##### Table of Contents





---



QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE QUARTERLY PERIOD ENDED December 31, 2000





|                                   |  |                                                
|---------------------------------- |  | -----------------------------------------------
|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.

|    |  |   
|--- |  | --
|Yes |  | No

The number of shares of Common Stock outstanding as of January 31, 2001 was
5,288,710.

Transitional Small Business Disclosure Format:

|    |  |   
|--- |  | --
|Yes |  | No





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TABLE OF CONTENTS



|                              |                                                                                               |                                                                                                       |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------- |  |  |  |  |  | 
|Part I. Financial Information
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | Balance Sheets - December 31, 2000 and June 30,2000                                                  
|                              |                                                                                               | Statements of Operations - Three Months and Six Months Ended
December 31, 2000 and 1999, respectively
|                              |                                                                                               | Statements of Cash Flows - Six Months Ended
December 31, 2000 and 1999                               
|                              |                                                                                               | Notes to Financial Statements                                                                        
|                              | Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
|Part II. Other Information   
|                              | Item 2. Use of Proceeds                                                                      
|                              | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|Signatures                   
|Exhibit Index                
|Financial Data Schedule      



---



INDEX TO FORM 10-QSB

|                                      |                                                                            |                                                              |                                          |    |          |   | 
|------------------------------------- | -------------------------------------------------------------------------- | ------------------------------------------------------------ | ---------------------------------------- | -- | -------- | - | 
|                                      |                                                                            |                                                              |                                          |    | Page No.
|                                      |                                                                            |                                                              |                                          |    |         
|PART I.        FINANCIAL INFORMATION:
|                                     
|                                     
|                                     
|                                     
|                                      | Item 1.        Financial Statements                                        |                                                              |                                          | 3  |         
|                                     
|                                     
|                                     
|                                     
|                                      |                                                                            | Balance Sheets  December 31, 2000 and June 30, 2000         |                                          |    | 3        |  
|                                     
|                                     
|                                     
|                                     
|                                      |                                                                            | Statements of Operations  Three Months and Six Months Ended
|                                     
|                                     
|                                     
|                                     
|                                      |                                                                            |                                                              | December 31, 2000 and 1999, respectively |    |          | 4 | 
|                                     
|                                     
|                                     
|                                     
|                                      |                                                                            | Statements of Cash Flows  Six Months Ended                 
|                                     
|                                     
|                                     
|                                     
|                                      |                                                                            |                                                              | December 31, 2000 and 1999               |    |          | 5 | 
|                                     
|                                     
|                                     
|                                     
|                                      |                                                                            | Notes to Financial Statements                                |                                          |    | 6        |  
|                                     
|                                     
|                                     
|                                     
|                                      | Item 2.        Managements Discussion and Analysis of Financial Condition
|                                     
|                                     
|                                     
|                                     
|                                      |                                                                            | and Results of Operations                                    |                                          |    | 7        |  
|                                     
|                                     
|                                     
|                                     
|PART II.        OTHER INFORMATION:   
|                                     
|                                     
|                                     
|                                     
|                                      | Item 2.        Use of Proceeds                                             |                                                              |                                          | 11 |         
|                                     
|                                     
|                                     
|                                     
|                                      | Item 4.        Submission of Matters to a Vote of Security Holders         |                                                              |                                          | 11 |         
|                                     
|                                     
|                                     
|                                     
|                                      | Item 6.        Exhibits and Reports on Form 8-K                            |                                                              |                                          | 11 |         
|                                     
|                                     
|                                     
|                                     
|SIGNATURES                            |                                                                            |                                                              | 12                                       |   
|                                     
|                                     
|                                     
|                                     
|EXHIBIT INDEX                         |                                                                            |                                                              | 13                                       |   

