##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION    FORM 10-QSB QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2004 Commission File Number: 0-24635 HYPERTENSION DIAGNOSTICS, INC.  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 x No o The number of shares of Common Stock outstanding as of October 31, 2004 was
27,092,385. Transitional Small Business Disclosure Format: Yes o No x 1




---



HYPERTENSION DIAGNOSTICS, INC. INDEX TO FORM 10-QSB Page No.PART I. FINANCIAL INFORMATION:Item 1. Financial Statements
    
    
    3Balance Sheets  September 30, 2004 and June 30, 2004
    
    
    3Statements of Operations  Three Months Ended
September 30, 2004 and 2003, respectively
    
    
    4Statements of Cash Flows  Three Months Ended
September 30, 2004 and 2003, respectively
    
    
    5Notes to Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    8Item 4. Controls and Procedures
    
    
    17PART II. OTHER INFORMATION:Item 1. Legal Proceedings
    
    
    18Item 2. Changes in Securities
    
    
    18Item 6. Exhibits and Reports on Form 8-K
    
    
    18SIGNATURES
    
    
    20CERTIFICATIONS
    
    
    21Certification of CEO Pursuant to 13a-14 and 15d-14Certification of CFO Pursuant to 13a-14 and 15d-14Certificate Pursuant to 18 U.S.C. Section 1350
  2




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements Hypertension Diagnostics, Inc. 
  September 30,
    
    June 30,2004
    
    2004AssetsCurrent Assets:Cash and cash equivalents
    
    $
    1,174,596
    
    
    $
    1,378,293Accounts receivable
    
    
    123,210
    
    
    
    207,710Interest receivable
    
    
    
    
    
    
    8,920Inventory
    
    
    369,218
    
    
    
    224,824Prepaids and other current assets
    
    
    55,030
    
    
    
    55,497Total Current Assets
    
    
    1,722,054
    
    
    
    1,875,244Property and Equipment:Leasehold improvements
    
    
    17,202
    
    
    
    17,202Furniture and equipment
    
    
    1,294,241
    
    
    
    1,260,549Less accumulated depreciation and amortization
    
    
    (957,946
    )
    
    
    (915,619
    )353,497
    
    
    
    362,132Other Assets
    
    
    6,530
    
    
    
    6,530Total Assets
    
    $
    2,082,081
    
    
    $
    2,243,906Liabilities and Shareholders EquityCurrent Liabilities:Accounts payable
    
    $
    147,406
    
    
    $
    84,802Accrued payroll and payroll taxes
    
    
    529,953
    
    
    
    520,864Deferred revenue
    
    
    5,175
    
    
    
    Other accrued expenses
    
    
    20,833
    
    
    
    26,054Total Current Liabilities
    
    
    703,367
    
    
    
    631,720Deferred Revenue, less current portion
    
    
    4,000
    
    
    
    4,800Shareholders Equity:Series A Convertible Preferred Stock, $.01 par value:Authorized shares5,000,000Issued and outstanding shares843,917 and 803,484
at September 30, 2004 and June 30, 2004, respectively
    
    
    8,439
    
    
    
    8,035Common Stock, $.01 par value:Authorized shares150,000,000Issued and outstanding shares27,092,385 and 26,449,378
at September 30, 2004 and June 30, 2004, respectively
    
    
    270,924
    
    
    
    264,494Additional paid-in capital
    
    
    24,780,179
    
    
    
    24,585,206Accumulated deficit
    
    
    (23,684,828
    )
    
    
    (23,250,349
    )Total Shareholders Equity
    
    
    1,374,714
    
    
    
    1,607,386Total Liabilities and Shareholders Equity
    
    $
    2,082,081
    
    
    $
    2,243,906
 See accompanying notes. 3




---



##### Table of Contents



Hypertension Diagnostics, Inc. 
 Statements of Operations Three Months EndedSeptember 302004
    
    2003Revenue:Equipment sales
    
    $
    35,850
    
    
    $
    73,745Equipment rental
    
    
    118,148
    
    
    
    89,896Service/contract income
    
    
    99,423
    
    
    
    85,257253,421
    
    
    
    248,898Cost of Sales
    
    
    47,202
    
    
    
    46,493Gross Profit
    
    
    206,219
    
    
    
    202,405Expenses:Selling, general and administrative
    
    
    647,642
    
    
    
    615,474Total Expenses
    
    
    647,642
    
    
    
    615,474Operating Loss
    
    
    (441,423
    )
    
    
    (413,069
    )Other Income (Expense):Interest income
    
    
    6,944
    
    
    
    6,069Interest expense
    
    
    
    
    
    
    (50,185
    )6,944
    
    
    
    (44,116
    )Net Loss
    
    $
    (434,479
    )
    
    $
    (457,185
    )Basic and Diluted Net Loss per Share
    
    $
    (.02
    )
    
    $
    (.03
    )Weighted Average Shares Outstanding
    
    
    27,001,928
    
    
    
    14,876,805
 See accompanying notes. 4




---



##### Table of Contents



Hypertension Diagnostics, Inc. 
 Statements of Cash Flows Three Months EndedSeptember 302004
    
    2003Operating Activities:Net loss
    
    $
    (434,479
    )
    
    $
    (457,185
    )Adjustments to reconcile net loss to net
cash used in operating activities:Value of stock options, Common Stock and warrants
issued in lieu of cash
    
