##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION    FORM 10-QSB QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE QUARTERLY PERIOD ENDED March 31, 2004 Commission File Number: 0-24635 HYPERTENSION DIAGNOSTICS, INC.  MINNESOTA
    
    41-1618036(State of incorporation)
    
    (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 o The number of shares of Common Stock outstanding as of April 30, 2004 was
24,868,755. Transitional Small Business Disclosure Format: Yeso         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
    
    
    3Balance Sheets  March 31, 2004 and June 30, 2003
    
    
    3Statements of Operations  Three Months and Nine Months Ended March 31, 2004 and 2003
    
    
    4Statements of Cash Flows  Nine Months Ended March 31, 2004 and 2003
    
    
    5Notes to Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10Item 3. Controls and Procedures
    
    
    20PART II.OTHER INFORMATION:Item 1. Legal Proceedings
    
    
    22Item 2. Changes in Securities
    
    
    22Item 3. Defaults Upon Senior Securities
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    22Item 5. Other Information
    
    
    22Item 6. Exhibits and Reports on Form 8-K
    
    
    22SIGNATURES
    
    
    23CERTIFICATIONS
    
    
    24Certification of CEOCertification of CFOCertification Pursuant to 18 U.S.C. Section 1350
  2




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements Hypertension Diagnostics, Inc. 
 Balance Sheets March 31,
    
    June 30,2004
    
    2003AssetsCurrent Assets:Cash and cash equivalents
    
    $
    1,205,665
    
    
    $
    90,335Accounts receivable
    
    
    79,852
    
    
    
    124,351Interest receivable
    
    
    11,684
    
    
    
    14,710Inventory, net
    
    
    254,558
    
    
    
    333,241Prepaids and other current assets
    
    
    72,378
    
    
    
    39,876Total Current Assets
    
    
    1,624,137
    
    
    
    602,513Property and Equipment:Leasehold improvements
    
    
    17,202
    
    
    
    17,202Furniture and equipment
    
    
    1,260,549
    
    
    
    1,222,169Less accumulated depreciation
    
    
    (870,982
    )
    
    
    (722,712
    )406,769
    
    
    
    516,659Prepaid Offering Expenses
    
    
    
    
    
    
    29,002Other Assets
    
    
    6,530
    
    
    
    6,730Total Assets
    
    $
    2,037,436
    
    
    $
    1,154,904Liabilities and Shareholders EquityCurrent Liabilities:Accounts payable
    
    $
    130,775
    
    
    $
    101,821Accrued payroll and payroll taxes
    
    
    413,862
    
    
    
    251,773Convertible notes payable
    
    
    
    
    
    
    481,492Deferred revenue
    
    
    
    
    
    
    153,553Other accrued expenses
    
    
    13,680
    
    
    
    43,910Total Current Liabilities
    
    
    558,317
    
    
    
    1,032,549Shareholders Equity:Series A Convertible Preferred Stock, $.01 par value:Authorized shares5,000,000Issued and outstanding shares704,093 and -0-
at March 31, 2004 and June 30, 2003, respectively
    
    
    7,041
    
    
    
    Common Stock, $.01 par value:Authorized shares150,000,000Issued and outstanding shares24,868,755 and 10,291,088
at March 31, 2004 and June 30, 2003, respectively
    
    
    248,688
    
    
    
    102,911Additional paid-in capital
    
    
    24,120,672
    
    
    
    21,429,844Accumulated deficit
    
    
    (22,897,282
    )
    
    
    (21,410,400
    )Total Shareholders Equity
    
    
    1,479,119
    
    
    
    122,355Total Liabilities and Shareholders Equity
    
    $
    2,037,436
    
    
    $
    1,154,904
 See accompanying notes. 3




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Hypertension Diagnostics, Inc. 
 Statements of Operations Three Months Ended
    
    Nine Months EndedMarch 31
    
    March 312004
    
    2003
    
    2004
    
    2003Revenue:Equipment sales
    
    $
    10,450
    
    
    $
    77,287
    
    
    $
    147,695
    
    
    $
    227,675Equipment rental
    
    
    132,914
    
    
    
    84,364
    
    
    
    324,734
    
    
    
    245,959Service/contract income
    
    
    67,157
    
    
    
    17,417
    
    
    
    220,711
    
    
    
    52,250210,521
    
    
    
    179,068
    
    
    
    693,140
    
    
    
    525,884Cost of Sales
    
    
    37,584
    
    
    
    34,338
    
    
    
    122,580
    
    
    
    87,695Gross Profit
    
    
    172,937
    
    
    
    144,730
    
    
    
    570,560
    
    
    
    438,189Expenses:Selling, general and administrative
    
    
    665,771
    
    
    
    652,515
    
    
    
    2,030,620
    
    
    
    2,684,497Total Expenses
    
    
    665,771
    
    
    
    652,515
    
    
    
    2,030,620
    
    
    
    2,684,497Operating Loss
    
    
    (492,834
    )
    
    
    (507,785
    )
    
    
    (1,460,060
    )
    
    
    (2,246,308
    )Other Income (Expense):Interest income
    
    
    7,821
    
    
    
    4,044
    
    
    
    23,363
    
    
    
    17,176Interest expense
    
    
    
    
    
    
    (57,511
    )
    
    
    (50,185
    )
    
    
    (210,200
    )7,821
    
    
    
    (53,467
    )
    
    
    (26,822
    )
    
    
    (193,024
    )Net Loss
    
    $
    (485,013
    )
    
    $
    (561,252
    )
    
    $
    (1,486,882
    )
    
    $
    (2,439,332
    )Basic and Diluted Net Loss per Share
    
    $
    (.02
    )
    
    $
    (.06
    )
    
    $
    (.07
    )
    
    $
    (.31
    )Weighted Average Shares Outstanding
    
    
    24,016,177
    
    
    