2



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##### Table of Contents









Item 1. Financial Statements




Balance Sheets

|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |   |        |           | 
|--------------------------------------------------- | ---------------------------------------------------------- | ----------------------------------------------------- | ---------------------------------------------- | ------------------------------------------ | - | ------------ | --------- | ---------- | - | ------ | --------- | 
|                                                    |                                                            |                                                       |                                                |                                            |   | December 31, |           | June 30,  
|                                                    |                                                            |                                                       |                                                |                                            |   | 2000         |           | 2000      
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |           
|Assets                                              |                                                            |                                                       |                                                |                                           
|                                                   
|Current Assets:                                    
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Cash and cash equivalents                                  |                                                       | $                                              | 3,001,583                                  |   |              | $         | 4,018,745  |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Accounts receivable                                        |                                                       |                                                | 935,215                                    |   |              |           | 71,022     |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Interest receivable                                        |                                                       |                                                | 5,023                                      |   |              |           | 2,342      |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Inventory                                                  |                                                       |                                                | 1,294,827                                  |   |              |           | 1,295,416  |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Prepaid expenses                                           |                                                       |                                                | 51,383                                     |   |              |           | 12,933     |  
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |  
|                                                    |                                                            |                                                       |                                                | Total Current Assets                       |   |              | 5,288,031 |            |   |        | 5,400,458 | 
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|Property and Equipment:                            
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Leasehold improvements                                     |                                                       |                                                | 17,202                                     |   |              |           | 17,202     |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Furniture and equipment                                    |                                                       |                                                | 575,519                                    |   |              |           | 536,175    |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Less accumulated depreciation                              |                                                       |                                                | (244,639                                   | ) |              |           | (191,469   | )
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |  
|                                                    |                                                            |                                                       |                                                |                                            |   |              | 348,082   |            |   |        | 361,908   | 
|                                                   
|                                                   
|                                                   
|                                                   
|Patents, net of accumulated amortization of $31,805
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | and $28,405 at December 31 and June 30, 2000,
respectively |                                                       |                                                | 13,600                                     |   |              |           | 17,000     |  
|                                                   
|                                                   
|                                                   
|                                                   
|Other Assets                                        |                                                            |                                                       | 6,730                                          |                                            |   |              | 6,730     |           
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |  
|                                                    |                                                            |                                                       |                                                | Total Assets                               |   | $            | 5,656,443 |            |   | $      | 5,786,096 | 
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|Liabilities and Shareholders Equity               
|                                                   
|                                                   
|                                                   
|                                                   
|Current Liabilities:                               
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Accounts payable                                           |                                                       | $                                              | 148,456                                    |   |              | $         | 167,779    |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Accrued payroll and payroll taxes                          |                                                       |                                                | 279,218                                    |   |              |           | 250,277    |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Other accrued expenses                                     |                                                       |                                                | 37,740                                     |   |              |           | 2,857      |  
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |  
|                                                    |                                                            |                                                       |                                                | Total Current Liabilities                  |   |              | 465,414   |            |   |        | 420,913   | 
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                   
|Shareholders Equity:                              
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Preferred Stock, $.01 par value:                          
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    |                                                            | Authorized shares5,000,000                          
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    |                                                            | Issued and outstanding sharesnone                   
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Common Stock, $.01 par value:                              |                                                      
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    |                                                            | Authorized shares25,000,000                         
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    |                                                            | Issued and outstanding shares5,288,710 and 5,173,697
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    |                                                            |                                                       | at December 31 and June 30, 2000, respectively |                                            |   | 52,887       |           |            |   | 51,737 |          
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Additional paid-in capital                                 |                                                       |                                                | 14,514,994                                 |   |              |           | 14,211,307 |  
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Deferred compensation                                      |                                                       |                                                | (47,540                                    | ) |              |           | (83,210    | )
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Accumulated deficit                                        |                                                       |                                                | (9,329,312                                 | ) |              |           | (8,814,651 | )
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |  
|                                                    |                                                            |                                                       |                                                | Total Shareholders Equity                 |   |              | 5,191,029 |            |   |        | 5,365,183 | 
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |  
|                                                    |                                                            |                                                       |                                                | Total Liabilities and Shareholders Equity |   | $            | 5,656,443 |            |   | $      | 5,786,096 | 
|                                                    |                                                            |                                                       |                                                |                                            |   |              |           |            |  

See accompanying notes.

