EP Medsystems (EPMD) 10-Q 2007 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the period ended: March 31, 2007

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission File Number: 0-28260

EP MEDSYSTEMS, INC.

(Exact name of registrant as specified in its charter)

New Jersey	22-3212190
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

575 Route 73 N. Building D, West Berlin, New Jersey	08091
(Address of principal executive offices)	(Zip Code)

(856) 753-8533

(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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.    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:

Class	Outstanding at May 7, 2007
Common Stock, without par value	30,365,236 shares

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

FORM 10-Q

CONTENTS

		Page
PART I — FINANCIAL INFORMATION
Item 1.
	Financial Statements
	Consolidated Balance Sheets at March 31, 2007 (unaudited) and December 31, 2006	3
	Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006 (unaudited)	4
	Consolidated Statement of Changes in Shareholders’ Equity for the three months ended March 31, 2007 (unaudited)	5
	Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006 (unaudited)	6
	Notes to Consolidated Financial Statements (unaudited)	7
Item 2.
	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.
	Quantitative and Qualitative Disclosures About Market Risk	18
Item 4.
	Controls and Procedures	18
PART II — OTHER INFORMATION
Item 1.
	Legal Proceedings	19
Item 2.
	Unregistered Sales of Equity Securities and Use of Proceeds	19
Item 3.
	Defaults Upon Senior Securities	19
Item 4.
	Submission of Matters to a Vote of Security Holders	19
Item 5.
	Other Information	19
Item 6.
	Exhibits	19
Signatures		20
Exhibit Index		21

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	March 31, 2007			December 31, 2006
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	7,709,289		$	7,743,239
Accounts receivable, net of allowances for doubtful accounts of $217,000 and $308,000 as of March 31, 2007 and December 31, 2006, respectively		3,407,348			4,808,225
Inventories, net of reserves		3,036,646			2,859,677
Prepaid expenses and other current assets		406,268			419,411
Total current assets		14,559,551			15,830,552
Property, plant and equipment, net		1,829,105			1,937,131
Goodwill		341,730			341,730
Other intangible assets, net		180,244			187,081
Other assets		16,258			14,851
Total assets	$	16,926,888		$	18,311,345
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Secured convertible note, current		1,992,038			—
Accounts payable		1,548,403			1,531,799
Accrued expenses		1,481,066			1,722,944
Deferred revenue		628,020			542,351
Total current liabilities		5,649,527			3,797,094
Deferred warranty revenue, non-current		379,099			335,658
Secured convertible note, non-current		—			1,989,760
Total liabilities	$	6,028,626		$	6,122,512
Commitments and contingencies		—			—
Shareholders’ equity:
Preferred stock, no par value, 5,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $.001 stated value, 40,000,000 shares authorized 30,365,236 shares issued at March 31, 2007 and December 31, 2006, respectively		30,366			30,366
Additional paid-in capital		67,637,771			67,423,769
Accumulated other comprehensive loss		(348,392	)		(352,628	)
Treasury stock, 50,000 shares at cost		(100,000	)		(100,000	)
Accumulated deficit		(56,321,483	)		(54,812,674	)
Total shareholders’ equity		10,898,262			12,188,833
Total liabilities and shareholders’ equity	$	16,926,888		$	18,311,345

The accompanying notes are an integral part of these statements.

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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	��	For the Three Months Ended
		March 31, 2007			March 31, 2006
Net sales		$	3,544,245		$	4,078,111
Cost of products sold			1,156,762			1,588,236
Gross profit			2,387,483			2,489,875
Operating costs and expenses:
Sales and marketing expenses			2,310,059			2,402,312
General and administrative expenses			946,082			863,235
Research and development expenses			665,449			698,093
Total operating expenses			3,921,590			3,963,640
Loss from operations			(1,534,107	)		(1,473,765	)
Interest and other income			89,791			40,274
Interest expense			(64,493	)		(60,706	)
Net loss		$	(1,508,809	)	$	(1,494,197	)
Basic and diluted loss per share		$	(.05	)	$	(.06	)
Weighted average shares outstanding used to compute basic and diluted loss per share			30,365,236			26,165,556

The accompanying notes are an integral part of these statements.

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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2007

	Common Stock Shares	Common Stock Amount		Preferred Stock Shares	Preferred Stock Amount	Additional Paid-in Capital		Accumulated Other Comprehensive Loss			Treasury Stock			Accumulated Deficit			Total
Balance, December 31, 2006	30,365,236	$	30,366	—	—	$	67,423,769	$	(352,628	)	$	(100,000	)	$	(54,812,674	)	$	12,188,833
Share-based compensation	—		—	—	—		214,002		—			—			—			214,002
Foreign currency translation	—		—	—	—		—		4,236			—			—			4,236
Net loss	—		—	—	—		—		—			—			(1,508,809	)		(1,508,809	)
Balance, March 31, 2007	30,365,236	$	30,366	—	—	$	67,637,771	$	(348,392	)	$	(100,000	)	$	(56,321,483	)	$	10,898,262

The accompanying notes are an integral part of this statement.