    9,463,110
    
    
    
    20,598,659
    
    
    
    7,871,211
 See accompanying notes. 4




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Hypertension Diagnostics, Inc. 
 Statements of Cash Flows Nine Months EndedMarch 312004
    
    2003Operating Activities:Net loss
    
    $
    (1,486,882
    )
    
    $
    (2,439,332
    )Adjustments to reconcile net loss to net
cash used in operating activities:Value of stock options, Common Stock and warrants
issued in lieu of cash
    
    
    5,791
    
    
    
    350,000Depreciation
    
    
    148,270
    
    
    
    162,588Amortization
    
    
    
    
    
    
    3,400Amortization of debt discount
    
    
    48,531
    
    
    
    149,023Interest expense  converted to Common Stock
    
    
    11,956
    
    
    
    13,711Change in operating assets and liabilities:Accounts receivable
    
    
    44,499
    
    
    
    188,077Interest receivable
    
    
    3,026
    
    
    
    (7,124
    )Related party note receivable
    
    
    
    
    
    
    117,000Inventory
    
    
    45,496
    
    
    
    46,308Prepaids and other assets
    
    
    (3,300
    )
    
    
    (31,864
    )Accounts payable
    
    
    28,954
    
    
    
    (66,938
    )Accrued payroll and payroll taxes
    
    
    162,089
    
    
    
    4,173Deferred revenue
    
    
    (153,553
    )
    
    
    (52,250
    )Other accrued expenses
    
    
    (30,230
    )
    
    
    (27,167
    )Net cash used in operating activities
    
    
    (1,175,353
    )
    
    
    (1,590,395
    )Investing Activities:Purchase of property and equipment
    
    
    (5,191
    )
    
    
    Net cash used in investing activities
    
    
    (5,191
    )
    
    
    Financing Activities:Issuance of Preferred and Common Stock
    
    
    2,295,874
    
    
    
    57,400Net cash provided by financing activities
    
    
    2,295,874
    
    
    
    57,400Net increase (decrease) in cash and cash equivalents
    
    
    1,115,330
    
    
    
    (1,532,995
    )Cash and cash equivalents at beginning of period
    
    
    90,335
    
    
    
    1,824,238Cash and cash equivalents at end of period
    
    $
    1,205,665
    
    
    $
    291,243Supplemental Schedule of Noncash Financing Activities:Conversion of notes payable and accrued interest into Common Stock
    
    $
    541,980
    
    
    $
    877,993
 See accompanying notes. 5




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Hypertension Diagnostics, Inc. 
 
  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 and nine months
ended March 31, 2004 are not necessarily indicative of the results that may be
expected for the full year ending June 30, 2004. The June 30, 2003 balance
sheet was derived from audited financial statements. For further information,
refer to the financial statements and notes included in our Annual Report on
Form 10-KSB, as amended, for the fiscal year ended June 30, 2003. The policies
described in that report are used for preparing quarterly reports.  2.
    
    Unit Placements The August Placement On August 28, 2003, we completed the private placement offering (the
August Placement) of 585,980 units (the Units) to a group of investors led
by Mark N. Schwartz, who is our Chief Executive Officer. Gross proceeds from
this offering were approximately $2,300,000 and net proceeds were $1,873,383.
The 585,980 Units are comprised of 585,980 shares of Series A Convertible
Preferred Stock, 9,318,866 shares of common stock, and warrants as follows:  
    
    Nine-month preferred stock purchase warrants permitting the holders
to purchase up to an aggregate of 585,980 shares of Series A Preferred
Stock at an exercise price of $2.04 per share.
    
    Nine-month common stock purchase warrants permitting the holders to
purchase up to an aggregate of 9,318,866 shares of common stock at an
exercise price of $0.17 per share.
    
    Eighteen-month preferred stock purchase warrants permitting the
holders to purchase up to an aggregate of 468,797 shares of Series A
Preferred Stock at an exercise price of $2.64 per share.
    
    Eighteen-month common stock purchase warrants permitting the
holders to purchase up to an aggregate of 7,455,114 shares of common
stock at an exercise price of $0.22 per share.
    
    Sixty-month preferred stock purchase warrants permitting the
holders to purchase up to an aggregate of 410,198 shares of Series A
Preferred Stock at an exercise price of $3.60 per share; and
    
    Sixty-month common stock purchase warrants permitting the holders
to purchase up to an aggregate of 6,523,233 shares of common stock at
an exercise price of $0.30 per share. As a condition to the August Placement, each of the investors in the
August Placement (each, an Investor and collectively, the Investors)
entered into a Shareholders Agreement, Voting Agreement, with an irrevocable
proxy, and Registration Rights Agreement. 6




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Hypertension Diagnostics, Inc.
Notes to Financial Statements (Continued)
March 31, 2004  2.
    