3



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##### Table of Contents






Statements of Operations

|                                               |                                     |                         |           |                    |           |                  |            |         |           |      |           |           |           |   |            |           |            |  
|---------------------------------------------- | ----------------------------------- | ----------------------- | --------- | ------------------ | --------- | ---------------- | ---------- | ------- | --------- | ---- | --------- | --------- | --------- | - | ---------- | --------- | ---------- | -
|                                               |                                     |                         |           | Three Months Ended |           | Six Months Ended
|                                               |                                     |                         |           | December 31        |           | December 31     
|                                               |                                     |                         |           |                    |           |                 
|                                               |                                     |                         |           | 2000               |           | 1999             |            | 2000    |           | 1999
|                                               |                                     |                         |           |                    |           |                  |            |         |           |     
|Revenue:                                      
|                                              
|                                              
|                                              
|                                              
|                                               | Equipment sales                     |                         | $         | 1,204,500          |           |                  | $          | 57,499  |           |      | $         | 1,653,304 |           |   | $          | 128,997   |           
|                                              
|                                              
|                                              
|Cost and Expenses:                            
|                                              
|                                              
|                                              
|                                              
|                                               | Cost of equipment sales             |                         |           | 296,707            |           |                  |            | 12,420  |           |      |           | 371,612   |           |   |            | 29,953    |           
|                                              
|                                              
|                                              
|                                              
|                                               | Research and development            |                         |           | 58,670             |           |                  |            | 164,687 |           |      |           | 130,704   |           |   |            | 227,958   |           
|                                              
|                                              
|                                              
|                                              
|                                               | Selling, general and administrative |                         |           | 901,542            |           |                  |            | 926,220 |           |      |           | 1,608,860 |           |   |            | 1,676,931 |           
|                                               |                                     |                         |           |                    |           |                  |            |         |           |      |           |           |           |   |            |           |            |  
|                                               |                                     | Total Cost and Expenses |           |                    | 1,256,919 |                  |            |         | 1,103,327 |      |           |           | 2,111,176 |   |            |           | 1,934,842  |  
|                                               |                                     |                         |           |                    |           |                  |            |         |           |      |           |           |           |   |            |           |            |  
|Operating (Loss)                               |                                     |                         | (52,419   | )                  |           |                  | (1,045,828 | )       |           |      | (457,872  | )         |           |   | (1,805,845 | )        
|                                              
|Other Income:                                 
|                                              
|                                              
|                                              
|                                              
|                                               | Interest income                     |                         |           | 53,929             |           |                  |            | 86,837  |           |      |           | 112,062   |           |   |            | 178,119   |           
|                                               |                                     |                         |           |                    |           |                  |            |         |           |      |           |           |           |   |            |           |            |  
|                                               |                                     | Net Income (Loss)       |           | $                  | 1,510     |                  |            | $       | (958,991  | )    |           | $         | (345,810  | ) |            | $         | (1,627,726 | )
|                                               |                                     |                         |           |                    |           |                  |            |         |           |      |           |           |           |   |            |           |            |  
|                                              
|                                              
|                                              
|Basic and Dilutive Net Income (Loss) per Share |                                     | $                       | .00       |                    |           | $                | (.19       | )       |           | $    | (.07      | )         |           | $ | (.32       | )        
|                                              
|                                              
|                                              
|                                              
|Weighted Average Shares Outstanding            |                                     |                         | 5,280,761 |                    |           |                  | 5,109,235  |         |           |      | 5,242,443 |           |           |   | 5,109,235  |          

See accompanying notes.

4



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##### Table of Contents






Statements of Cash Flows

|                                                                                |                                             |                      |                                                  |        |                  |            |            |        |        |            |  
|------------------------------------------------------------------------------- | ------------------------------------------- | -------------------- | ------------------------------------------------ | ------ | ---------------- | ---------- | ---------- | ------ | ------ | ---------- | -
|                                                                                |                                             |                      |                                                  |        | Six Months Ended
|                                                                                |                                             |                      |                                                  |        | December 31     
|                                                                                |                                             |                      |                                                  |        |                 
|                                                                                |                                             |                      |                                                  |        | 2000             |            | 1999      
|                                                                                |                                             |                      |                                                  |        |                 
|                                                                               
|Operating Activities:                                                          
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|Net loss                                                                        |                                             | $                    | (345,810                                         | )      |                  | $          | (1,627,726 | )     
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|Adjustments to reconcile net loss to net
    cash used in operating activities:
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Value of stock options granted in lieu     
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             | of cash compensation |                                                  |        | 35,670           |            |            |        | 35,670 |           
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Depreciation                                |                      |                                                  | 53,170 |                  |            |            | 48,445 |       
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Amortization                                |                      |                                                  | 3,400  |                  |            |            | 3,400  |       
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Change in operating assets and liabilities:
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             |                      | Accounts receivable                              |        |                  | (864,193   | )          |        |        | 94,230     |  
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             |                      | Interest receivable                              |        |                  | (2,681     | )          |        |        | (152       | )
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             |                      | Inventory                                        |        |                  | 589        |            |        |        | (596,704   | )
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             |                      | Prepaid expenses                                 |        |                  | (38,450    | )          |        |        | (62,728    | )
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             |                      | Accounts payable                                 |        |                  | (19,323    | )          |        |        | 123,030    |  
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             |                      | Accrued payroll and payroll taxes                |        |                  | 28,941     |            |        |        | 55,197     |  
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             |                      | Other accrued expenses                           |        |                  | 34,883     |            |        |        | (8,262     | )
|                                                                                |                                             |                      |                                                  |        |                  |            |            |       
|                                                                                |                                             |                      | Net cash used in operating activities            |        |                  | (1,113,804 | )          |        |        | (1,935,600 | )
|                                                                               
|Investing Activities:                                                          
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|Purchase of property and equipment                                              |                                             |                      | (39,344                                          | )      |                  |            | (71,667    | )     
|                                                                                |                                             |                      |                                                  |        |                  |            |            |       
|                                                                                |                                             |                      | Net cash used in investing activities            |        |                  | (39,344    | )          |        |        | (71,667    | )
|                                                                               
|Financing Activities:                                                          
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|Issuance of Common Stock                                                        |                                             |                      | 135,986                                          |        |                  |            |           |       
|                                                                                |                                             |                      |                                                  |        |                  |            |            |       
|                                                                                |                                             |                      | Net cash provided by financing activities        |        |                  | 135,986    |            |        |        |           |  
|                                                                                |                                             |                      |                                                  |        |                  |            |            |       
|Net (decrease) in cash and cash equivalents                                     |                                             |                      | (1,017,162                                       | )      |                  |            | (2,007,267 | )     
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                             |                      | Cash and cash equivalents at beginning of period |        |                  | 4,018,745  |            |        |        | 7,684,525  |  
|                                                                                |                                             |                      |                                                  |        |                  |            |            |       
|Cash and cash equivalents at end of period                                      |                                             | $                    | 3,001,583                                        |        |                  | $          | 5,677,258  |       
|                                                                                |                                             |                      |                                                  |        |                  |            |            |       