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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	For the Three Months Ended
	March 31, 2007			March 31, 2006
Cash flows from operating activities:
Net loss	$	(1,508,809	)	$	(1,494,197	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		238,223			264,667
Accretion of note discount		2,278			2,450
Amortization of beneficial conversion feature		4,767			5,132
Noncash expenses in connection with issuance of options to consultant		—			196,480
Share-based compensation		214,002			192,021
Bad debt (recovery) expense		(91,000	)		27,000
Changes in assets and liabilities:
Decrease (increase) in accounts receivable		1,491,877			(792,170	)
Increase in inventories		(214,318	)		(48,696	)
Decrease (increase) in prepaid expenses and other assets		6,969			(47,674	)
Increase (decrease) in accounts payable		16,604			(538,806	)
Decrease in accrued expenses and deferred revenue		(112,736	)		(15,670	)
Net cash provided by (used in) operating activities	$	47,857		$	(2,249,463	)
Cash flows from investing activities:
Capital expenditures		(60,605	)		(23,839	)
Patent costs		(25,438	)		—
Net cash used in investing activities	$	(86,043	)	$	(23,839	)
Cash flows from financing activities:
Net proceeds from issuance of common stock, net of offering expenses		—			9,479,149
Net cash provided by financing activities	$	—		$	9,479,149
Effect of exchange rate changes		4,236			(10,410	)
Net (decrease) increase in cash and cash equivalents		(33,950	)		7,195,437
Cash and cash equivalents, beginning of period		7,743,239			5,180,001
Cash and cash equivalents, end of period	$	7,709,289		$	12,375,438
Supplemental cash flow information
Cash paid for interest	$	49,950		$	44,972

The accompanying notes are an integral part of these statements.

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EP MEDSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Note 1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the financial information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (including normal recurring adjustments) considered necessary for a fair presentation have been included.

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

The results of operations for the respective interim periods are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in EP MedSystems, Inc.’s (the “Company” or “EP MedSystems’”) Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission (“SEC” or “Commission”).

The Company believes that its existing cash will enable the Company to meet its liquidity needs through at least December 31, 2007. We will continue to rely on outside sources of financing to meet our long-term capital needs. Further, there can be no assurance, assuming we successfully raise additional funds, that we will achieve positive cash flow. If we are not able to secure additional funding, we will be required to scale back our sales and marketing efforts, research and development programs, preclinical studies and clinical trials, and general and administrative activities.

Note 2. Inventories

Inventories are valued at the lower of cost or market with cost being determined on a first-in, first-out basis. Inventories consist of the following at March 31, 2007 and December 31, 2006:

	March 31, 2007 (unaudited)			December 31, 2006
Raw materials	$	1,479,597		$	1,487,745
Work in process		218,254			165,903
Finished goods		1,642,795			1,492,029
Reserve for obsolescence		(304,000	)		(286,000	)
	$	3,036,646		$	2,859,677

Note 3. Notes payable

On August 28, 2003, the Company issued a Secured Convertible Note (the “Convertible Note”) to Laurus Master Fund, Ltd. (“Laurus”) and entered into a related Security Agreement with Laurus, pursuant to which Laurus provided the Company with a $4,000,000 revolving asset-based credit facility in the form of a three-year Convertible Note secured by the accounts receivable, inventory, real property and other assets of the Company, other than intellectual property.

At the closing of the transaction, the Company issued the Convertible Note to Laurus having a principal amount of $4,000,000 and received net proceeds of $2,661,600. An additional $1,000,000 of the Convertible Note was previously restricted and those restrictions were released during the third quarter of 2004. The balance of the proceeds was used to pay fees incurred in connection with this transaction. Deferred financing fees are being amortized over the life of the Convertible Note using the effective interest method. In addition, the Company paid a portion of the fees payable to an intermediary, Biscayne Capital Markets, Inc. (“Biscayne”), in 40,000 shares of the Company’s Common Stock having a market value on the date of closing of this transaction equal to $100,000. The net proceeds of the Convertible Note was used by the Company for working capital purposes and payment of outstanding debt.

The portion of the Convertible Note against which Laurus advances funds based on the Company’s accounts receivable bears interest at the prime rate, with a floor of 4%, and the balance (the “Advance Amounts”) bears interest at the prime rate plus 2%, effective interest rate of 14% for the year ended December 31, 2006, including accretion of debt discount and

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amortization of the beneficial conversion feature. One half of Advance Amounts outstanding on February 28, 2005 was required to be repaid on or before that date. However, there were no Advance Amounts on that date, as the net collateral exceeded the principal amount outstanding on the Convertible Note. The remaining balance of the Advance Amounts outstanding on the date of the closing was required to be repaid on or before August 28, 2006. On November 9, 2005, the Convertible Note’s maturity date was extended to February 28, 2008. The Company evaluated the impact of the change in the maturity date on the present value of the cash flows of the Convertible Note in conjunction with EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments.” This EITF provides guidance when a modification of a debt instrument should be considered an extinguishment. The change in the present value of the modification did not meet the criteria to be treated as an extinguishment. The Company, subject to certain rights of cancellation, may extend the credit facility by Laurus, on a year-by-year basis, commencing February 28, 2008. The Company may repay in cash, without penalty, up to $500,000 of the Convertible Note in any one calendar year, plus all Advance Amounts.

Subject to certain volume limitations and other conditions, all or a portion of the Convertible Note was convertible into the Common Stock of the Company at the Company’s option if the market price of the Company’s Common Stock reached a level, for 11 consecutive trading days, which is above 120% of $2.55 (the “Fixed Conversion Price”), which through December 14, 2004 was $2.55 and which was a price in excess of the market price of the Company’s Common Stock on the date of closing. Subject to certain volume limitations and other conditions, Laurus has the option to convert all or a portion of the Convertible Note into shares of the Company’s Common Stock at the Fixed Conversion Price.