    Unit Placements (Continued) The Shareholders Agreement contains provisions relating to, among other
things, preemptive rights, rights of first refusal and approval of certain
transactions. The Voting Agreement provides, among other things, that each
party to the Voting Agreement will agree to vote all of the Stock (which means
shares of common stock, preferred stock and any other class of our equity
securities and shall include any shares of common stock issuable upon exercise,
exchange or conversion of securities exercisable or exchangeable for or
convertible into shares of our common stock) held by such party in favor of
certain composition of the Board and an increase in the number of shares of
authorized common stock. To effectuate the Voting Agreement, each Investor
executed a proxy in favor of Mark N. Schwartz with respect to all shares of
Stock owned by such Investor. Pursuant to the Registration Rights Agreement,
during the period commencing 120 days after the final closing of the Unit
Placement and expiring 48 months after the final closing of the Unit Placement,
the holders of the Units are entitled to a one-time demand that we effect as
soon as practicable the registrations of the certain components of the Units,
subject to customary restrictions. The Registration Rights Agreement also
grants the Investors certain registration rights commonly called piggy-back
registration rights. Because of our lack of sufficient authorized common stock, we had agreed
to seek the approval of our shareholders of an amendment to our Articles of
Incorporation increasing the number of shares of common stock authorized to at
least 150,000,000 shares (or such other number as may be sufficient to allow
for the reservation for issuance of all of the shares of common stock
underlying each outstanding security convertible or exercisable for or
exchangeable into, common stock) (the Proposal). In connection with the
closing of the August Placement, we agreed to call a meeting of our
shareholders and to obtain the approval of our shareholders of the Proposal
within 120 days of the final closing of the August Placement. We held an
Annual Meeting of Shareholders on December 3, 2003 and our shareholders
approved the Proposal. Bridge Financing Loans To facilitate our continued operations pending a closing of the August
Placement, we obtained $20,000 bridge financing loans on August 4, 2003 from
each of Kenneth W. Brimmer, a Director, and James S. Murphy, our Senior Vice
President, Finance and Administration, and Chief Financial Officer. On August
15, 2003, we obtained an additional $75,000 bridge financing loan from Dr. Jay
N. Cohn, a Director. The bridge financing loans were each evidenced by
unsecured promissory notes (collectively, the Bridge Financing Notes). The
Bridge Financing Notes accrued interest at the annual rate of 8% and were due
on demand of the holder at any time after September 1, 2003. In connection
with the August Placement, the principal amounts due under the Bridge Financing
Notes were automatically converted into Units in the August Placement at the
same rate as a cash investment. Satisfaction of the Notes Pursuant to a Subscription Agreement dated March 27, 2002, we issued
three-year 8% Convertible Notes (the Notes) to Alpha Capital
Aktiengesellschaft (Alpha), Stonestreet Limited Partnership (Stonestreet),
Palisades Equity Fund, L.P. (Palisades), Ellis Enterprises Ltd. (Ellis) and
Bristol Investment Fund, Ltd. (Bristol) in an aggregate principal amount of
$2,000,000. On August 28, 2003, we closed the transactions under a Conversion and
Voting Agreement dated August 1, 2003 (Conversion Agreement) with Alpha,
Stonestreet and Ellis (collectively, the Holders), the remaining holders of
the Notes, for the complete satisfaction and discharge of all amounts and
obligations under the Notes, including any penalties relating to the Notes. As
of August 1, 2003, all principal and interest under the Notes of Bristol and
Palisades had been converted into shares of our common stock pursuant to the
terms of the Notes. 7




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Hypertension Diagnostics, Inc.
Notes to Financial Statements (Continued)
March 31, 2004  2.
    
    Unit Placements (Continued) Pursuant to the Conversion Agreement, the Holders converted 1/3 of the
outstanding principal and accrued but unpaid interest as of July 10, 2003 into
1,472,168 shares of common stock. The rate of this conversion was 1 share of
common stock for each $.12 of outstanding principal and accrued but unpaid
interest. Further, we issued to the Holders 1,766,599 shares of common stock
in connection with the satisfaction of the remaining 2/3 of the outstanding
principal and accrued but unpaid interest (a rate of conversion of 1 share of
common stock for each $.20 of outstanding principal and accrued but unpaid
interest). As of July 10, 2003, there was $518,023.50 in outstanding principal
and $11,956.57 in accrued but unpaid interest relating to the Notes. Each of the Holders also executed and delivered an irrevocable proxy in
favor of Mark N. Schwartz to vote in favor of the Proposal and such other
matters (provided such matters do not adversely effect the rights of the
Holders) as may be presented at meetings of our shareholders during the term of
the proxy. The proxies expire August 28, 2007. The February Placement On February 9, 2004, we completed an additional private placement offering
of 118,113 units (the Units) to a group of investors. Gross proceeds from
this offering were $461,370 and net proceeds were $413,121. The 118,113 Units
are comprised of 118,113 shares of Series A Convertible Preferred Stock,
1,878,365 shares of common stock, and warrants as follows:  
    
    Nine-month preferred stock purchase warrants permitting the holders
to purchase up to an aggregate of 118,113 shares of Series A Preferred
Stock at an exercise price of $2.04 per share.
    
    Nine-month common stock purchase warrants permitting the holders to
purchase up to an aggregate of 1,878,365 shares of common stock at an
exercise price of $0.17 per share.
    
    Eighteen-month preferred stock purchase warrants permitting the
holders to purchase up to an aggregate of 94,496 shares of Series A
Preferred Stock at an exercise price of $2.64 per share.
    
    Eighteen-month common stock purchase warrants permitting the
holders to purchase up to an aggregate of 1,502,702 shares of common
stock at an exercise price of $0.22 per share.
    
    Sixty-month preferred stock purchase warrants permitting the
holders to purchase up to an aggregate of 82,686 shares of Series A
Preferred Stock at an exercise price of $3.60 per share; and
    
    Sixty-month common stock purchase warrants permitting the holders
to purchase up to an aggregate of 1,314,868 shares of common stock at
an exercise price of $0.30 per share. As a condition to investing in the February Placement, each investor
executed an irrevocable proxy in favor of Mark N. Schwartz and joinder
agreements agreeing to be bound by the terms of the Shareholders Agreement,
Voting Agreement and Registration Rights Agreement, which were executed by the
investors in the August Placement. 8




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Hypertension Diagnostics, Inc.
Notes to Financial Statements (Continued)
March 31, 2004  2.
    
    Unit Placements (Continued) As a result of the February and August Placements, Mark N. Schwartz
obtained voting control (through his ownership of shares of common stock,
Series A Preferred Stock, and pursuant to the irrevocable proxies described
above) of approximately 60 percent of our voting securities.  3.
    