See accompanying notes.

5



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##### Table of Contents






December 31, 2000



|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 six months ended December 31, 2000 are not
necessarily indicative of the results that may be expected for the full
year ending June 30, 2001. The June 30, 2000 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, 2000, as amended. The
policies described in that report are used for preparing quarterly
reports.



|2. |  | Shareholders Equity
|-- |  | --------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In July and August 1998, the Company raised $9,188,414 (net of
underwriting discounts and offering expenses), through an initial public
offering of 2,587,500 units (which included 337,500 additional units to
cover over-allotments) at $4.125 per unit. Each unit consists of one
share of Common Stock and one Redeemable Class A Warrant (the Class A
Warrant) which entitled the holder to purchase one share of
Common Stock at an exercise
price of $5.50 per Warrant, subject to adjustment. The Class A Warrant
Agreement was amended as of January 23, 2001 to reduce the exercise price
of the Class A Warrant from $5.50 to $5.15 per share of Common Stock
issuable upon exercise of the Class A Warrant. The Class A Warrants are
subject to redemption by the Company for $.01 per Warrant at any time
commencing 90 days after the Effective Date (July 23, 1998), provided
that the closing bid price of the Company's Common Stock exceeds $6.50 (subject to
adjustment) for 14 consecutive trading days. Written notice must precede
redemption by 30 days and must be sent within 10 business days of the 14
consecutive trading day period. The Class A Warrants expire on July 22,
2002.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On January 23, 2001, the Company commenced an offering of up to 2,752,192
Redeemable Class B Warrants enabling holders to purchase one share of its
$.01 par value Common Stock (the Class B Warrants). As an incentive to
exercise its outstanding Class A Warrants, the Company is offering the
Class B Warrants to those holders of the Class A Warrants who properly
exercise a Class A Warrant in the offering period. The offering period
begins January 23, 2001 and expires at 5:00 p.m. Central Time, March 26,
2001. If all of the Class A Warrant holders exercised their Class A
Warrants in this offering, the Company would receive approximately $14
million in net proceeds. The Class B Warrants expire on January 23, 2006
and have an exercise price of $9.00 per share of the Company's Common Stock issuable
upon exercise. The Class B Warrants are redeemable by the Company for
$.01 per Class B Warrant at any time the closing bid price of its Common
Stock exceeds $13.50 (subject to adjustment) for 5 consecutive trading
days, as reported by The Nasdaq SmallCap Market. The Company has applied
for listing of the Class B Warrants on The Nasdaq SmallCap Market,
although the listing of the Class B Warrants on The Nasdaq SmallCap Market
or any exchange cannot be assured.

6



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##### Table of Contents






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 wish to 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 2000 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 generate
revenue; our need for additional capital; the
availability of third-party reimbursements; market acceptance of our products;
the ability to operate and maintain the Central Data Management Facility
(CDMF) on a commercial scale; 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; 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; and our ability
to protect our proprietary technology. We undertake no responsibility to
update any forward-looking statement.

Forward-looking statements involve risks and uncertainties, including
those discussed under Risk Factors, that could cause actual results to differ
materially from those anticipated. Because actual results may differ, readers
are cautioned not to place undue reliance on these forward-looking statements.