Following the conversion into the Company’s Common Stock by the Company and/or Laurus of an aggregate of $2,000,000 of the principal amount of the Convertible Note (a “Conversion Event”), the Fixed Conversion Price will be adjusted upward to a price which is 115% of the average of the closing price of the Company’s Common Stock for the three trading days prior to the Conversion Event. On December 15, 2004, the balance of the first $2,000,000 of the principal amount was converted into shares of the Company’s common stock. The fixed conversion price was adjusted upwards from $2.55 to $4.20, on the remaining $2,000,000 principal balance. Subject to certain limitations, including the repayment obligations with respect to Advance Amounts described above, the dollar amounts of the Convertible Note converted may be re-borrowed. In connection with the private placement consummated in March of 2006, certain anti-dilution provisions of the Laurus Convertible Note resulted in a reduction of the conversion price of that note from $4.20 to $3.96.

The Fixed Conversion Price is subject to adjustment, with customary exceptions and on a weighted-average basis, in connection with sales of the Company’s securities below the Fixed Conversion Price then in effect, and is also subject to adjustment for stock splits, combinations, stock dividends and similar events. As part of the credit facility transaction, Laurus and the intermediary also received warrants to purchase an aggregate of 240,750 shares of the Company’s Common Stock (the “Warrants”), with exercise prices set as follows: $2.93 per share for the purchase of up to the first 133,750 shares, $3.19 per share for the purchase of up to the next 80,250 shares, and $3.70 per share for the purchase of up to the final 26,750 shares. The expiration date of the warrant is August 28, 2010. The exercise price of the warrants and the number of shares underlying the warrants are subject to adjustments for stock splits, combinations, stock dividends and similar events.

In October 2003, the Company registered, under the Securities Act of 1933, as amended, 1,500,000 shares of its Common Stock which may be received by Laurus upon conversion of the Convertible Note and exercise of the Warrant and the remaining 293,628 of such shares were registered in November of 2004.

In accordance with the provisions of Emerging Issues Task Force (EITF) Issue 00-27, “Application of EITF Issue No. 98-5 ‘Accounting for Convertible Securities with Beneficial Conversion Features of Contingently Adjustable Conversion Ratios’, to Certain Convertible Securities”, the allocated value of the Convertible Note contained a beneficial conversion feature calculated based on the difference between the effective conversion price of the proceeds allocated to the Convertible Notes and the Warrants at the date of issuance. The amount arising from the beneficial conversion feature aggregated approximately $486,000 and is being amortized as interest expense from the date of the issuance of the Convertible Note to the mandatory redemption date of February 28, 2008. The Company valued the Convertible Note and the Warrants at issuance. The fair value of the Warrants at the time of issue was $407,500. In accordance with EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” the Company marked the Warrants to market at September 30, 2003 incurring a non-cash charge of $264,000. The registration rights agreement associated with the Convertible Note was amended on November 25, 2003 and, as a result, the amount associated with the Warrants was transferred to equity. The Company marked the Warrants to market at the date of the amendment which reduced the overall expense to $210,750 for the year ended December 31, 2003. The net carrying value of the Convertible Note, after allocation of the fair value of the Warrants is being accreted to interest expense over the term of the Convertible Note using the effective interest method.

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Note 4. Shareholders’ Equity

Preferred Stock

EP MedSystems is authorized to issue 5,000,000 shares of undesignated preferred stock, no par value per share. The Board of Directors has the authority to issue preferred stock in one or more classes, to fix the number of shares constituting a class and the stated value thereof, and to fix the terms of any such class, including dividend rights, dividend rates, conversion or exchange rights, voting rights, rights and terms of redemption, the redemption price and the liquidation preference of such shares or class.

Common Stock

EP MedSystems is authorized to issue 40,000,000 shares of common stock, no par value, $.001 stated value per share, of which a total of 30,365,236 shares were issued and 50,000 shares were held in Treasury Stock at March 31, 2007 and December 31, 2006.

During 2005, three separate options to purchase shares of the Company’s common stock were issued to a physician consultant, engaged as the Company’s senior medical advisor, in the amounts of 40,000, 40,000 and 100,000 shares of common stock respectively, on which the exercise price of the options was equal to the fair market value of the Company’s common stock on the date of the grant. With respect to the two 40,000 option issuances, they vest in equal installments over three years and the Company expensed $171,000 representing the fair value of the options measured using the Black-Scholes option pricing model for each grant as follows: risk free rate of 3.77% and 4.33%; 10 year life, and volatility percentage of 77.98% and 81.1%. The issuance of an option in the amount of 100,000 shares of the Company’s common stock did not meet the criteria for expensing in 2005. In the first quarter of 2006, the consultant’s performance obligation in connection with these options was fulfilled and the Company recorded an expense of $196,480, valued using the Black-Scholes option pricing model for each grant as follows: risk free rate of 4.82%, 10 year life, and volatility percentage of 84.23%.

On March 27, 2006, the Company completed a $10,000,000 private placement of its common stock to a number of accredited investors. The Company issued 3.78 million shares of its common stock at a purchase price of $2.25 per share. In addition, FatBoy Capital, LP purchased approximately 617,000 shares of common stock at a price of $2.43 per share in accordance with NASDAQ marketplace rules. David Jenkins, the Company’s Chairman is a managing member of FatBoy Capital’s general partner. In connection with this transaction, certain anti-dilution provisions of the Laurus Convertible Note resulted in a reduction of the conversion price of that note from $4.20 to $3.96.