    Stock Based Compensation We have adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (FASB
123), but apply Accounting Principles Board Opinion No. 25 (APB 25) and related
interpretations in accounting for our plans. Under APB 25, when the exercise
price of employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized. In accordance
with FASB 123 and EITF 96-18, Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services,transactions in which equity instruments are issued in exchange for
services are measured at the fair value of the consideration received or the
fair value of the equity instruments issued, whichever is a more reliable
measure. We account for stock options under APB 25, under which no compensation
cost has been recognized. Had compensation cost for these options been
determined consistent with FASB 123, the net loss and basic and diluted net
loss per share would have been increased to the following pro forma amounts for
the three months and nine months ended March 31, 2004 and March 31, 2003: Three Months Ended March 31
    
    Nine Months Ended March 312004
    
    2003
    
    2004
    
    2003Net Loss:As Reported
    
    $
    (485,013
    )
    
    $
    (561,252
    )
    
    $
    (1,486,882
    )
    
    $
    (2,439,332
    )Pro
Forma
    
    
    (530,560
    )
    
    
    (617,476
    )
    
    
    (1,622,320
    )
    
    
    (2,617,107
    )Basic and Diluted Net Loss per Share:As
Reported
    
    $
    (0.02
    )
    
    $
    (0.06
    )
    
    $
    (0.07
    )
    
    $
    (0.31
    )Pro
Forma
    
    
    (0.02
    )
    
    
    (0.07
    )
    
    
    (0.08
    )
    
    
    (0.33
    )
  4.
    
    Litigation On March 17, 2004, we received a letter from counsel of one of our
employees of alleged illegal and unethical reimbursement practices by us. In
addition, on March 18, 2004, we received a letter from counsel of one of our
former employees of our alleged failure to pay for accrued vacation time. Each
of these letters also alleged violation of applicable whistleblower statutes.
Although no formal claim has been filed with respect to these matters, we have
initiated internal investigations and intend to actively pursue these matters
until they have been satisfactorily resolved. At this time, we are unable to
assess the
likelihood of an unfavorable outcome or the extent of possible damages, if
any, arising from these matters. 9




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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 2003 Annual Report on Form 10-KSB, as amended,
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 may result in lower revenues; the illiquidity
of our securities on the OTC Bulletin Board and the related restrictions on our
securities relating to penny stocks; 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 the
CDMF; 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/PulseWave 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. Further, 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.
    
    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 (the CDMF), 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 (CVProfile Reports) which they generate each month.
We anticipate that marketing the CVProfilor® DO-2020 System
under a per-patient-tested rental program (as opposed to a
capital sale approach) will allow us to accelerate the rate of
product acceptance in the medical 10




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marketplace and should allow physician usage fees to eventually
generate the majority of our revenue.
    
    The CVProfilor® MD-3000 System is being marketed
through exclusive 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. The CVProfilor® DO-2020 System was launched late in the 3rd Quarter of
fiscal year 2001 (March 2001) and had its first reported revenue in the 1st
Quarter of fiscal year 2002, which ended September 30, 2001. Reductions in
comparative revenue between fiscal year 2002 and fiscal year 2003 relate to our
planned conversion from capital sales of our HDI/PulseWave CR-2000 Research
System in fiscal year 2001 to our per-patient-tested rental revenue model
associated with physician use of our FDA cleared CVProfilor® DO-2020 System in
fiscal year 2002. Although we are attempting to maintain a balance in
marketing the HDI/PulseWave CR-2000 on a capital sales basis with the
CVProfilor® DO-2020 on a per-patient-tested basis, we expect that our
per-patient-tested marketing of the CVProfilor® DO-2020 will ultimately
produce the majority of our revenue. 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. 101,
Revenue Recognition. Pursuant to SAB No. 101, 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.
In addition, title passes to the customer or distributor upon shipment. At the
time of shipment, all of the criteria for recognition set forth in SAB No. 101
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. 101 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 exchange our
product. Warranty repairs on all of the above are handled on a repair or
replacement basis, 11




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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. 101. 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 historic write-offs. 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. Results of Operations As of March 31, 2004, we had an accumulated deficit of $(22,897,282),
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 March 31, 2004, we had cash and cash
equivalents of $1,205,665. We anticipate that these funds, in conjunction with
revenue anticipated to be earned from placements of our CVProfilor® DO-2020
Systems, anticipated sales of our CR-2000 Research Systems, as well as
anticipated operating cost reductions, will allow us to pursue our business
development strategy for at least the next twelve months following March 31,
2004. Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003 The following is a summary of our Revenue and Cost of Sales for the three
months ended March 31, 2004 and 2003: Three Months Ended March 31, 2004Equipment
    
    Equipment
    
    Service/Total
    
    Sales
    
    Rental
    
    ContractRevenue
    
    $
    210,521
    
    
    $
    10,450
    
    
    $
    132,914
    
    
    $
    67,157Cost of Sales
    
    
    37,584
    
    
    
    3,064
    
    
    
    26,056
    
    
    
    8,464Gross Profit
    
    $
    172,937
    
    
    $
    7,386
    
    
    $
    106,858
    
    
    $
    58,693
 Three Months Ended March
31, 2003Equipment
    
    Equipment
    
    Service/Total
    
    Sales
    
    Rental
    
    ContractRevenue
    
    $
    179,068
    
    
    $
    77,287
    
    
    $
    84,364
    
    
    $
    17,417Cost of Sales
    
    $
    34,338
    
    
    
    17,603
    
    
    
    16,735
    
    
    
    Gross Profit
    
    $
    144,730
    
    
    $
    59,684
    
    
    $
    67,629
    
    
    $
    17,417
 Total Equipment Sales Revenue for the three months ended March 31, 2004
was $10,450, compared to $77,287 for the three months ended March 31, 2003.
Revenue relating to international equipment sales was $10,450 for the three
months ended March 31, 2004 and $77,287 for the three months ended March 31,
2003. Although we continue to pursue sales of the CR-2000 Research Systems,
the majority of our time and attention is now, and is expected to continue to
be, focused on expanding CVProfilor® DO-2020 System placements
(per-patienttested rental program) and attempting to increase its utilization
in U.S. physicians medical offices and clinics and seeking to increase third
party 12