    
    10,013
    
    
    
    Depreciation
    
    
    42,327
    
    
    
    53,304Amortization of debt discount
    
    
    
    
    
    
    48,531Interest expense  converted to Common Stock
    
    
    
    
    
    
    11,956Change in operating assets and liabilities:Accounts receivable
    
    
    84,500
    
    
    
    28,143Interest receivable
    
    
    8,920
    
    
    
    (2,635
    )Inventory
    
    
    (144,394
    )
    
    
    26,256Prepaids and other current assets
    
    
    467
    
    
    
    (1,177
    )Accounts payable
    
    
    62,604
    
    
    
    170,202Accrued payroll and payroll taxes
    
    
    9,089
    
    
    
    15,081Deferred revenue
    
    
    4,375
    
    
    
    (85,256
    )Other accrued expenses
    
    
    (5,221
    )
    
    
    (12,629
    )Net cash used in operating activities
    
    
    (361,799
    )
    
    
    (205,409
    )Investing Activities:Purchase of property and equipment
    
    
    (33,692
    )
    
    
    Net cash used in investing activities
    
    
    (33,692
    )
    
    
    Financing Activities:Issuance of Preferred Stock and Common Stock
    
    
    191,794
    
    
    
    1,873,483Net cash provided by financing activities
    
    
    191,794
    
    
    
    1,873,483Net increase (decrease) in cash and cash equivalents
    
    
    (203,697
    )
    
    
    1,668,074Cash and cash equivalents at beginning of period
    
    
    1,378,293
    
    
    
    90,335Cash and cash equivalents at end of period
    
    $
    1,174,596
    
    
    $
    1,758,409Supplemental Cash Flow Information:Cash paid for interest
    
    $
    
    
    
    $
    977Supplemental Schedule of Noncash Investing and Financing Activities:Conversion of notes payable and accrued interest into Common Stock
    
    $
    
    
    
    $
    541,980Transfer of asset from inventory to property and equipment
    
    
    
    
    
    
    30,779
 See accompanying notes. 5




---



##### Table of Contents



Hypertension Diagnostics, Inc. 
 
  1.
    
    Interim Financial Information The accompanying unaudited financial statements have been prepared in
accordance with the instructions to Form 10-QSB and do not include all the
information and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, these unaudited
financial statements reflect all adjustments, consisting only of normal and
recurring adjustments necessary for a fair presentation of the financial
statements. The results of operations for the three months ended September 30,
2004 are not necessarily indicative of the results that may be expected for the
full year ending June 30, 2005. The June 30, 2004 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, 2004. The policies described in that
report are used for preparing quarterly reports.  2.
    
    Exercise of warrants In July 2004, the Company issued 643,007 shares of common stock and 40,433
shares of Series A Preferred Stock, to holders of warrants to purchase common
stock and Series A Preferred Stock, resulting in gross proceeds to the Company
of $191,794. The exercise price was $.17 per share of common stock and $2.04
per share of Series A Preferred Stock. The Company has granted certain
registration rights covering all of the common stock and Series A Preferred
Stock sold in the offering to the investors. These warrants relate to the
nine-month stock purchase warrants issued in the August 28, 2003 private
placement offering. These warrants were exercisable until May 28, 2004. In
May 2004, the Company extended the expiration date of these warrants to July
15, 2004. For those warrant holders who exercised at least fifty percent (50%)
of the number of shares underlying these warrants by July 15, 2004, the Company
further extended the expiration date of these remaining warrants to November 9,
2004. In November 2004, the Company further extended the expiration date of these
remaining warrants to
March 15, 2005. On February 9, 2004, the Company completed a private placement offering to
a group of investors. As part of this offering, the Company issued nine-month
stock purchase warrants to purchase common stock and Series A Preferred Stock.
These warrants were exercisable until November 9, 2004. In November 2004, the
Company extended the expiration date of these warrants to March 15, 2005. In
addition, for those holders who exercise with respect to at least fifty percent
(50%) of the shares underlying their November 9 warrants, the Company has
agreed to extend the exercise date of such November 9 warrants for an
additional period, expiring July 31, 2005.  3.
    
    Litigation On March 17, 2004, the Company received a letter from counsel of one of
its employees alleging illegal and unethical reimbursement practices, and also
alleging violation of applicable whistleblower statutes. On March 18, 2004,
the Company received a letter from counsel of one of its former employees
alleging failure to pay for accrued vacation time, and also alleging violation
of applicable whistleblower statutes. On August 25, 2004, the Company
entered into a binding memorandum of understanding agreeing to settle
such employees disputes. As settlement in full of these
employees claims, the Company
agreed to make cash payments and issue shares of freely tradable shares of its
common stock to these parties in an aggregate cash amount of $130,000 and
shares in an aggregate amount equal to a fair market value of $100,000. The
Company intends to enter into long form agreements setting forth the 6




---



##### Table of Contents



Hypertension Diagnostics, Inc.
Notes to Financial Statements
September 30, 2004  3.
    
    Litigation (continued) details of such agreement in the near future. The total of $230,000 has been
accrued as accrued payroll at September 30, 2004 and
June 30, 2004. The Company has retained a reimbursement
consultant to investigate the whistleblower claims, and such
consultant has indicated its belief that such claims lack merit.  4.
    
