to outsource our quality systems and regulatory affairs functions.  Included in the $29,853 expense amount for the three months ended September 30, 2006 is $3,405 that relates to services provided by outside service consultants in support of our quality systems pertaining to manufacturing, certification and marketing of our medical devices both domestically and internationally, as well as support of regulatory affairs matters.



Selling, marketing and promotion expense increased from $215,514 for the three months ended September 30, 2005 to $291,240 for the three months ended September 30, 2006, a 35% increase.  This category includes wages and commissions paid by us relating to our sales and marketing efforts, as well as travel and convention expenses.  This increase is due mainly to an increase in our sales force.



Legal and audit/accounting fees increased from $53,992 to $74,232 for the three months ended September 30, 2005 and 2006, respectively, a 37% increase.  This increase was due primarily to higher legal fees in connection with the matters discussed in footnote #2 to the financial statements.





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Interest income was $13,586 and $11,476 for the three months ended September 30, 2006 and 2005, respectively.



Net loss was $188,081 for the three months ended September 30, 2006, compared to a net loss of $337,217 for the three months ended September 30, 2005, a 44% decrease.  For the three months ended September 30, 2006, basic and diluted net loss per share was $0.00, based on weighted average shares outstanding of 40,157,106.  For the three months ended September 30, 2005, basic and diluted net loss per share was $(.01), based on weighted average shares outstanding of 32,930,909.





Liquidity and Capital Resources



Cash and cash equivalents had a net decrease of $157,775 and $356,212 for the three months ended September 30, 2006 and September 30, 2005, respectively.  The significant elements of these changes were as follows:



|                                                                                                                                                         |  |                                 |  |              
|-------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- |  | -------------
|                                                                                                                                                         |  | Three Months Ended September 30
|Net cash used in operating activities:                                                                                                                   |  | 2006                            |  | 2005         
|  net (loss), as adjusted for non-cash items                                                                                                            |  | $   (100,875)                   |  | $   (293,961)
|  (decrease) in accrued payroll and payroll taxes:                                                                                                      |  | (A)    (160,597)                |  | (27,833)     
|  (A) $133,875 of the $160,597 relates to the estimated amount due our chief executive officer as part of his compensation for services provided to us. |  |                                 |  |              



We have incurred operating losses and have not generated positive cash flow from operations.  As of September 30, 2006, we had an accumulated deficit of $26,166,400.



As of September 30, 2006, we had cash and cash equivalents of $1,565,138 and anticipate that these funds, in conjunction with revenue anticipated to be earned from placements and sales of our CVProfilor® DO-2020 Systems, anticipated sales of our CR-2000 Research Systems, anticipated operating cost reductions, as well as anticipated proceeds from the exercise by holders of stock purchase warrants to purchase our common stock and Series A Preferred Stock, will allow us to pursue our business development strategy for at least the next twelve months following September 30, 2006.



Our current marketing strategy focuses on marketing the CVProfilor® DO-2020 System to physicians who treat patients with diabetes and hypertension.  We believe these physicians have the greatest interest in, and use for, our product.  Therefore, the most critical factor in our ability to increase rental revenue rests in our ability to expand our marketing and distribution network to increase placements, sales and utilization of our CVProfilor® DO-2020 System.



Further, the existence, timing and extent of reimbursement of physicians for the use of our CVProfilor® DO-2020 affects the availability of our working capital.  Reimbursement will always vary considerably by the patients medical necessity, by physician, by provider, by geography and by provider coverage plans, making the process of obtaining reimbursement for the CVProfilor® DO-2020 by current physician customers an important component of our products success.  To the extent that reimbursement is unavailable or inadequate, physicians will be less likely to use the CVProfilor® DO-2020.



No assurance can be given that additional working capital will be obtained in a timely manner or on terms and conditions acceptable to us or our shareholders. Our financing needs are based upon management estimates as to future revenue and expense.  Our business plan and our financing needs are also subject to change based upon, among other factors, market conditions, and our ability to materially



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increase the revenue generated by our CVProfilor® DO-2020 System and other cash flow from operations.  Our efforts to raise additional funds may be hampered by the fact that our securities are quoted on the OTC Bulletin Board, are illiquid and are subject to the rules relating to penny stocks.



We have historically obtained working capital from the issuance of our securities.  On August 28, 2003, we completed the private placement offering of 585,980 units to a group of investors led by Mark N. Schwartz, our Chief Executive Officer.  Gross proceeds from this offering were $2,289,001 and net proceeds were $1,873,383.  On February 9, 2004, we completed an additional private placement offering  of 118,113 units to a group of investors.  Gross proceeds from this offering were $461,370 and net proceeds were $413,121.  In June 2004, we issued 1,580,623 shares of common stock and 99,391 shares of Series A Preferred Stock, to holders of warrants to purchase common stock and Series A Preferred Stock, resulting in gross proceeds of $471,464.  In July 2004, we issued 643,007 shares of common stock and 40,433 shares of Series A Preferred Stock, to holders of warrants to purchase common stock and Series A Preferred Stock, resulting in gross proceeds of $191,794.  In March and April 2005, we issued 2,756,534 shares of common stock and 173,341 shares of Series A Preferred Stock, to holders of warrants to purchase common stock and Series A Preferred Stock, resulting in gross proceeds of $822,227.  During the period between January 2006 and  June 2006, we issued 2,807,549 shares of common stock and 155,163 shares of Series A Preferred Stock, to holders of warrants to purchase common stock and Series A Preferred Stock, resulting in gross proceeds of $973,976.