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##### Table of Contents



reimbursements for such utilization. The reason for the shift in our
strategic focus to the CVProfilor® DO-2020 System was: a) FDA 510(k) clearance
to market it in the United States on November 1, 2000; and b) the potential
practicing physician market is significantly larger than the research market
for the CR-2000 Research System. 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. We
believe there are three ways we could expand our marketing and distribution
network: 1) the development of an internal sales force; 2) a strategic
partnership with a firm that possesses a distribution network calling on these
same physicians; or 3) a combination of the internal sales force and external
distribution network methods. We believe this dual method of expansion offers
us the greatest opportunity for success. We anticipate adding additional sales
personnel at the same time that we pursue discussions with firms that have an
interest in representing our CVProfilor® DO-2020 System nationwide. In the
short term, we have been focused on and will continue to focus on international
sales of our CR-2000 Research System and CVProfilor® MD-3000 System as a means
of generating cash to support operational expenses. 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. Therefore, we continue to devote considerable
effort to activities such as payer advocacy and coding clarification directed
at long-term reimbursement in our target markets. We provide assistance to
physicians with the ongoing process of insurance billing procedures in an
attempt to facilitate reimbursement coverage and payment on a nationwide basis. 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 March 31, 2004, we recognized Revenue for the
CVProfilor® DO-2020 System per-patient-tested rental program of $132,914,
compared to $84,364 for the three months 13




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ended March 31, 2003. The per test
fee is recognized as Revenue when we determine that collectibility is probable,
which currently is upon cash receipt. For the three months ended March 31, 2004, Service/Contract Income was
$67,157, compared to $17,417 for the three months ended March 31, 2003. For
the three months ended March 31, 2004, $7,657 pertains to a service warranty
contract with a customer who purchased certain CR-2000 Research Systems from
us. The balance, $59,500, represents contract income pertaining to our
agreement with a pharmaceutical company to attend certain hypertension and
cardiology meetings in both the U.S. and internationally. Under this
agreement, we provide our CardioVascular Profiling Systems and certain
employees who test visitors to the pharmaceutical companys exhibition booth. Total expenses for the three months ended March 31, 2004 were $665,771,
compared to $652,515 for the three months ended March 31, 2003. The following
is a summary of the major categories included in selling, general and
administrative expenses: Three Months EndedMarch 312004
    
    2003Wages, related expenses and benefits
    
    $
    227,358
    
    
    $
    132,297Patents and related expenses
    
    
    12,389
    
    
    
    6,323Outside consultants
    
    
    36,218
    
    
    
    68,419Rent (building/equipment) and
utilities
    
    
    24,105
    
    
    
    26,398Insurance-general and directors/officers liability
    
    
    20,374
    
    
    
    19,685Selling, marketing and promotion, including applicable wages
    
    
    190,917
    
    
    
    140,997Legal and audit/accounting fees
    
    
    88,019
    
    
    
    34,667Royalties
    
    
    4,301
    
    
    
    4,850Depreciation and amortization
    
    
    20,076
    
    
    
    36,622Convertible debt private placement expenses
    
    
    
    
    
    
    4,972Related party receivable write-off
    
    
    
    
    
    
    117,000Other-general and administrative
    
    
    42,014
    
    
    
    60,285Total selling, general and administrative expenses
    
    $
    665,771
    
    
    $
    652,515
 Wages, related expenses and benefits increased from $132,297 to $227,358
for the three months ended March 31, 2003 and March 31, 2004, respectively. In
late December 2002, we implemented a plan to conserve cash through reductions
in selling, general and administrative expenses, which included the reduction
in the number of our employees, transitioning some employees to part-time
employment status and the reduction in salaries of executive management. The
reduction in salaries of executive management amounted to approximately
$112,000 for the period late December 2002 through late June 2003. Executive
management salaries were restored to their original levels in late June 2003.
Included in the $227,358 expense amount for the three months ended March 31,
2004 is an accrued compensation
charge of $59,000 that relates to the amount due our chief executive
officer as part of his agreed upon compensation for services provided to us. Outside consultants expense decreased from $68,419 for the three months
ended March 31, 2003 to $36,218 for the three months ended March 31, 2004.
Included in the $68,419 expense amount for the three months ended March 31,
2003 is a non-cash expense charge of $50,000 that relates to a Consulting
Agreement for investor communications and public relations consulting services
with HRI Consultants. In consideration for the consulting services, we issued
300,000 shares of common stock and warrants to purchase up to 100,000 shares of
common stock at $1.50 per share. The fair value of the issued shares and
warrants was based on the agreed upon contract price of $400,000. The
Consulting Agreement 14




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involved certain services to be performed, including the
following: introduce us to various interested parties in the financial
community; assist and consult us with respect to our relations with brokers,
dealers, analysts and other investment professionals; and financial public
relations generally. The fair value of this agreement was expensed as services
were provided. Included in the $36,218 expense amount for the three months
ended March 31, 2004 is a non-cash expense charge of $5,791 that relates to the
fair value of options granted to independent outside consultants during the
period. The fair value of these option grants is expensed as services are
provided. Selling, marketing and promotion expense increased from $140,997 for the
three months ended March 31, 2003 to $190,917 for the three months ended March
31, 2004. This category includes wages and commissions paid by us relating to
our sales and marketing efforts, as well as travel and convention expenses.
Our planned conversion from capital sales of our HDI/PulseWave CR-2000
Research System in fiscal year 2001 to our per-patient-tested rental revenue
model associated with our FDA cleared CVProfilor® DO-2020 System in fiscal year
2002 had no material effect on our total expenses in this category, as our
sales force has merely redirected its efforts to placements of our rental units
in physicians offices. Legal and audit/accounting fees increased from $34,667 to $88,019 for the
three months ended March 31, 2003 and 2004, respectively. This increase was
due primarily to additional expenses incurred in connection with the
preparation of a registration statement and other reports and communications
with the U.S. Securities and Exchange Commission in the three month period
ended March 31, 2004. Interest income was $7,821 and $4,044 for the three months ended March 31,
2004 and 2003, respectively. Interest expense was $-0- and $57,511 for the three months ended March 31,
2004 and 2003, respectively. A further breakdown of the components of interest
expense is as follows: Three Months EndedMarch 312004
    