    Stock-Based Compensation The Company accounts for stock-based transactions under SFAS No. 123,
Accounting for Stock-Based Compensation.As permitted by SFAS No. 123, the
Company has elected to continue following the guidance of APB Opinion No. 25
(as interpreted by FIN 44) for measurement and recognition of stock-based
transactions with employees and non-employee directors. Because stock options
have been granted at exercise prices at least equal to the fair market value of
the stock at grant
date, no compensation cost has been recognized for stock options issued to
employees and non-employee directors under the stock option plans. Stock-based
transactions with non-employees are accounted for in accordance with SFAS No.
123 and related interpretations. If compensation cost for the Companys stock option plans had been
determined based on the fair value at the grant dates, consistent with the
method provided in SFAS No. 123, net loss and net loss per share would have
been as follows: Three months ended September 302004
    
    2003Net Loss:As reported
    
    $
    (434,479
    )
    
    $
    (457,185
    )Fair value compensation expense
    
    
    (50,623
    )
    
    
    (47,156
    )Pro forma
    
    $
    (485,102
    )
    
    $
    (504,341
    )Basic and Diluted Net Loss per Share:As reported
    
    $
    (0.02
    )
    
    $
    (0.03
    )Fair value compensation expense
    
    
    
    
    
    
    Pro forma
    
    $
    (0.02
    )
    
    $
    (0.03
    )Stock Based Compensation:As reported
    
    $
    
    
    
    $
    Fair value compensation expense
    
    
    (50,623
    )
    
    
    (47,156
    )Pro forma
    
    $
    (50,623
    )
    
    $
    (47,156
    )
 Pro forma information regarding net loss is required by Statement of
Financial Accounting Standards No. 123, and has been determined as if the
Company had accounted for its stock options under the fair value method of that
Statement. The fair value of these options granted during the three months
ended September 30, 2004 and September 30, 2003 was estimated using the
Black-Scholes option pricing model with the following weighted average
assumptions: 7




---



##### Table of Contents



Hypertension Diagnostics, Inc.
Notes to Financial Statements
September 30, 2004  4.
    
    Stock-Based Compensation (continued) ExpectedRisk-Free
    
    Dividend
    
    Expected
    
    ExpectedThree Months Ended
    
    Interest Rate
    
    Yield
    
    Life
    
    VolatilitySeptember 30, 2004
    
    
    3.60
    %
    
    None
    
    5 years
    
    
    1.060September 30, 2003
    
    
    2.46
    %
    
    None
    
    5 years
    
    
    .915
 
 Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations Forward-Looking Statements This report contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. In addition, we may make
forward-looking statements orally in the future by or on behalf of the Company.
When used, the words believe, expect, will, can, estimate,
anticipate and similar expressions are intended to identify forward-looking
statements. We caution readers not to place undue reliance on any
forward-looking statements and to recognize that the statements are not
predictions of actual future results. Actual results could differ materially
from those anticipated in the forward-looking statements due to the risks and
uncertainties set forth in our 2004 Annual Report on Form 10-KSB under the
caption Risk Factors, as well as others not now anticipated. These risks and
uncertainties include, without limitation: our ability to develop a business
model to timely generate acceptable levels of revenues; the control exercised
by the Schwartz Group; negative effect on our stock price resulting from
available securities for sale; our need for additional capital; our dependence
on our CVProfilor® DO-2020; the availability of third-party reimbursements for
the use of our products; increased market acceptance of our products; our
marketing strategy may result in lower revenues; the illiquidity of our
securities on the OTC Bulletin Board and the related restrictions on our
securities relating to penny stocks; potential violations by us of federal
and state securities laws; the availability of integral components for our
products; our ability to develop distribution channels; increased competition;
changes in government regulation; health care reforms; exposure to potential
product liability; our ability to protect our proprietary technology;
regulatory restrictions pertaining to data privacy issues in utilizing the
CDMF; and the ability to manufacture our products on a commercial scale and in
compliance with regulatory requirements. We undertake no responsibility to
update any forward-looking statement. These forward-looking statements are only
made as of the date of this report. In addition to the risks we have
articulated above, changes in market conditions, changes in our business and
other factors may result in different or increased risks to our business in the
future that are not foreseeable at this time. Overview We are engaged in the design, development, manufacture and marketing of
proprietary medical devices that we believe non-invasively detect subtle
changes in the elasticity of both large and small arteries. We are currently
marketing three products: the HDI/PulseWave CR-2000 Research CardioVascular
Profiling System, the CVProfilor® DO-2020 CardioVascular Profiling System and
the CVProfilor® MD-3000 CardioVascular Profiling System. 8




---



##### Table of Contents




    
    The CR-2000 Research System is being marketed
worldwide for research purposes only to clinical research
investigators for the purpose of collecting data in
cardiovascular studies. Further, because the CR-2000 Research
System bears the CE Mark (CE0123 ) and meets the European
Union Medical Device Directive, physicians may use the CR-2000
Research System with patients in a clinical setting in the
European Union.
    