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 large and small arteries. Vascular compliance or
arterial elasticity has been investigated for many years and clinical studies
suggest that a lack of arterial elasticity is an early indicator of vascular
disease. We are currently marketing two versions of our Product: the
HDI/PulseWave CR-2000 Research CardioVascular Profiling System and
the CVProfilor DO-2020 CardioVascular Profiling System, and we plan
to market the CVProfilor MD-3000 CardioVascular Profiling System.
The CR-2000 Research System is being marketed worldwide, has a medical device
CE Mark (CE0123) which allows it to be marketed as a medical device in the
European Union and is being marketed for research purposes only in the United
States (that is, not for screening, diagnosing, monitoring or determining
treatment of patients). The CVProfilor DO-2020 System, intended for
use by United States physicians to screen patients for the presence of
underlying vascular disease, is an FDA regulated medical device. On November
2, 2000, we obtained FDA approval to market the CVProfilor DO-2020
System and while we expect the CVProfilor DO-2020 System to generate
the majority of our revenues in the future, to date, it has not yet generated
any revenues. The CVProfilor DO-2020 System is being marketed to
primary care physicians and other health care professionals on a
per-patient-tested rental basis. Utilizing our Central Data Management
System (the CDMF), we are able to track utilization of the
CVProfilor DO-2020 System in each physicians clinic and to invoice
our physician customers on the number of CardioVascular Profile Reports they
generate in their clinics each month. We anticipate that marketing the
CVProfilor DO-2020 System under a per-patient-tested rental
program as opposed to a capital sale will allow us to accelerate the rate of
Product acceptance in the medical marketplace and allow physician usage fees to
eventually generate the majority of our revenues. The CVProfilor
MD-3000 System will provide physicians outside the United States with key
cardiovascular parameters, which we believe will provide clinically beneficial
information useful in screening patients who may be at risk for
future cardiovascular disease and in monitoring the effectiveness of treatment
of patients with previously

7



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##### Table of Contents



diagnosed cardiovascular disease. The
CVProfilor MD-3000 System requires that we obtain a CE Mark in order
for it to be marketed inside the European Union and will require regulatory
approval to be marketed in Japan and China.

Results of Operations

As of December 31, 2000, we had an accumulated deficit of $(9,329,312),
attributable primarily to research and development and general and
administrative expenses. Until we are able to generate significant revenues
from our activities, we expect to continue to incur operating losses.

Three Months Ended December 31, 2000 Compared to Three Months Ended December
31, 1999

For the three months ended December 31, 2000 and 1999, we recorded revenue
of $1,204,500 and $57,499, respectively, relating to sales of the
HDI/PulseWave CR-2000 Research CardioVascular Profiling System.

Total cost and expenses for the three months ended December 31, 2000 were
$1,256,919 compared to $1,103,327 for the three months ended December 31, 1999.
Approximately 5% of the $1,256,919 and 15% of the $1,103,327 total cost and
expenses were related to research and development expenses. A further
breakdown of research and development expenses is as follows:

|                                                        |                                      |                                         |   |        |              |  |      |         |         |  | 
|------------------------------------------------------- | ------------------------------------ | --------------------------------------- | - | ------ | ------------ |  | ---- | ------- | ------- |  | 
|                                                        |                                      |                                         |   |        | Three Months
|                                                        |                                      |                                         |   |        | Ended       
|                                                        |                                      |                                         |   |        | December 31 
|                                                        |                                      |                                         |   |        |             
|                                                        |                                      |                                         |   |        | 2000         |  | 1999
|                                                        |                                      |                                         |   |        |              |  |      |        
|Design and development of prototype devices and other  
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | enhancements and improvements        |                                         | $ | 40,835 |              |  | $    | 146,852 |        
|                                                       
|                                                       
|                                                       
|                                                       
|Recognized compensation cost for value of stock options
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | granted in lieu of cash compensation |                                         |   | 17,835 |              |  |      | 17,835  |        
|                                                        |                                      |                                         |   |        |              |  |      |         |         |  | 
|                                                        |                                      | Total research and development expenses |   | $      | 58,670       |  |      | $       | 164,687 | 
|                                                        |                                      |                                         |   |        |              |  |      |         |         |  | 