Note 5. Stock Based Compensation

Effective January 1, 2006, the Company adopted FASB Statement No. 123R, “Shared-Based Payment”. Statement 123R requires that the compensation cost relating to share-based payment transaction be recognized in financial statements. That cost is measured based on the fair value of the equity or liability instruments issued.

The Company currently has five stock-based employee compensation plans. Share-based compensation of $214,000 and $192,000 net of a fully reserved tax benefit or $0.01 per share, was recognized for the three months ended March 31, 2007 and 2006, respectively. The Company anticipates that share-based compensation for its employees will not exceed $1,000,000, net of tax benefits for the year ended December 31, 2007. The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions used for grants in 2007: expected volatility of 82%; risk-free interest rate of 4.58% and an expected life of 7.5 to 10 years.

EP MedSystems records the fair value of stock issuances to non-employees based on the market price on the date issued. The amount is expensed, capitalized or recorded as a reduction of paid-in capital, depending on the purpose for which the stock is issued. It is EP MedSystems’ policy to account for stock options granted to non-employees in accordance with Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” and the fair value is measured using the Black-Scholes option pricing model under SFAS No. 123.

Note 6. Industry Segment and Geographic Information

EP MedSystems manages its business based on one reportable segment, the manufacture and sale of cardiac electrophysiology products. EP MedSystems’ chief operating decision-makers use consolidated results to make operating and strategic decisions.

The following table sets forth product sales by geographic segment for the three months ended March 31, 2007 and 2006.

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	For The Three Months Ended March 31,
	2007		2006
United States	$	2,478,000	$	2,665,000
Europe/Middle East		764,000		362,000
Asia and Pacific Rim		302,000		1,051,000
	$	3,544,000	$	4,078,000

Sales of EP MedSystems’ cardiac electrophysiology equipment and related catheters aggregated approximately $3,158,000 and $386,000 respectively, for the three months ended March 31, 2007, and $3,705,000 and $373,000, respectively, for the comparable period in 2006. EP MedSystems’ long-lived assets are primarily located in the U.S.

Net sales for the three months ended March 31, 2007 were billed in two currencies: $3,298,000 in U.S. dollars and the equivalent of $246,000 in Euros. Management has determined the impact of foreign currency risk on sales to be minimal since a majority of sales are billed in U.S. dollars. EP MedSystems does incur translation gains and losses, which are recorded in shareholders’ equity. Cumulative translation losses amounted to approximately $348,000 as of March 31, 2007. In addition, EP MedSystems had not entered into any derivative financial instruments for hedging or other purposes.

Note 7. Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of shares of common stock outstanding. Due to the losses incurred for the quarter, diluted net loss per share does not differ from basic net loss per share for each period presented, since potential shares of common stock issuable upon the exercise of stock options, warrants, and convertible debt are anti-dilutive for all periods presented. Accordingly, approximate potential common shares of 4,361,000 and 3,247,000 for the three months ended March 31, 2007 and 2006, respectively, have been excluded from the diluted per share calculation.

Note 8. Comprehensive Income/Loss

For the three months ended March 31, 2007 and 2006, EP MedSystems’ comprehensive loss consisted of net loss and foreign currency translation adjustments. The comprehensive losses for the three months ended March 31, 2007 and 2006, were approximately $1,505,000.

Note 9. Recently Issued Accounting Standards

The FASB released SFAS No. 157, “Fair Value Measurements,” to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements. SFAS No. 157 will be effective for fiscal years and interim periods beginning after November 17, 2007. The company is assessing the impact the adoption of SFAS No. 157 will have on its consolidated financial position and results of operations.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, “Considering the Effect of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB108). SAB108 addresses inconsistencies in the way companies evaluate and quantify the impact of financial statement misstatements. Historically, companies have evaluated financial statement misstatements using one of two different methods, based on either the effect of the misstatement on the income statement or the balance sheet. SAB108 requires companies to utilize a “dual-approach” to assessing the quantitative effect of financial statement misstatements. This method requires quantification of misstatements based on the effect on both of the company’s financial statements and the related financial statement disclosures. This guidance must be applied to annual financial statements for fiscal years ending after November 15, 2006. The Company adopted SAB108 as of December 31, 2006. The application of SAB108 did not have a material impact on the Company’s financial position or results of operations.

On February 15, 2007, the FASB issued SFAS Statement No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities,” (SFAS159). The Fair value option established by SFAS 159 permits, but does not require, all entities to choose to measure eligible items at fair value at specified election dates. An entity would report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective as of the beginning of an entity’s fiscal year that begins after November 15, 2007. The Company is currently assessing what the impact of the adoption of this SFAS would be on the Company’s financial position and/or results of operations.

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Note 10. Commitments and Contingencies

Export Compliance

During the second quarter of 2005, the Company announced it was under investigation by the United States Department of Commerce, the United States Attorney’s Office for the District of New Jersey and the United States Department of the Treasury in connection with the sale of certain of its products to Iran. In addition, the Company announced the SEC was conducting a confidential, informal inquiry into the Company’s financial and accounting reporting regarding there investigations.