    In the U.S., the CVProfilor® DO-2020 System is
being marketed to primary care physicians and other health
care professionals on a per-patient-tested rental basis. It
can also be purchased or leased. Utilizing our Central Data
Management Facility (the CDMF), we are able to track
utilization of the CVProfilor® DO-2020 System in each
physicians office and medical clinic and to invoice our
physician customers on the number of CardioVascular Profile
Reports (CVProfile Reports) which they generate each month.
We anticipate that marketing the CVProfilor® DO-2020 System
under a per-patient-tested rental program (as opposed to a
capital sale approach) will allow us to accelerate the rate of
product acceptance in the medical marketplace and should allow
physician usage fees to eventually generate the majority of
our revenue.
    
    The CVProfilor® MD-3000 System is being marketed
through exclusive distributors to physicians outside the
United States. These distributors purchase the product from
us and then re-sell it to end-user physicians in their
territory. The CVProfilor® MD-3000 System has a CE Mark that
allows it to be marketed within European Union countries. The
CVProfilor® MD-3000 may require certain regulatory approval
for it to be marketed in other countries throughout the world. Critical Accounting Policies The financial statements are prepared in accordance with accounting
principles generally accepted in the U.S., which requires us to make estimates
and assumptions in certain circumstances that affect amounts reported in the
accompanying financial statements and related footnotes. In preparing these
financial statements, management has made its best estimates and judgments of
certain amounts included in the financial statements, giving due consideration
to materiality. We do not believe there is a great likelihood that materially
different amounts would be reported related to the accounting policies
described below. However, application of these accounting policies involves
the exercise of judgment and use of assumptions as to future uncertainties and,
as a result, actual results could differ from these estimates. Revenue Recognition. We recognize revenue in accordance with U.S.
Securities and Exchange Commissions Staff Accounting Bulletin (SAB) No. 101,
Revenue Recognition. Pursuant to SAB No. 101, the Company recognizes revenue
from the sale of equipment at the time of shipment to a customer or
distributor. Shipment occurs only after receipt of a valid purchase order.
Payments from customers and distributors are either made in advance of shipment
or within a short time frame after shipment. In the case of sales to
distributors, such payment is not contingent upon resale of the product to end
users. Shipping and handling costs are included as cost of equipment sales.
In addition, title passes to the customer or distributor upon shipment. At the
time of shipment, all of the criteria for recognition set forth in SAB No. 101
have been met: persuasive evidence of an arrangement exists, delivery has
occurred or services have been rendered, the selling price is fixed or
determinable and collectability is reasonably assured. 9




---



##### Table of Contents



Equipment rental revenue, whether from the minimum monthly fee or from the
per-patient-tested fee, is recognized when collection is probable, which is
currently upon cash receipt. At the time of receipt of rental revenues, all
of the criteria for recognition set forth in SAB No. 101 have been met:
persuasive evidence of an arrangement exists, delivery has occurred or services
have been rendered, the selling price is fixed or determinable and
collectability is reasonably assured. In the case of either a sale or rental of our product, there are no
post-shipment obligations which affect the timing of revenue recognition.
Neither customers nor distributors have a right to return or exchange our
product. Warranty repairs on all of the above are handled on a repair or
replacement basis, at our discretion. We did not incur any significant
warranty repair costs for the three months ended September 30, 2004 and 2003,
respectively. Further, there is no installation of our product; it is ready to
use when plugged into an electrical outlet and no specialized knowledge is
required to ready it for use. For these reasons, we have concluded that our
revenue recognition policy is appropriate and in accordance with SAB No. 101. Allowance for Doubtful Accounts. Accounts receivable are reviewed to
determine the need for an allowance for amounts that may become uncollectible
in the future. The necessity of an allowance is based on managements review
of accounts receivable balances and historic write-offs. Inventories and Related Allowance for Excess and Obsolete Inventory.
Inventories are valued at the lower of cost or market and reviewed to determine
the need for an allowance for excess and obsolete inventories. The need for an
allowance is based on managements review of inventories on hand compared to
estimated future usage and sales. Research and Development. We did not incur any research and development
costs for the three months ended September 30, 2004 and 2003, respectively. Results of Operations As of September 30, 2004, we had an accumulated deficit of $(23,684,828),
attributable primarily to selling, general and administrative expenses. Until
we are able to generate significant revenue from our activities, we expect to
continue to incur operating losses. As of September 30, 2004, we had cash and
cash equivalents of $1,174,596. We anticipate that these funds, in conjunction
with revenue anticipated to be earned from placements of our CVProfilor®
DO-2020 Systems, anticipated sales of our CR-2000 Research Systems, as well as
anticipated operating cost reductions, will allow us to pursue our business
development strategy for at least the next twelve months following September
30, 2004. Three Months Ended September 30, 2004 Compared to Three Months Ended September
30, 2003 The following is a summary of our Revenue and Cost of Sales for the three
months ended September 30, 2004 and 2003, respectively: 10




---



##### Table of Contents



Three Months Ended September 30, 2004Equipment
    
    Equipment
    
    Service/Total
    
    Sales
    
    Rental
    
    ContractRevenue
    
    $
    253,421
    
    
    $
    35,850
    
    
    $
    118,148
    
    
    $
    99,423Cost of Sales
    
    
    47,202
    
    
    
    5,181
    
    
    
    26,287
    
    
    
    15,734Gross Profit
    
    $
    206,219
    
    
    $
    30,669
    
    
    $
    91,861
    
    
    $
    83,689
 Three Months Ended September 30, 2003Equipment
    
    Equipment
    
    Service/Total
    
    Sales
    
    Rental
    
    ContractRevenue
    
    $
    248,898
    
    
    $
    73,745
    
    
    $
    89,896
    
    
    $
    85,257Cost of Sales
    
    
    46,493
    
    
    