The following is a summary of the major categories included in selling, general
and administrative expenses:

|                                                             |                                                    |   |         |                    |  |      |         |         |  | 
|------------------------------------------------------------ | -------------------------------------------------- | - | ------- | ------------------ |  | ---- | ------- | ------- |  | 
|                                                             |                                                    |   |         | Three Months Ended
|                                                             |                                                    |   |         | December 31       
|                                                             |                                                    |   |         |                   
|                                                             |                                                    |   |         | 2000               |  | 1999
|                                                             |                                                    |   |         |                    |  |      |        
|Wages, related expenses and benefits                         |                                                    | $ | 258,972 |                    |  | $    | 299,042 |        
|                                                            
|                                                            
|                                                            
|                                                            
|Patents and related expenses                                 |                                                    |   | 25,972  |                    |  |      | 14,584  |        
|                                                            
|                                                            
|                                                            
|                                                            
|Outside consultants                                          |                                                    |   | 23,770  |                    |  |      | 101,527 |        
|                                                            
|                                                            
|                                                            
|                                                            
|Rent-building and utilities                                  |                                                    |   | 23,332  |                    |  |      | 21,913  |        
|                                                            
|                                                            
|                                                            
|                                                            
|Insurance-general and directors/officers liability           |                                                    |   | 13,744  |                    |  |      | 12,392  |        
|                                                            
|                                                            
|                                                            
|                                                            
|Selling, marketing and promotion, including applicable wages |                                                    |   | 362,389 |                    |  |      | 300,425 |        
|                                                            
|                                                            
|                                                            
|                                                            
|Royalties                                                    |                                                    |   | 36,690  |                    |  |      | 1,725   |        
|                                                            
|                                                            
|                                                            
|                                                            
|Depreciation and amortization                                |                                                    |   | 28,924  |                    |  |      | 27,026  |        
|                                                            
|                                                            
|                                                            
|                                                            
|Other-general and administrative                             |                                                    |   | 127,749 |                    |  |      | 147,586 |        
|                                                             |                                                    |   |         |                    |  |      |         |         |  | 
|                                                             | Total selling, general and administrative expenses |   | $       | 901,542            |  |      | $       | 926,220 | 
|                                                             |                                                    |   |         |                    |  |      |         |         |  | 

Our number of employees decreased from seventeen in the three months ended
December 31, 1999 to thirteen in the three months ended December 31, 2000.

8



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##### Table of Contents



Selling, marketing and promotion expense increased from $300,425 for the
three months ended December 31, 1999 to $362,389 for the three months ended
December 31, 2000. This category includes wages and commissions paid by us
relating to our sales and marketing efforts as well as travel and convention
expenses.

Interest income was $53,929 and $86,837 for the three months ended
December 31, 2000 and 1999, respectively.

Net income was $1,510 for the three months ended December 31, 2000
compared to a net (loss) of ($958,991) for the three months ended December 31,
1999. For the three months ended December 31, 2000, basic and dilutive net
income per share was $.00, based on weighted average shares outstanding of
5,280,761. For the three months ended December 31, 1999, basic and dilutive
net loss per share was $(.19), based on weighted average shares outstanding of
5,109,235.

Six Months Ended December 31, 2000 Compared to Six Months Ended December 31,
1999

Revenue was $1,653,304 and $128,997 for the six months ended December 31,
2000 and 1999, respectively. This revenue related to sales of the
HDI/PulseWave CR-2000 Research CardioVascular Profiling System.

Total cost and expenses for the six months ended December 31, 2000 were
$2,111,176 compared to $1,934,842 for the six months ended December 31, 1999.
Approximately 6% of the $2,111,176 and 12% of the $1,934,842 total cost and
expenses were related to research and development expenses. A further
breakdown of research and development expenses is as follows:

|                                                        |                                      |                                         |   |        |                  |  |      |         |         |  | 
|------------------------------------------------------- | ------------------------------------ | --------------------------------------- | - | ------ | ---------------- |  | ---- | ------- | ------- |  | 
|                                                        |                                      |                                         |   |        | Six Months Ended
|                                                        |                                      |                                         |   |        | December 31     
|                                                        |                                      |                                         |   |        |                 
|                                                        |                                      |                                         |   |        | 2000             |  | 1999
|                                                        |                                      |                                         |   |        |                  |  |     
|Design and development of prototype devices and other  
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | enhancements and improvements        |                                         | $ | 95,034 |                  |  | $    | 192,288 |        
|                                                       
|                                                       
|                                                       
|                                                       
|Recognized compensation cost for value of stock options
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | granted in lieu of cash compensation |                                         |   | 35,670 |                  |  |      | 35,670  |        
|                                                        |                                      |                                         |   |        |                  |  |      |         |         |  | 
|                                                        |                                      | Total research and development expenses |   | $      | 130,704          |  |      | $       | 227,958 | 
|                                                        |                                      |                                         |   |        |                  |  |      |         |         |  | 