Item 3.

Controls and Procedures.



(a) Evaluation of Disclosure Controls and Procedures.



Under the supervision and with the participation of our Chief Executive Officer, Mark N. Schwartz, and Manager of Finance and Accounting, Kellie D. Nelsen, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended) as of the end of the period covered by this report.  Based upon that review, our Chief Executive Officer and Manager of Finance and Accounting concluded that, as of the evaluation date, our controls and procedures are effective.



(b) Changes in Internal Controls over Financial Reporting.



There have been no changes in internal control financial reporting that occurred during the fiscal period covered by this report that have materially affected, or are reasonably likely to materially affect, the registrants internal control over financial reporting.



The Company is in the process of complying with the mandates of Section 404 of the Sarbanes-Oxley Act of 2002.  The U.S. Securities and Exchange Commission  recently adopted rules that delay the Companys schedule for compliance with Section 404 until the Companys fiscal year ending June 30, 2008.  The regulatory agencies are continuing to study the issues surrounding compliance, particularly as it relates to smaller public companies.  The Company has done due diligence to understand the requirements and corresponding work necessary to successfully document the Companys system of internal control to the standards and satisfaction of third parties.  The potential cost of compliance with Section 404 to the Companys shareholders in relation to the benefits may be significant.  In considering the Companys compliance efforts, the Company believes that these additional costs and expenses will confirm the existence of an effective and functioning internal control system.



The Company intends to diligently pursue implementation and compliance with Section 404 requirements.  The Company does not believe it is in the shareholders best interests to incur unnecessary outsized costs in this effort, as the Company has an existing system of centralized review and controls.  Consequently, the Company will make every effort to comply with Section 404 requirements, but also



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will attempt to minimize the expense of this effort.  As a result of this cautioned approach and the complexity of compliance, there is a risk that, notwithstanding the Companys best efforts, the Company may fail to demonstrate a compliance program that fully meets the standards of Section 404 as interpreted by the Companys independent accountants.









PART II. OTHER INFORMATION



Item 1.

Legal Proceedings



On March 17, 2004, the Company received a letter from counsel for one of its employees alleging that the Companys reimbursement practices were illegal and unethical and also alleging violation of applicable whistleblower statutes.  On March 18, 2004, the Company received a letter from counsel for one of its former employees alleging that the Company failed to pay for accrued vacation time and also alleging violation of applicable whistleblower statutes.  On August 25, 2004, the Company entered into a binding memorandum of understanding with these individuals agreeing to settle these disputes.  As settlement in full of these employees claims, the Company agreed to pay the individuals an aggregate amount of $130,000 in cash and to issue shares of unrestricted Company common stock with a market value of $100,000.  The Company also retained a reimbursement consultant to investigate the whistleblower claims, and such consultant indicated its belief that such claims lack merit.



In May 2005, plaintiffs filed a motion to enforce the memorandum of understanding.  The Company filed a counter-motion seeking to enforce the return of property provisions in the memorandum of understanding.  On September 9, 2005, the Hennepin County District Court (the Court) ruled in favor of plaintiffs.  Pursuant to the Order, on September 30, 2005, the Company provided the Court with a check for deposit in the Courts account in the amount of $138,382 ($130,000 for the cash portion of the mediated settlement, and $8,382 for court and administrative costs and interest) to secure the judgment pending post-Order motions seeking further relief.  The Company filed a Notice of Appeal of the Courts decision on November 7, 2005.  On December 14, 2005, the Court denied plaintiffs motion for a supersedeas bond and instead ordered the defendants to deliver to the Hennepin County Court Administrator a stock certificate for 714,286 shares of the Companys common stock.  Additionally, the Court ordered that the $138,382 in funds on deposit with the Court remain on deposit with the Court for the duration of the parties appeal process.  On August 8, 2006, the Minnesota State Court of Appeals affirmed the decision of the Hennepin County District Court.  The Company has decided not to appeal the Court of Appeals decision to the Minnesota State Supreme Court and has attempted to negotiate a cash settlement in lieu of payment of 714,286 shares of common stock which, under the terms of the memorandum of understanding, would require registration with the U.S. Securities and Exchange Commission.  On October 13, 2006, the Company paid an additional $3,000 to Mansfield, Tanick & Cohen, P.A. for interest in connection with the cash settlement in this matter.





The Company is involved in various other legal actions in the ordinary course of its business.  Although the outcome of any such legal actions cannot be predicted, management believes that there are no pending legal proceedings against or involving the Company for which the outcome is likely to have a material adverse effect upon the Companys financial position or results of operations.







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Item 6.

Exhibits



(a)

The following Exhibits are furnished pursuant to Item 601 of Regulation S-B:



|     |                                                                                           
|---- | ------------------------------------------------------------------------------------------
|31.1 | Certification of Chief Executive Officer pursuant to 13a-14 and 15d-14 of the Exchange Act
|31.2 | Certification of Chief Financial Officer pursuant to 13a-14 and 15d-14 of the Exchange Act
|32   | Certificate pursuant to 18 U.S.C. § 1350                                                  







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SIGNATURES





In accordance with the requirements of the Exchange Act, the Registrant has caused this Form 10-QSB to be signed on its behalf by the undersigned, thereunto duly authorized.







HYPERTENSION DIAGNOSTICS, INC.By/s/ Kellie D. NelsenKellie D. NelsenManager of Finance and Accounting(principal financial officer)


Date:  November 14, 2006





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