    2003Convertible Notes Payable:8% interest on outstanding principal balances
    
    $
    
    
    
    $
    12,826Fair value basis allocation to the five-year
warrants to purchase 250,000 shares of
Common Stock ($315,789), being amortized on a
straight-line basis over the three (3) year term of the
debt agreement and as the debt is converted
    
    
    
    
    
    
    44,685Total Interest Expense
    
    $
    
    
    
    $
    57,511
 Net loss was $(485,013) for the three months ended March 31, 2004,
compared to a net loss of $(561,252) for the three months ended March 31, 2003.
For the three months ended March 31, 2004, basic and diluted net loss per
share was $(.02), based on weighted average shares outstanding of 24,016,177.
For the three months ended March 31, 2003, basic and diluted net loss per share
was $(.06), based on weighted average shares outstanding of 9,463,110. 15




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Nine Months Ended March 31, 2004 Compared to Nine Months Ended March 31, 2003 The following is a summary of our Revenue and Cost of Sales for the nine
months ended March 31, 2004 and 2003: Nine Months Ended March 31, 2004Equipment
    
    Equipment
    
    Service/Total
    
    Sales
    
    Rental
    
    ContractRevenue
    
    $
    693,140
    
    
    $
    147,695
    
    
    $
    324,734
    
    
    $
    220,711Cost of Sales
    
    
    122,580
    
    
    
    21,839
    
    
    
    73,762
    
    
    
    26,979Gross Profit
    
    $
    570,560
    
    
    $
    125,856
    
    
    $
    250,972
    
    
    $
    193,732
 Nine Months Ended March 31, 2003Equipment
    
    Equipment
    
    Service/Total
    
    Sales
    
    Rental
    
    ContractRevenue
    
    $
    525,884
    
    
    $
    227,675
    
    
    $
    245,959
    
    
    $
    52,250Cost of Sales
    
    
    87,695
    
    
    
    47,863
    
    
    
    39,832
    
    
    
    Gross Profit
    
    $
    438,189
    
    
    $
    179,812
    
    
    $
    206,127
    
    
    $
    52,250
 Total Equipment Sales Revenue for the nine months ended March 31, 2004 was
$147,695, compared to $227,675 for the nine months ended March 31, 2003. This
decrease was mainly due to our anticipated revenue shift from the CR-2000
Research System (Equipment Sales) to the CVProfilor® DO-2020 System
(per-patient-tested rental program). The CR-2000 Research System is being
marketed for research purposes only in the United States, while the
CVProfilor® DO-2020 System is being marketed to primary care physicians and
other health care professionals on a per-patient-tested rental basis. The
reason for the shift in our strategic focus to the CVProfilor® DO-2020 System
was: a) FDA 510(k) clearance to market it in the United States on November 1,
2000; and b) the potential practicing physician market is significantly larger
than the research market for the CR-2000 Research System. The majority of our
time and attention is now, and will continue to be, focused on expanding
CVProfilor® DO-2020 System placements and utilization in U.S. physicians
medical offices and clinics. This shift in our strategic focus began in the
fourth quarter of fiscal year 2001. Revenue relating to international
equipment sales was $61,945 for the nine months ended March 31, 2004 and
$186,676 for the nine months ended March 31, 2003. For the nine months ended March 31, 2004, we recognized Revenue for the
CVProfilor® DO-2020 per-patient-tested rental program of $324,734, compared
to $245,959 for the nine months ended March 31, 2003. The per test fee is
recognized as Revenue when we determine that collectibility is probable, which
currently is upon cash receipt. Total expenses for the nine months ended March 31, 2004 were $2,030,620,
compared to $2,684,497 for the nine months ended March 31, 2003. The following
is a summary of the major categories included in selling, general and
administrative expenses: 16




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Nine Months EndedMarch 312004
    
    2003Wages, related expenses and benefits
    
    $
    672,230
    
    
    $
    595,097Patents and related expenses
    
    
    27,650
    
    
    
    39,036Outside consultants
    
    
    70,757
    
    
    
    451,851Rent (building/equipment) and
utilities
    
    
    73,125
    
    
    
    77,525Insurance-general and directors/officers liability
    
    
    55,117
    
    
    
    64,548Selling, marketing and promotion, including applicable wages
    
    
    618,535
    
    
    
    740,215Legal and audit/accounting fees
    
    
    222,375
    
    
    
    173,263Royalties
    
    
    14,173
    
    
    
    14,209Depreciation and amortization
    
    
    74,240
    
    
    
    126,153Convertible debt private placement expenses
    
    
    
    
    
    
    45,198Related party receivable write-off
    
    
    
    
    
    
    117,000Other-general and administrative
    
    
    202,418
    
    
    