The following is a summary of the major categories included in selling,
general and administrative expenses:

|                                                             |                                                    |   |         |                  |  |      |         |           |  | 
|------------------------------------------------------------ | -------------------------------------------------- | - | ------- | ---------------- |  | ---- | ------- | --------- |  | 
|                                                             |                                                    |   |         | Six Months Ended
|                                                             |                                                    |   |         | December 31     
|                                                             |                                                    |   |         |                 
|                                                             |                                                    |   |         | 2000             |  | 1999
|                                                             |                                                    |   |         |                  |  |     
|Wages, related expenses and benefits                         |                                                    | $ | 455,718 |                  |  | $    | 538,343 |          
|                                                            
|                                                            
|                                                            
|                                                            
|Patents and related expenses                                 |                                                    |   | 35,453  |                  |  |      | 43,966  |          
|                                                            
|                                                            
|                                                            
|                                                            
|Outside consultants                                          |                                                    |   | 71,355  |                  |  |      | 194,521 |          
|                                                            
|                                                            
|                                                            
|                                                            
|Rent-building and utilities                                  |                                                    |   | 45,173  |                  |  |      | 44,391  |          
|                                                            
|                                                            
|                                                            
|                                                            
|Insurance-general and directors/officers liability           |                                                    |   | 26,481  |                  |  |      | 23,595  |          
|                                                            
|                                                            
|                                                            
|                                                            
|Selling, marketing and promotion, including applicable wages |                                                    |   | 594,287 |                  |  |      | 516,950 |          
|                                                            
|                                                            
|                                                            
|                                                            
|Royalties                                                    |                                                    |   | 49,599  |                  |  |      | 3,870   |          
|                                                            
|                                                            
|                                                            
|                                                            
|Depreciation and amortization                                |                                                    |   | 56,570  |                  |  |      | 51,846  |          
|                                                            
|                                                            
|                                                            
|                                                            
|Other-general and administrative                             |                                                    |   | 274,224 |                  |  |      | 259,449 |          
|                                                             |                                                    |   |         |                  |  |      |         |           |  | 
|                                                             | Total selling, general and administrative expenses |   | $       | 1,608,860        |  |      | $       | 1,676,931 | 
|                                                             |                                                    |   |         |                  |  |      |         |           |  | 

9



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##### Table of Contents



Our number of employees decreased from seventeen in the six months ended
December 31, 1999 to thirteen in the six months ended December 31, 2000.

Selling, marketing and promotion expense increased from $516,950 for the
six months ended December 31, 1999 to $594,287 for the six months ended
December 31, 2000. This category includes wages and commissions paid by us
relating to our sales and marketing efforts as well as travel and convention
expenses.

Interest income was $112,062 and $178,119 for the six months ended
December 31, 2000 and 1999, respectively.

Net loss was $(345,810) and $(1,627,726) for the six months ended December
31, 2000 and 1999, respectively. For the six months ended December 31, 2000,
basic and dilutive net loss per share was $(.07), based on weighted average
shares outstanding of 5,242,443. For the six months ended December 31, 1999,
basic and dilutive net loss per share was $(.32), based on weighted average
shares outstanding of 5,109,235.

Liquidity and Capital Resources

Cash and cash equivalents had a net decrease of $1,017,162 for the six
months ended December 31, 2000. The significant elements of this change were
as follows: net cash used in operating activities net loss, as adjusted for
non-cash items, of $253,570; increase in accounts receivable  $864,193; net
cash provided by financing activities issuance of Common Stock  $135,986.
For the six months ended December 31, 1999, cash and cash equivalents had a net
decrease of $2,007,267. The significant elements of this change were as
follows: net cash used in operating activities net loss, as adjusted for
non-cash items, of $(1,540,211); increase in inventory -$596,704; increase in
accounts payable  $123,030.

In July 1998, we completed our initial public offering (IPO) in which we
sold 2,250,000 units at $4.125 per unit, each unit consisting of one share of
Common Stock and one Redeemable Class A Warrant. In August 1998, the
underwriter exercised in full an overallotment option to purchase an additional
337,500 units. Total net proceeds from the IPO were $9,188,414. As of
December 31, 2000, we have cash and cash equivalents of $3,001,583, and
anticipate that these funds should allow us to pursue the different elements of
our business development strategy for at least the next 8 months. Our business
plan and financing needs are subject to change depending on, among other
things, market conditions, timing of our marketing efforts regarding the
CVProfilor DO-2020 System, business opportunities and cash flow from
operations. Pending application of the net proceeds, such proceeds will be
invested in short-term, high quality, interest-bearing instruments.

Although not assured, in addition to the net proceeds from the IPO, we may
derive over a period of time up to $14,173,789 from the exercise of the
2,752,192 Redeemable Class A Warrants. Each Redeemable Class A Warrant
entitles the holder to purchase one share of our Common Stock at an exercise price of $5.15 per
Warrant, subject to adjustment. The Redeemable Class A Warrants are subject to
redemption by us for $.01 per Warrant at any time commencing October 21, 1998,
provided that the closing bid price of our Common Stock exceeds $6.50 (subject
to adjustment) for 14 consecutive trading days. The Redeemable Class A
Warrants expire on July 22, 2002. The amounts, if any, that we derive from the
exercise of such Redeemable Class A Warrants will be used in connection with
our development opportunities, business plan activities and/or working capital
requirements.