In March of 2006, the Company announced the U.S. Attorney’s office informed the Company that it would not prosecute the Company in connection with this matter. In the third quarter of 2006, we announced a settlement agreement with the Department of Commerce for $244,000 in which the Company did not admit or deny guilt. The Company also announced that it had made an offer to settle with the Department of the Treasury. In the first quarter of 2007, the Company announced it had signed a settlement agreement with the Department of the Treasury without admitting or denying guilt for a payment of $33,000, which had been accrued in 2006.

The Company cannot assure that the ongoing informal inquiry by the SEC will not result in other significant costs, fines or penalties that could, in the aggregate, have a material adverse effect on our business, financial condition, prospects or results of operations. The Company has made no provision for any future costs associated with these investigations or any costs associated with the Company’s defense or negotiations with the SEC entities to resolve this final outstanding issue.

Field Action Recall

In the first quarter of 2006, the Company initiated a field action recall of its stimulator product which was substantially completed in the first quarter of 2007. On April 24, 2007, the Company was informed that the FDA had audited the recall and considered it terminated for the domestic units. The Company had accrued $50,000 in the three months ended March 31, 2006 for costs associated with the recall. In connection with the recall, the FDA performed an audit of the subject facility and issued the Company a report containing several observations and the Company responded to this report. As a result of this audit, the FDA sent a Warning Letter to the Company that identified certain issues with respect to the Company’s conformity with the FDA’s quality system regulations and certain reporting requirements. The FDA has requested a written plan outlining the steps to address the issues identified in the letter. The Company has already undertaken steps toward addressing the observations from the FDA’s audit of the Company’s facility and has responded to the FDA’s request for a written plan. Failure to promptly address these issues may result in regulatory action including but not limited to seizure, injunction and/or civil monetary penalties. The Company believes it can fully address the concerns of the FDA without a material impact to its business.

Income Taxes

EP MedSystems, Inc. and its subsidiaries are subject to U.S. federal income tax, foreign tax liabilities as well as income tax of multiple state jurisdictions. The Company has substantial federal and New Jersey state net operating losses. There are no tax years by any jurisdiction under examination at this time.

On January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation requires that the Corporation recognize the impact of a tax position in the financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. In accordance with the provisions of FIN 48, any cumulative effect resulting from the change in accounting principle is to be recorded as an adjustment to the opening balance of deficit. The adoption of FIN 48 did not result in a material impact on the Company’s financial position or results of operations.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We were incorporated in January 1993 and operate in a single industry segment. We develop, manufacture, market and sell a line of products for the cardiac rhythm management, or electrophysiology (EP), market used to diagnose, monitor, visualize and treat irregular heartbeats known as arrhythmias. Since our inception, we have acquired technology and marketing rights, have developed new products and have begun marketing various electrophysiology products, including our

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EP-WorkMate^® computerized electrophysiology workstation, our EP-4™ Computerized Cardiac Stimulator, diagnostic electrophysiology catheters (including our unique one-piece catheter) and our ALERT^® System (including the ALERT^® Companion II and ALERT^® family of internal cardioversion catheters), ViewMate^® and ViewMate II intracardiac ultrasound catheter system and related disposable supplies.

Our core diagnostic product is the EP-WorkMate^® platform which consists of the EP-WorkMate^® recording system and the EP-4™ Computerized Cardiac Stimulator. The EP-WorkMate^® system is a computerized electrophysiology workstation that monitors displays and stores cardiac electrical activity and arrhythmia data. It offers, among other features, display and storage of up to 192 intracardiac signals, real-time diagnosis, analysis and integration with our own proprietary systems, such as our EP-4™ Stimulator, as well as with the systems of other market leaders and with other technologies and systems. The EP-4™ Stimulator is a computerized signal generator and processor which, when integrated with the EP-WorkMate^® system, is used to stimulate the heart with electrical impulses in order to locate arrhythmia. For the three months ended March 31, 2007 and 2006, the EP-WorkMate^® platform accounted for approximately 90% and 88%, respectively, of our total sales. We also market a line of diagnostic electrophysiology catheters for stimulation and sensing of electrical signals during electrophysiology studies, which represented approximately 1% and 2% of our total sales revenues for the three months ended March 31, 2007 and 2006, respectively.

We have also developed an intracardiac echo (ultrasound or ICE) ultrasound catheter system, including the ViewMate^® and ViewMate II ultrasound imaging console and ViewFlex^TM intracardiac imaging catheters. These products offer high-resolution, real-time ultrasound capability designed to improve a physician’s or clinician’s ability to visualize inside the chambers of the heart. We believe the ViewMate^® and ViewMate II Ultrasound systems may play an important role for a broad range of potential applications in electrophysiology and cardiology. Sales of the ViewMate^® system and related ViewFlex™ catheters accounted for approximately 6% of our total sales revenues in the three months ended March 31, 2007 and 2006, respectively. In January 2007, we announced the new ViewMate II ultrasound system based on Philips Medical Systems’ HDII XE platform. Philips will act as an original equipment manufacturer for the product to be sold under our proprietary name ViewMate II. As part of the joint development and distribution agreement, Philips may offer the ICE option to its customers on the HDII XE ultrasound system, providing an additional sales channel for our ViewFlex catheters.

We have also developed a product for the treatment of atrial fibrillation known as the ALERT^® System, which uses a patented electrode catheter to deliver measured, variable, low-energy electrical impulses directly to the inside of the heart to convert atrial fibrillation to a normal heart rhythm. Sales of the ALERT^® System and related catheters accounted for approximately 3% and 4% of our total sales revenues for the three months ended March 31, 2007 and 2006, respectively.