    240,402Total selling, general and administrative expenses
    
    $
    2,030,620
    
    
    $
    2,684,497
 Wages, related expenses and benefits increased from $595,097 to $672,230
for the nine months ended March 31, 2003 and March 31, 2004, respectively. In
late December 2002, we implemented a plan to conserve cash through reductions
in selling, general and administrative expenses, which included the reduction
in the number of our employees, transitioning some employees to part-time
employment status and the reduction in salaries of executive management. The
reduction in salaries of executive management amounted to approximately
$112,000 for the period late December 2002 through late June 2003. Executive
management salaries were restored to their original levels in late June 2003.
Included in the $672,230 expense amount for the nine months ended March 31,
2004 is an accrued compensation charge of $196,000 that relates to the amount
due our chief executive officer as part of his agreed upon compensation for
services provided to us. Outside consultants expense decreased from $451,851 for the nine months
ended March 31, 2003 to $70,757 for the nine months ended March 31, 2004.
Included in the $451,851 expense amount is a non-cash expense charge of
$350,000 relating to our June 2002 Consulting Agreement with HRI Consultants.
The fair value of this agreement was expensed as services were provided. The
fair value of the issued shares and warrants to HRI Consultants was based on
the agreed upon contract price of $400,000. The Consulting Agreement involved
certain services to be performed, including the following: introduce the
Company to various interested parties in the financial community; assist and
consult the Company with respect to its relations with brokers, dealers,
analysts and other investment professionals; and financial public relations
generally. Included in the $70,757 expense amount for the nine months ended
March 31, 2004 is a non-cash expense charge of $5,791 that relates to the fair
value of options granted to independent outside consultants during the period. Selling, marketing and promotion expense decreased from $740,215 for the
nine months ended March 31, 2003 to $618,535 for the nine months ended March
31, 2004. This category includes wages and commissions paid by us relating to
our sales and marketing efforts as well as travel and convention expenses. The
decrease in our number of employees accounted for most of this decrease in
expenses. Legal and audit/accounting fees increased from $173,263 to $222,375 for
the nine months ended March 31, 2003 and 2004, respectively. This increase was
due primarily to the following: additional 17




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expenses incurred in connection with
the preparation of a registration statement and other reports and
communications with the U.S. Securities and Exchange Commission; and expenses
associated with the Annual Meeting of Shareholders that was held on December 3,
2003. Interest income was $23,363 and $17,176 for the nine months ended March
31, 2004 and 2003, respectively. Interest expense was $50,185 and $210,200 for the nine months ended March
31, 2004 and 2003, respectively. A further breakdown of the components of
interest expense is as follows: Nine Months EndedMarch 312004
    
    2003Convertible Notes Payable:8% interest on outstanding principal balances
    
    $
    1,205
    
    
    $
    61,177Fair value basis allocation to the five-year warrants
to purchase 250,000 shares of Common Stock
($315,789), being amortized on a straight-line basis
over the three (3) year term of the debt agreement
and as the debt is converted
    
    
    48,531
    
    
    
    149,023Other-miscellaneous
    
    
    449
    
    
    
    Total Interest Expense
    
    $
    50,185
    
    
    $
    210,200
 Net loss was $(1,486,882) and $(2,439,332) for the nine months ended March
31, 2004 and 2003, respectively. For the nine months ended March 31, 2004,
basic and diluted net loss per share was $(.07), based on weighted average
shares outstanding of 20,598,659. For the nine months ended March 31, 2003,
basic and diluted net loss per share was $(.31), based on weighted average
shares outstanding of 7,871,211. Liquidity and Capital Resources Cash and cash equivalents had a net increase of $1,115,330 and a net
decrease of $(1,532,995) for the nine months ended March 31, 2004 and March 31,
2003, respectively. The significant elements of these changes were as follows: Nine Months Ended March 312004
    
    2003Net cash used in operating activities: net loss, as adjusted for non-cash items
    
    $
    (1,272,334
    )
    
    $
    (1,760,610
    ) decrease in accounts receivable:
    
    
    44,499
    
    
    
    (A)188,077 (A) $104,500 accounts receivable
balance regarding one customer at June
30, 2002 pertaining to a service
warranty contract was received in July
2002. decrease in related party note receivable: (B) This amount pertains to a
non-trade receivable/interest bearing
loan to a shareholder that was written
off.
    
    
    
    
    
    
    (B)117,000
 18




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Nine Months Ended March 312004
    
    2003 increase in accrued payroll and payroll taxes: (C) During the nine months ended
March 31, 2004, $196,000 of accrued
compensation has been recorded that
pertains to the amount due our chief
executive officer as part of his agreed
upon compensation for services provided
to us.
    
    (C)
    162,089
    
    
    
    4,173 decrease in deferred revenue: (D) Approximately 80% of this
decrease pertains to deferred revenue
recognized relating to our services
contract agreement with a
pharmaceutical company.
    
    (D)
    (153,553
    )
    
    
    (52,550
    )Net cash provided by financing activities:
    
    (E)
    2,295,874
    
    
    
    57,400 issuance of Preferred and Common Stock: (E) On August 28, 2003, we completed
the private placement offering of
585,980 Units to a group of investors
led by Mark N. Schwartz, who is our
Chief Executive Officer. Gross
proceeds from this offering were
approximately $2,300,000 and net
proceeds were $1,873,383. The 585,980
Units are comprised of 585,980 shares
of Series A Convertible Preferred
Stock, 9,318,866 shares of common
stock, and a series of six (6) purchase
warrants. 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. The 118,113
Units are comprised of 118,113 shares
of Series A Convertible Preferred
Stock, 1,878,365 shares of common
stock, and a series of six (6) purchase
warrants.
 We have incurred operating losses and have not generated positive cash
flow from operations. As of March 31, 2004, we had an accumulated deficit of
$(22,897,282). 19