10



---



##### Table of Contents









Item 2.     Use of Proceeds

The following table sets forth our use of the net proceeds from our
initial public offering, from July 28, 1998 through December 31, 2000:

|                                                         |                                                           |  |           |           |   |           | 
|-------------------------------------------------------- | --------------------------------------------------------- |  | --------- | --------- | - | --------- | 
|Temporary investments (U.S. Government obligations/notes
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         | and U.S. Government money market funds; other short-term,
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         | high quality, interest-bearing instruments                |  | $         | 2,391,174 |  
|                                                        
|                                                        
|                                                        
|                                                        
|Central Data Management Facility                         |                                                           |  | 318,194   |          
|                                                        
|                                                        
|                                                        
|                                                        
|Purchase of property and equipment                       |                                                           |  | 442,607   |          
|                                                        
|                                                        
|                                                        
|                                                        
|Selling, marketing and promotion                         |                                                           |  | 1,788,879 |          
|                                                        
|                                                        
|                                                        
|                                                        
|Wages, related expenses and benefits                     |                                                           |  | 2,074,257 |          
|                                                        
|                                                        
|                                                        
|                                                        
|Outside consultants                                      |                                                           |  | 520,612   |          
|                                                        
|                                                        
|                                                        
|                                                        
|Inventory                                                |                                                           |  | 1,652,691 |          
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |                                                           |  |           |           |   |          
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |                                                           |  |           |           | $ | 9,188,414
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |                                                           |  |           |           |   |          

As of February 12, 2001, we have not received any proceeds from our
offering of Redeemable Class B Warrants to certain holders of our Class A
Warrants.




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



|(a) |  | The Annual Meeting of Shareholders was held on December 8, 2000.
|--- |  | ----------------------------------------------------------------
|   
|(b) |  | The results of the shareholders votes were as follows:         

|                                     |                      |  |     |           |         |  |         |        |  |  |  |       | 
|------------------------------------ | -------------------- |  | --- | --------- | ------- |  | ------- | ------ |  |  |  | ----- | 
|                                     |                      |  | For |           | Against |  | Abstain
|                                     |                      |  |     |           |         |  |        
|1. Re-Election of Class II Director:
|                                    
|                                    
|                                    
|                                    
|                                     | Greg H. Guettler     |  |     | 4,443,463 |         |  |         |       |  |  |  | 3,000 | 
|                                    
|                                    
|                                    
|                                    
|2. Approval of Selection of         
|                                    
|                                    
|                                    
|                                    
|                                     | Independent Auditors |  |     | 4,388,613 |         |  |         | 57,300 |  |  |  | 550   | 




Item 6.       Exhibits and Reports on Form 8-K



|(a) |  | The following Exhibits are furnished pursuant to Item 601 of Regulation S-B:
|--- |  | ----------------------------------------------------------------------------

|            |  |                                                                
|----------- |  | ---------------------------------------------------------------
|Exhibit No. |  | Description                                                    
|            |  |                                                                
|           
|27          |  | Financial Data Schedule for the quarter ended December 31, 2000

11



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##### Table of Contents





|(b) |  | Reports on Form 8-K.
|--- |  | --------------------

The Company filed a Current Report on Form 8-K on November 3, 2000 (File
No. 0-24635) regarding the U.S. Food and Drug Administration (FDA) 510(k)
clearance to market the Companys CVProfilor DO-2020 CardioVascular
Profiling System, including related matters.

The Company filed a Current Report on Form 8-K on November 9, 2000 (File
No. 0-24635) regarding the Companys discussion of potential revenues for
fiscal year 2001, including the timing of the possible commencement of the
receipt of revenues related to the marketing of the Companys
CVProfilor DO-2020 CardioVascular Profiling System.




SIGNATURES

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

| |                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------
| | HYPERTENSION DIAGNOSTICS, INC                                                                                                                     
|
|
|
|
| | By /s/ James S. Murphy
James S. Murphy
Senior Vice President, Finance and
Administration and Chief Financial Officer
(principal financial officer)

Date: February 12, 2001

12



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##### Table of Contents






|            |  |                                                                
|----------- |  | ---------------------------------------------------------------
|Exhibit No. |  | Description                                                    
|            |  |                                                                
|           
|           
|           
|           
|27          |  | Financial Data Schedule for the quarter ended December 31, 2000

13