Critical Accounting Policies

Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. The Commission indicated that a critical accounting policy is one which is important to the portrayal of the company’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Note 2 of our Notes to the Consolidated Financial Statements I filed on Form 10-K for as of and for the year ended December 31, 2006 includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. In addition, Financial Reporting Release No. 61 requires all companies to include a discussion to address, among other things, liquidity, off-balance sheet arrangements, contractual obligations and commercial commitments. The following is a brief discussion of the more significant accounting policies and methods used by us.

General

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Judgments and assessments of uncertainties are required in applying the Company’s accounting policies in the valuation of accounts receivable, valuation of inventory, valuation of goodwill intangibles, and other long-term assets, income taxes and share-based compensation. The Company bases its judgments and estimates on historical experience and other assumptions that it believes are reasonable. Although these estimates are based upon management’s knowledge of current events, the estimates may ultimately differ from actual results.

Revenue Recognition

We ship products to our customers based on FOB shipping point and, as such, recognize revenue from product sales on the date of shipment. Installation of the products is considered perfunctory. Payments received in advance of shipment of product are deferred until such products are shipped. We do not have royalty agreements that result in revenue to us and we do not provide distributors or end-users with a general right to return products purchased.

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We have three sales channels: Direct sales to customers, sales to independent distributors, and sales to alliance partners. Our products do not require “installation” in the traditional sense, but the EP-WorkMate system does require a set up. For distributors, the distributor is responsible for all set-up of all electronic hardware products, and we have no obligation after shipment of products to the distributors. For direct sales, while the customer can perform the set-up on its own, our personnel generally will assist customers in this process. The set-up process, which takes approximately 1-2 hours to complete, is usually performed shortly after shipment and primarily consists of assembling the workstation cart and plugging in the monitors, printer, isolation transformer, and the EP-4 Stimulator to the main computer. This process does not impact our standard payment terms. For sales to distributors, payment terms are defined in the distributor agreements as 100% of the purchase price being due 30 to 60 days after shipment. For direct sales, payment terms are agreed in advance of the sale and generally require a 50% deposit prior to shipment, with the balance due 30 to 60 days after shipment.

We provide a one-year warranty on all of its electronic products, and in accordance with Statement of Financial Accounting Standard No. 5 “Accounting for Contingencies”, accrues for the estimated cost of providing the warranty at the time of sale. Further, the Company incurs discretionary costs to service its products in connection with product performance issues. The estimates of the future warranty costs are based on historical experience.

	For the Three Months Ended March 31,
	2007			2006
Beginning balance	$	272,000		$	313,000
Warranties		79,000			98,000
Warranty payments		(84,000	)		(93,000	)
Ending balance	$	267,000		$	318,000

We also sell various types of warranty contracts to our customers. These contracts range in term from one to five years. Revenue is recognized on these contracts on a straight-line basis over the life of the contract.

Valuation of Accounts Receivable

We continuously monitor customers’ balances, collections and payments, and maintain a provision for estimated credit losses based upon our historical experience, changes in the financial condition of our customers, and any specific customer collection issues that we have identified. As these factors change, our allowance for doubtful accounts may change in subsequent accounting periods. In addition, due to the significant average selling price of our equipment, any single write-off of a customer balance could be substantial. We may request letters of credit from our customers when we believe that there is a significant risk of credit loss. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.

Valuation of Inventory

We value our inventory at the lower of cost or market, with cost being determined on a first-in, first-out basis. We continually monitor our slow-moving items, and establish reserve amounts on a specific identification basis, as necessary. In addition, due to the fact that our business is dependent on the latest computer technology, we continually monitor our inventory and products for obsolescence. If we determine market value to be less than cost, we write down the cost to that value. Additional reserves are sometimes established as a result of lack of marketability or changes in customer consumption patterns. Management’s judgment is necessary in determining the realizable value of those products to arrive at the proper obsolescence reserve. Generally, we do not experience significant writedowns, losses, etc. with the valuation of our inventory; however, these reserves are estimates, which could change significantly, either favorably or unfavorably, depending on market and competitive conditions.

Valuation of Goodwill, Intangible Assets, and Other Long-Lived Assets

We assess the impairment of identifiable intangibles, long-lived assets and enterprise level goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. This is in addition to the Company’s annual test. Factors we consider important which could trigger an impairment review include the following:

• significant underperformance relative to expected historical or projected future operating results;

• significant changes in the manner of our use of the acquired assets or the strategy for our overall business;

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• significant negative industry or economic trends;

• significant decline in our stock price for a sustained period; and

• our market capitalization relative to net book value.

When we determine that the carrying value of intangibles, long-lived assets and related goodwill and enterprise level goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.

Income Taxes

We account for our income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. We have fully reserved our deferred tax asset given our past history of operating losses.

Results of Operations.

Three Months Ended March 31, 2007 versus March 31, 2006

Net sales decreased $534,000 (or 13%) to $3,544,000 for the three months ended March 31, 2007, as compared to $4,078,000 for the comparable period in 2006. In 2006, we recorded approximately $705,000 of nonrecurring sales to our Japanese distributor who completed an upgrade program in that quarter.

Gross profit on sales for the three months ended March 31, 2007 was $2,387,000, as compared to $2,490,000 for the same period in 2006. The gross profit margin increased as a percentage of sales from 61% to 67%. This increase in gross margin is a result of a number of factors. In the first quarter of 2006 we had an additional costs of $50,000 associated with our field action recall. We realized increase in the average selling prices of certain product lines and we had a larger percentage of high margin products in 2007 as compared to the same period in 2006.