    13,026
    
    
    
    21,766
    
    
    
    11,701Gross Profit
    
    $
    202,405
    
    
    $
    60,719
    
    
    $
    68,130
    
    
    $
    73,556
 Total Equipment Sales Revenue for the three months year ended September
30, 2004 was $35,850, compared to $73,745 for the three months ended September
30, 2003. Revenue relating to international equipment sales was $35,850 for
the three months ended September 30, 2004 and $51,495 for the three months
ended September 30, 2003. Although we continue to pursue sales of the CR-2000
Research Systems, the majority of our time and attention is now, and it is
expected to continue to be, focused on expanding CVProfilor® DO-2020 System
placements (per-patient-tested rental program) and attempting to increase its
utilization in U.S. physicians medical offices and clinics and seeking to
increase third party reimbursements for such utilization. The reason for the
shift in our strategic focus to the CVProfilor® DO-2020 System was: a) FDA
510(k) clearance to market it in the United States on November 1, 2000; and b)
the potential practicing physician market is significantly larger than the
research market for the CR-2000 Research System. This shift in our strategic
focus began in the fourth quarter of fiscal year 2001. Placements of the CVProfilor® DO-2020 System, and satisfactory utilization
by physicians of those systems placed, has taken more time and resources than
originally anticipated due to delays in obtaining consistent and satisfactory
levels of third party reimbursements to physicians utilizing the CVProfilor®
DO-2020 System and delays in integrating the CVProfilor® DO-2020 System into
the clinic operations in which they are placed. We have commenced focusing our
resources on specific regional markets that we believe are more likely to
generate higher levels of acceptance of the CVProfilor® DO-2020 System by
physicians and a greater amount of reimbursements by third party payors to such
physicians. We believe this approach is the most effective method of both
increasing placements of the CVProfilor® DO-2020 System and increasing the
physician utilizations of such systems placed. Our current marketing strategy
focuses on marketing the CVProfilor® DO-2020 System to physicians who treat
patients with diabetes and hypertension. We believe these physicians have the
greatest interest in, and use for, our product. Therefore, the most critical
factor in our ability to increase rental revenue rests in our ability to expand
our marketing and distribution network to increase placements and utilization
of our CVProfilor® DO-2020 System. We believe there are three ways we could
expand our marketing and distribution network: 1) the development of an
internal sales force; 2) a strategic partnership with a firm that possesses a
distribution network calling on these same physicians; or 3) a combination of
the internal sales force and external distribution network methods. We believe
this dual method of expansion offers us the greatest opportunity for success.
We anticipate adding additional sales personnel at the same time that we pursue
discussions with firms that have an interest in representing our CVProfilor®
DO-2020 System nationwide. In the short term, we have also focused on
international sales of our CR-2000 Research System and CVProfilor® MD-3000
System as a means of generating cash to support operational expenses. 11




---



##### Table of Contents



Further, the existence, timing and extent of reimbursement of physicians
for the use of our CVProfilor® DO-2020 System affects the availability of our
working capital. Reimbursement will always vary considerably by the patients
medical necessity, by physician, by provider, by geography and by provider
coverage plans, making the process of obtaining reimbursement for the
CVProfilor® DO-2020 System by current physician customers an important
component of our products success. To the extent that reimbursement is unavailable or inadequate, physicians will be less
likely to use the CVProfilor® DO-2020 System. In addition, because our CVProfilor® DO-2020 System is being marketed on a
per-patient-tested basis, we have a delay in the cost recovery of our working
assets. Although our per-patient-tested marketing approach reduces the risk
and thereby increases the potential rate of acceptance for physician customers
willing to use the CVProfilor® DO-2020 System as compared to a capital
acquisition approach, it also delays our cash flow recovery of product costs.
Physician payments for use of the CVProfilor® DO-2020 System follow actual
utilization by some 60-90 days; utilization in one month is invoiced in the
following month and payment is generally received within 30 to 60 days of
invoicing. This delay in payment, therefore, requires six to twelve months to
fully recover product costs. These cash flow delays mean that we will generate
little, if any, cash during the initial placement of the product and will
require cash from other sources to support our operations during this period. For the three months ended September 30, 2004, we recognized Revenue for
the CVProfilor® DO-2020 System per-patient-tested rental program of $118,148,
compared to $89,896 for the three months ended September 30, 2003. The per
test fee is recognized as Revenue when we determine that collectibility is
probable, which currently is upon cash receipt. For the three months ended September 30, 2004, Service/Contract Income was
$99,423, compared to $85,257 for the three months ended September 30, 2003.
$95,000 of the $99,423 amount and $67,840 of the $85,257 amount represent
contract income pertaining to our agreement with a pharmaceutical company to
attend certain hypertension and cardiology meetings in both the U.S. and
internationally. Under this agreement, we provide our CardioVascular Profiling
Systems and certain employees who test visitors to the pharmaceutical companys
exhibition booth. Total selling, general and administrative expenses for the three months
ended September 30, 2004 were $647,642, compared to $615,474 for the three
months ended September 30, 2003. The following is a summary of the major
categories included in selling, general and administrative expenses: 12