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As of March 31, 2004, we had cash and cash equivalents of $1,205,665, and
anticipate that these funds, in conjunction with revenue anticipated to be
earned from placements of our CVProfilor® DO-2020 Systems, anticipated sales of
our CR-2000 Research Systems, as well as anticipated operating cost reductions,
will allow us to pursue our business development strategy for at least the next
twelve months following March 31, 2004. Our current marketing strategy focuses on marketing the CVProfilor®
DO-2020 System to physicians who treat patients with diabetes and hypertension.
Please see the section entitled Results of Operations: Three Months Ended
March 31, 2004 Compared to Three Months Ended March 31, 2003 for a fuller
description of our marketing strategy. In late December 2002, we implemented a plan to conserve cash through
reductions in selling, general and administrative expenses to improve working
capital management. This expense reduction plan included the reduction in the
number of our employees, transitioning some employees to part-time employment
status and reducing salaries of executive management. The reduction in
salaries of executive management amounted to approximately $112,000 for the
period late December 2002 through late June 2003. Executive management
salaries were restored to their original levels in late June 2003. While these
measures reduced the rate at which we used our available cash, they have
compromised, and will continue to compromise, our ability to pursue and
generate placements of our CVProfilor® DO-2020 Systems and sales of our CR-2000
Research Systems. Until we increase our sales and marketing staff and other
programs, we do not expect to generate significant levels of revenue. 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 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. In July 1998, we completed our initial public offering of
2,587,500 units, each unit consisting of one share of our common stock and one
Redeemable Class A Warrant (the Class A Warrant), which resulted in total net
proceeds to us of $9,188,414. Beginning on January 23, 2001 and ending on
March 26, 2001, we offered our Redeemable Class B Warrants (the Class B
Warrants) for no additional consideration to those holders of our Class A
Warrants who properly exercised a Class A Warrant in the offering period. We
raised $1,964,371 (net of offering expenses of $73,062) in connection with this
offering of the Class B Warrants. On March 27, 2002, we completed a private
placement to five investors consisting of three-year 8% Convertible Notes in
the aggregate principal amount of $2,000,000. Beginning on June 6, 2002 and
ending on November 14, 2002, we offered Class B Warrants for no additional
consideration to those holders of the Class A Warrants who properly exercised a
Class A Warrant in the offering period. Total gross proceeds from this
offering were $57,400. 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. Net proceeds from this offering were $1,873,383. On
February 9, 2004, we completed an additional private placement offering of
118,113 units to a group of investors. Net proceeds from this offering were
$413,121. 
 Item 3. Controls and Procedures. (a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer, Mark N. Schwartz, and Chief Financial
Officer, James S. Murphy, have evaluated our disclosure controls and procedures
as of the end of the period covered by this report. 20




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Based upon that review,
they have concluded that these controls and procedures are effective in
ensuring that material information related to us is made known to them by
others within the Company. (b) Changes in Internal Controls over Financial Reporting. There have been no significant 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, our
internal control over financial reporting. 21




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PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings. On March 17, 2004, we received a letter from counsel of one of our employees of
alleged illegal and unethical reimbursement practices by us. In addition, on
March 18, 2004, we received a letter from counsel of one of our former
employees of our alleged failure to pay for accrued vacation time. Each of
these letters also alleged violation of applicable whistleblower statutes.
Although no formal claim has been filed with respect to these matters, we have
initiated internal investigations and intend to actively pursue these matters
until they have been satisfactorily resolved. At this time, we are unable to
assess the likelihood of an unfavorable outcome or the extent of possible
damages, if any, arising from these matters. 
 Item 2. Changes in Securities See Item 5. Market for Common Equity and Related Stockholder Matters, Recent
Sales of Unregistered Securities of our Annual Report on Form 10-KSB for the
fiscal year ended June 30, 2003 for a description of issuances of unregistered
securities during the quarter ended September 30, 2003 in connection with the
Unit Placement and the closing of the Conversion and Voting Agreement. On February 9, 2004, we completed the February Placement consisting of 118,113
Units comprised of 118,113 shares of Series A Preferred Stock, 1,878,365 shares
of our common stock, and purchase warrants which entitle the holders thereof to
acquire an aggregate of 295,295 shares of Series A Preferred Stock and
4,695,935 shares of common stock. Based upon the manner of sale and
representations by the investors, we believe this issuance was exempt from
registration under Rule 506 of Regulation D, as this issuance was a private
placement not involving any public offering within the meaning of Section 4(2)
of the Securities Act of 1933, as amended. During the three months ended March 31, 2004, we granted options to purchase up
to an aggregate of 129,000 shares of common stock under our 1998 Stock Option
Plan to an employee and certain outside independent consultants. The employees
option vests over three (3) years and the consultants options vest over the
period commencing January 15, 2004 and ending December 31, 2004. Exercise
prices for all the option grants range from $0.22 to $0.33 per share. 
 Item 3. Defaults Upon Senior Securities Not Applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders Not Applicable. 
 Item 5. Other Information Not Applicable. 
 Item 6. Exhibits and Reports on Form 8-K (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 Act31.2
    
    Certification of Chief Financial Officer pursuant to
 22




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13a-14 and 15d-14 of the Exchange Act32
    
    Certificate pursuant to 18 U.S.C. § 1350
  (b)
    
    Reports on Form 8-K:We filed the following Current Reports on Form 8-K during the quarter
covered by this Form 10-QSB and the period ending on the date of this
Report:  
    
    Current Report on Form 8-K dated February
9, 2004 reporting under Item 5 an offering of units to
accredited and unaccredited investors, with each unit
consisting of shares of the Companys common stock, Series
A Convertible Preferred Stock, and a series of six (6)
purchase warrants. The offering resulted in a change of
control, whereby Mark N. Schwartz obtained additional
voting control of approximately 60% of the Companys voting
securities.
    
    Current Report on Form 8-K dated May 5,
2004 reporting under Item 5 a press release announcing our
agreement to provide ten CVProfilor® DO-2020 testing
devices to a Sacramento-based internist, our largest
contract to date with a single physician. 
 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/ James S. MurphyJames S. MurphySenior Vice President, Finance and

        Administration and Chief Financial Officer

        (principal financial officer) Date: May 14, 2004 23