Sales and marketing expenses decreased $92,000 (or 4%) to $2,310,000 for the three months ended March 31, 2007 as compared to the same period in 2006. Costs in our clinical affairs activities decreased $317,000 versus the first quarter of 2006. We completed phase I of our ICE Chip study in 2006 and funded the data analysis in the first quarter of 2007. We are evaluating the results and other possible studies. There was also a reduction of approximately $100,000 in bad debt expenses associated with the recovery of a previously written-off debt. The decreases in these costs were off set by approximately $290,000 in compensation, benefits and travel costs for additional headcount.

General and administrative expenses increased $83,000 (or 10%) to $946,000 for the three months ended March 31, 2007, as compared to the same period in 2006. The increase in administrative costs are primarily associated with an increase in compensation of $155,000, of which $25,000 is related to stock option expense. The Company retained a new Chief Executive Officer in the third quarter of 2006. We also had an additional $10,000 in travel and negative $14,000 impact from foreign currency. These costs were offset by a $114,000 decrease in legal costs as a result of the completion of the Company’s investigations with the U.S. Department of Commerce and the U.S. Department of the Treasury.

Research and Development costs decreased $33,000 (or 5%) to $665,000 for the three months ended March 31, 2006 as compared to the same period in 2006. This was primarily due to a decrease of $21,000 in travel costs related to certain research and development projects.

Interest and other income increased by $50,000 or 123% to $90,000 as a result of higher interest rates and higher cash balances in 2007 as a result of our private placement at the end of the first quarter of 2006.

Interest expense increased $4,000 for the three months ended March 31, 2007, as compared to the same period in 2006. The increase in interest expense is a result of higher interest rates offset by a lower accretion of debt discount and amortization of beneficial conversion feature.

Liquidity and Capital Resources

Since our incorporation in January 1993, our expenses have exceeded sales, resulting in an accumulated deficit of approximately $56.3 million at March 31, 2007 and approximately $54.8 million at December 31, 2006.

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Financing Activities

On August 28, 2003, we issued the Laurus Convertible Note to Laurus and entered into a related Security Agreement with Laurus, pursuant to which Laurus provided us with a $4,000,000 revolving asset-based credit facility in the form of a three-year Laurus Convertible Note secured by our accounts receivable, inventory, real property and other assets, other than intellectual property.

At the closing of the transaction, we issued the Laurus Convertible Note to Laurus having a principal amount of $4,000,000 and received net proceeds of $2,661,600. An additional $1,000,000 of the Laurus Convertible Note was previously restricted. Those restrictions were released during the third quarter of 2004 and that amount became available to us. The balance of the proceeds was used to pay fees incurred in connection with this transaction. Deferred financing fees are being amortized over the life of the Convertible Note using the effective interest method. In addition, we paid a portion of the fees payable to an intermediary, Biscayne Capital Markets, Inc. (“Biscayne”), in 40,000 shares of our common stock having a market value on the date of closing of this transaction equal to $100,000. The net proceeds of the Laurus Convertible Note have been, and will be, used for working capital purposes and payment of outstanding debt.

The portion of the Laurus Convertible Note against which Laurus advances funds based on our accounts receivable bears interest at the prime rate, with a floor of 4%, which is an effective interest rate of approximately 21% for the year ended December 31, 2005 (including accretion of discount and amortization of beneficial conversion feature), and the balance (the “Advance Amounts”) bears interest at the prime rate plus 2%. One half of the Advance Amounts outstanding on February 28, 2005 was required to be repaid on or before that date. However, there were no Advance Amounts outstanding on that date, as the net collateral exceeded the principal amount outstanding on the Laurus Convertible Note. The remaining balance of the Advance Amounts outstanding on the date of the closing was required to be repaid on or before August 28, 2006. On November 9, 2005, the Convertible Note’s maturity date was extended to February 28, 2008. Subject to certain rights of cancellation, we may extend the Laurus credit facility, on a year-by-year basis, commencing February 28, 2008. We may repay in cash, without penalty, up to $500,000 of the Laurus Convertible Note in any one calendar year, plus all Advance Amounts. The Company evaluated the impact of the change in the maturity date on the present value of the cash flows of the Convertible Note in conjunction with EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments.” This EITF provides guidance when a modification of a debt instrument should be considered an extinguishment. The change in the present value of the modification did not meet the criteria to be treated as an extinguishment. The Company, subject to certain rights of cancellation, may extend the credit facility by Laurus, on a year-by-year basis, commencing February 28, 2008. The Company may repay in cash, without penalty, up to $500,000 of the Convertible Note in any one calendar year, plus all Advance Amounts.

Subject to certain volume limitations and other conditions, all or a portion of the Laurus Convertible Note was convertible into our common stock at our option if the market price of our common stock reached a level, for 11 consecutive trading days, which was more than 120% of the fixed conversion price, as defined (the “Fixed Conversion Price”). Subject to certain volume limitations and other conditions, Laurus has the option to convert all or a portion of the Convertible Note into shares of our common stock at the Fixed Conversion Price.