---



##### Table of Contents



Three Months EndedSeptember 302004
    
    2003Wages, related expenses and benefits
    
    $
    121,233
    
    
    $
    136,746Patents and related expenses
    
    
    
    
    
    
    8,291Outside
consultants
    
    
    123,885
    
    
    
    21,746Rent (building/equipment) and
utilities
    
    
    23,651
    
    
    
    24,554Insurance-general and directors/officers liability
    
    
    20,203
    
    
    
    16,654Selling, marketing and promotion, including applicable wages
    
    
    170,011
    
    
    
    193,486Legal and audit/accounting fees
    
    
    124,171
    
    
    
    106,246Royalties
    
    
    4,620
    
    
    
    4,909Depreciation and amortization
    
    
    16,039
    
    
    
    31,538Other-general and administrative
    
    
    43,829
    
    
    
    71,304Total selling, general and administrative expenses
    
    $
    647,642
    
    
    $
    615,474
 Wages, related expenses and benefits decreased from $136,746 to $121,233
for the three months ended September 30, 2003 and September 30, 2004,
respectively. Our number of employees decreased from thirteen as of September
30, 2003 to seven as of September 30, 2004. Outside consultants expense increased from $21,746 for the three months
ended September 30, 2003 to $123,885 for the three months ended September 30,
2004. This increase is principally due to our need for specific consulting
services relating to our business as well as the situation of our employee
workforce reduction from thirteen employees at September 30, 2003 to seven
employees at September 30, 2004. We plan to increase our employee workforce by
2 to 4 persons during the fiscal year ended June 30, 2005. Selling, marketing and promotion expense decreased from $193,486 for the
three months ended September 30, 2003 to $170,011 for the three months ended
September 30, 2004. This category includes wages and commissions paid by us
relating to our sales and marketing efforts, as well as travel and convention
expenses. Our planned conversion from capital sales of our HDI/PulseWave
CR-2000 Research System to our per-patient-tested rental revenue model
associated with our FDA cleared CVProfilor® DO-2020 System had no material
effect on our total expenses in this category, as our sales force has merely
redirected its efforts to placements of our rental units in physicians
offices. The decrease in our number of employees accounted for most of this
decrease in expenses. Legal and audit/accounting fees increased from $106,246 to $124,171 for
the three months ended September 30, 2003 and 2004, respectively. This
increase was due primarily to additional expenses incurred in connection with
the filing of registration statements and other reports and communications with
the U.S. Securities and Exchange Commission. Interest income was $6,944 and $6,069 for the three months ended September
30, 2004 and 2003, respectively. Interest expense was $-0- and $50,185 for the three months ended September
30, 2004 and 2003, respectively. A further breakdown of the components of
interest expense is as follows: 13




---



##### Table of Contents



Three Months EndedSeptember 302004
    
    2003Convertible Notes Payable:8% interest on outstanding principal balances
    
    $
    
    
    
    $
    1,205Fair value basis allocation to the five-year warrants to purchase
250,000 shares of Common Stock ($315,789), being amortized
on a straight-line basis over the three (3) year term of the debt
agreement and as the debt is converted
    
    
    
    
    
    
    48,531Other  miscellaneous
    
    
    
    
    
    
    449Total Interest Expense
    
    $
    
    
    
    $
    50,185
 Net loss was $(434,479) for the three months ended September 30, 2004,
compared to a net loss of $(457,185) for the three months ended September 30,
2003. For the three months ended September 30, 2004, basic and diluted net
loss per share was $(.02), based on weighted average shares outstanding of
27,001,928. For the three months ended September 30, 2003, basic and diluted
net loss per share was $(.03), based on weighted average shares outstanding of
14,876,805. Liquidity and Capital Resources Cash and cash equivalents had a net decrease of $(203,697) and a net
increase of $1,668,074 for the three months ended September 30, 2004 and
September 30, 2003, respectively. The significant elements of these changes
were as follows: Three Months Ended September 30Net cash used in operating activities:
    
    2004
    
    2003- net loss, as adjusted for non-cash items
    
    $
    (382,139
    )
    
    $
    (343,394
    )- (increase) decrease in inventory:
    
    (A)
    (144,394
    )
    
    
    170,202- (A)      In September 2004, we purchased
certain inventory parts from a single
vendor in the amount of $161,192.- increase in accounts payable:
    
    
    62,604
    
    
    (B)
    170,202- (B)      This increase mainly relates to legal
and audit fees re: the following
events/transactions that occurred in
August 2003 and September 2003:
completion of private placement
offering of securities; preparation
and filing of Form 10-KSB annual
report for fiscal year ended June 30,
2003; preparation of informational
 14




---



##### Table of Contents



Three Months Ended September 30Net cash used in operating activities:
    
    2004
    
    2003statement for annual meeting of
shareholders; and preparation and
filing of amended Form 10-KSB
annual report for fiscal year ended
June 30, 2002- increase (decrease) in deferred revenue:
    
    
    4,375
        
    (C)

    (82,256
    )- (C)      Approximately 80% of this decrease pertains to
deferred revenue recognized relating to our services
contract agreement with a pharmaceutical company.Net cash provided by financing activities:- issuance of Preferred and Common Stock:
    
    
    191,794
    
    
    (D)
    1,873,483- (D)      On August 28, 2003, we completed the
private placement offering (the Unit Placement)
of 585,980 units (the Units) to a group of
investors led by Mark N. Schwartz, who is our
Chief Executive Officer. Gross proceeds from
this offering were approximately $2,300,000 and
net proceeds were $1,873,483. The 585,980 Units
are comprised of 585,980 shares of Series A
Convertible Preferred Stock, 9,318,866 shares of
common stock, and a series of six (6) purchase
warrants.
 We have incurred operating losses and have not generated positive cash flow
from operations. As of September 30, 2004, we had an accumulated deficit of
$(23,684,828). As of September 30, 2004, we had cash and cash equivalents of $1,174,596
and anticipate that these funds, in conjunction with revenue anticipated to be
earned from placements of our CVProfilor® DO-2020 Systems, anticipated sales of
our CR-2000 Research Systems, as well as anticipated operating cost reductions,
will allow us to pursue our business development strategy for at least the next
twelve months following September 30, 2004. Our current marketing strategy focuses on marketing the CVProfilor® DO-2020
System to physicians who treat patients with diabetes and hypertension. We
believe these physicians have the greatest interest in, and use for, our
product. Therefore, the most critical factor in our ability to increase rental
revenue rests in our ability to expand our marketing and distribution network
to increase placements and utilization of our CVProfilor® DO-2020 System. We
believe there are three ways we could expand our marketing and distribution
network: 1) the development of an internal sales force; 2) a strategic
partnership with a firm that possesses a distribution network calling on these
same physicians; or 3) a combination of the internal sales force and external
distribution network methods. We believe this dual method of expansion offers
us the greatest opportunity for success. We are pursuing discussions with 15




---



##### Table of Contents



firms that have an interest in representing our CVProfilor® DO-2020 System
nationwide. In the short term, we have also focused on international sales of
our CR-2000 Research System and CVProfilor® MD-3000 System as a means of
generating cash to support operational expenses. Within the next twelve
months, we also do not anticipate devoting any funds to research and
development activities. In late December 2002, we implemented a plan to conserve cash through
reductions in selling, general and administrative expenses to improve working
capital management. This expense reduction plan included the reduction in the
number of our employees, and transitioning some employees to part-time
employment status . While these measures reduced the rate at which we used our
available cash, they have compromised, and will continue to compromise, our
ability to pursue and generate placements of our CVProfilor® DO-2020 Systems
and sales of our CR-2000 Research Systems. Until we increase our sales and
marketing staff and other programs, we do not expect to generate significant
levels of revenue. Further, the existence, timing and extent of reimbursement of physicians
for the use of our CVProfilor® DO-2020 affects the availability of our working
capital. Reimbursement will always vary considerably by the patients medical
necessity, by physician, by provider, by geography and by provider coverage
plans, making the process of obtaining reimbursement for the CVProfilor®
DO-2020 by current physician customers an important component of our products
success. To the extent that reimbursement is unavailable or inadequate,
physicians will be less likely to use the CVProfilor® DO-2020. In addition, because our CVProfilor® DO-2020 is being marketed on a
per-patient-tested basis, we have a delay in the cost recovery of our working
assets. Although our per-patient-tested marketing approach reduces the risk
and thereby increases the potential rate of acceptance for physician customers
willing to use the CVProfilor® DO-2020 as compared to a capital acquisition
approach, it also delays our cash flow recovery of product costs. Physician payments for use of the
CVProfilor® DO-2020 follow actual utilization by some 60-90 days; utilization
in one month is invoiced in the following month and payment is generally
received within 30 to 60 days of invoicing. This delay in payment, therefore,
requires six to twelve months to fully recover product costs. These cash flow
delays mean that we will generate little, if any, cash during the initial
placement of the product and will require cash from other sources to support
our operations during this period. No assurance can be given that additional working capital will be obtained
in a timely manner or on terms and conditions acceptable to us or our
shareholders. Our financing needs are based upon management estimates as to
future revenue and expense. Our business plan and our financing needs are also
subject to change based upon, among other factors, market conditions, and our
ability to materially increase the revenue generated by our CVProfilor® DO-2020
System and other cash flow from operations. Our efforts to raise additional
funds may be hampered by the fact that our securities are quoted on the OTC
Bulletin Board, are illiquid and are subject to the rules relating to penny
stocks. We have historically obtained working capital from the issuance of our
securities. In July 1998, we completed our initial public offering of
2,587,500 units, each unit consisting of one share of our common stock and one
Redeemable Class A Warrant (the Class A Warrant) which resulted in total net
proceeds to us of $9,188,414. Beginning on January 23, 2001 and ending on
March 26, 2001, we offered our Redeemable Class B Warrants (the Class B
Warrants) for no additional consideration to those holders of our Class A
Warrants who properly exercised a Class A Warrant in the offering period. We
raised $1,964,371 (net of offering expenses of $73,062) in connection with this
offering of the Class B Warrants. On March 27, 2002, we completed a private
placement to five investors consisting of three-year 8% Convertible Notes in
the aggregate principal amount of $2,000,000. Beginning on June 6, 2002 and
ending on November 14, 2002, we offered Class B Warrants for no additional
consideration to those holders of the Class A Warrants who properly exercised a
Class A Warrant in the offering period. Total gross proceeds from this
offering were $57,400. On August 28, 2003, we completed the private placement
offering (the August Placement) of 585,980 units to a group of investors led
by Mark N. 16




---



##### Table of Contents



Schwartz, our Chief Executive Officer. Gross proceeds from this
offering were $2,289,001 and net proceeds were $1,873,383. On February 9,
2004, we completed an additional private placement offering (the February
Placement) of 118,113 units to a group of investors. Gross proceeds from this
offering were $461,370 and net proceeds were $413,121. In June 2004, we issued
1,580,623 shares of common stock and 99,391 shares of Series A Preferred Stock,
to holders of warrants to purchase common stock and Series A Preferred Stock,
resulting in gross proceeds of $471,464. In July 2004, we issued 643,007
shares of common stock and 40,433 shares of Series A Preferred Stock, to
holders of warrants to purchase common stock and Series A Preferred Stock,
resulting in gross proceeds of $191,794. 
 Item 4. Controls and Procedures. (a) Evaluation of Disclosure Controls and Procedures. The Companys Chief Executive Officer, Mark N. Schwartz, and Chief
Financial Officer, James S. Murphy, have evaluated the Companys disclosure
controls and procedures as of the end of the period covered by this report.
Based upon that review, they have concluded that these controls and procedures
are effective in ensuring that material information related to the Company is
made known to them by others within the Company. (b) Changes in Internal Controls over Financial Reporting. There have been no significant changes in internal control financial
reporting that occurred during the fiscal period covered by this report that
have materially affected, or are reasonably likely to materially affect, the
registrants internal control over financial reporting. 17




---



##### Table of Contents



PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings On March 17, 2004, we received a letter from counsel of one of our employees
alleging our illegal and unethical reimbursement practices and also alleging
violation of applicable whistleblower statutes. On March 18, 2004, we
received a letter from counsel of one of our former employees alleging our
failure to pay for accrued vacation time and also alleging violation of
applicable whistleblower statutes. On August 25, 2004, we entered into a
binding memorandum of understanding agreeing to settle such
employees disputes.
As settlement in full of these employees claims, we agreed to make cash payments and
issue shares of freely tradeable shares of our common stock to these parties in
an aggregate cash amount of $130,000 and shares in an aggregate amount equal to
a fair market value of $100,000. We intend to enter into long form agreements
setting forth the details of such agreement in the near future. The
Company has retained a reimbursement consultant to investigate the
whistleblower claims, and such consultant has indicated its belief
that such claims lack merit. Except as set forth above, we are not aware of any material pending or
threatened legal proceedings, which involve us. 
 Item 2. Changes in Securities In June 2004, the Company issued 1,580,623 shares of common stock and 99,391
shares of Series A Preferred Stock to holders of warrants to purchase common
stock and Series A Preferred Stock, resulting in gross proceeds to the Company
of $471,463. In addition, in July 2004, the Company issued 643,007 shares of
common stock and 40,433 shares of Series A Preferred Stock to holders of
warrants to purchase common stock and Series A Preferred Stock, resulting in
gross proceeds to the Company of $191,794 (previously disclosed in the
Companys Form 10-KSB, filed on September 29, 2004). The exercise price was
$.17 per share of common stock and $2.04 per share of Series A Preferred Stock.
These warrants relate to the nine-month stock purchase warrants issued in the
August 28, 2003 private placement offering. The Company has granted certain
registration rights covering all of the common stock and Series A Preferred
Stock sold in the offering to investors. In May 2004, the Company extended the
expiration date of these warrants to July 15, 2004. For those warrant holders
who exercised at least fifty percent (50%) of the number of shares underlying
these warrants by July 15, 2004, the Company further extended the expiration
date of their remaining warrants to November 9, 2004. In November 2004, the Company extended the exercise date of those warrants,
previously extended to November 9, 2004, to March 15, 2005. In addition, for
those warrant holders who exercised at least fifty percent (50%) of the number
of shares underlying those nine-month stock purchase warrants issued in the
February 9, 2004 private placement offering by March 15, 2005, the Company
further extended the expiration date of their remaining warrants to July 31,
2005. 
 Item 6. Exhibits and Reports on Form 8-K (a) The following Exhibits are furnished pursuant to Item 601 of Regulation
S-B: 31.1
    
    
    Certification of Chief Executive Officer pursuant to
13a-14 and 15d-14 of the Exchange Act31.2
    
    
    Certification of Chief Financial Officer pursuant to
 18




---



##### Table of Contents



13a-14 and 15d-14 of the Exchange Act32
    
    
    Certificate pursuant to 18 U.S.C. § 1350
 (b) Reports on Form 8-K. The Company filed the following Current Reports on Form 8-K during the
quarter covered by this Form 10-QSB: A Current Report dated August 18, 2004 in which we disclosed that certain
of our warrant holders
from our August Placement exercised their warrants to receive the benefits
of the extended exercise
period and the lowered warrant exercise prices for our Common Stock and
Series A Preferred Stock. 19




---



##### Table of Contents



SIGNATURES In accordance with the requirements of the Exchange Act, the Registrant
has caused this Form 10-QSB to be signed on its behalf by the undersigned,
thereunto duly authorized. HYPERTENSION DIAGNOSTICS, INC.By /s/ James S. MurphyJames S. Murphy
Senior Vice President, Finance and
Administration and Chief Financial Officer
(principal financial officer)
 Date: November 12, 2004 20