Following the conversion into our common stock by us and/or Laurus of an aggregate of $2,000,000 of the principal amount of the Convertible Note (a “Conversion Event”), the Fixed Conversion Price will be adjusted upward to a price which is 115% of the average of the closing price of our common stock for the three trading days prior to the Conversion Event. On December 15, 2004, the balance of the first $2,000,000 of the principal amount was converted into shares of our common stock at the Fixed Conversion Price, and the Fixed Conversion Price on the remaining $2,000,000 principal balance was adjusted upward from $2.55 to $4.20. Subject to certain limitations, including the repayment obligations with respect to Advance Amounts described above, the dollar amounts of the Laurus Convertible Note converted may be re-borrowed.

The Fixed Conversion Price is subject to adjustment, with customary exceptions and on a weighted-average basis, in connection with sales of our securities below the Fixed Conversion Price then in effect, and is also subject to adjustment for stock splits, combinations, stock dividends and similar events.

As part of the Laurus Convertible Note transaction, Laurus and Biscayne also received warrants to purchase an aggregate of 240,750 shares of our common stock (the “Warrants”), with exercise prices set as follows: $2.93 per share for the purchase of up to the first 133,750 shares, $3.19 per share for the purchase of up to the next 80,250 shares, and $3.70 per share for the purchase of up to the final 26,750 shares. The expiration date of the Warrants is August 28, 2010. The exercise price of the Warrants and the number of shares underlying the Warrants are subject to adjustments for stock splits, combinations, stock dividends and similar events.

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In October 2003, we registered, under the Securities Act of 1933, as amended, 1,500,000 shares of our common stock which may be received by Laurus upon conversion of the Convertible Note and exercise of the Warrant, and the remaining 293,628 of such shares were registered in November 2004.

In accordance with the provisions of Emerging Issues Task Force (EITF) Issue 00-27, “Application of EITF Issue No. 98-5 ‘Accounting for Convertible Securities with Beneficial Conversion Features of Contingently Adjustable Conversion Ratios’, to Certain Convertible Securities”, the allocated value of the Laurus Convertible Note contained a beneficial conversion feature calculated based on the difference between the effective conversion price of the proceeds allocated to the Convertible Note and the Warrants at the date of issuance. The amount arising from the beneficial conversion feature aggregated approximately $486,000 and is being amortized as interest expense from the date of the issuance of the Laurus Convertible Note to the mandatory redemption date of August 28, 2006. We valued the Laurus Convertible Note and the Warrants at issuance. The fair value of the Warrants at the time of issue was $407,500. In accordance with EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” we marked the Warrants to market at September 30, 2003 incurring a non-cash charge of $264,000. The registration rights agreement associated with the Convertible Note was amended on November 25, 2003 and, as a result, the amount associated with the Warrants was transferred to equity. We marked the Warrants to market at the date of the amendment which reduced the overall expense to $210,750 for the year ended December 31, 2003. The net carrying value of the Convertible Note, after allocation of the fair value of the Warrants, is being accreted to interest expense over the life of the agreement using the effective interest method.

During 2005, three separate options to purchase shares of the Company’s common stock were issued to its senior medical advisor in the amounts of 40,000, 40,000 and 100,000 shares of common stock respectively, on which the exercise price of the options was the fair market value of the Company’s common stock on the date of the grant. With respect to the two 40,000 option issuances, they vest in equal installments over three years and the Company expensed $171,000 representing the fair value of the options measured using the Black-Scholes option pricing model for each grant as follows: risk free rate of 3.77% and 4.33%; 10 year life, and volatility percentage of 77.98% and 81.1%. The issuance of an option in the amount of 100,000 shares of the Company’s common stock did not meet the criteria for expensing in 2005. In the first quarter of 2006, the consultant’s performance obligation in connection with these options was fulfilled and we recorded an expense of $196,480, valued using the Black-Scholes option pricing model for each grant as follows: risk free rate of 4.82%, 10 year life, and volatility percentage of 84.23%.

On March 27, 2006, the Company completed a $10,000,000 private placement of its common stock to a number of accredited investors. The Company issued 3.78 million shares of its common stock at a purchase price of $2.25 per share. In addition, FatBoy Capital, LP purchased approximately 617,000 shares of common stock at a price of $2.43 per share in accordance with NASAQ marketplace rules. David Jenkins, the Company’s Chairman is a managing member of FatBoy Capital’s general partner. In connection with this transaction, certain anti-dilution provisions of the Laurus Convertible Note resulted in a reduction of the conversion price of that note from $4.20 to $3.96.

Operating Activities

Net cash provided by operating activities for the three months ended March 31, 2007 was $48,000 as compared to a usage of cash by operations of $2,249,000 in the same period in 2006. This change in cash from operations during 2007 was primarily due to the decrease in our receivables of $1,492,000, when compared to an increase in receivables of $792,000 in the same period in 2006. Sales were lower in the three months ended March 31, 2007 when compared to the same period in 2006 and we collected a significant number of overdue receivables in the first quarter of 2007. Capital expenditures were $61,000 for the three months ended March 31, 2007 as compared to $24,000 for the same period in 2006. We expect to purchase capital equipment in 2007. We lease office space and certain office equipment under operating leases.

Assets decreased by $1,384,000 from $18,311,000 at December 31, 2006 to $16,927,000 at March 31, 2007. Accounts receivable decreased by $1,401,000 from December 31, 2006 with the previously discussed collection of accounts receivable.

Liabilities decreased $94,000 from $6,123,000 at December 31, 2006 to $6,029,000 at March 31, 2007 primarily due to a $242,000 reduction in accrued expenses offset by an increase in deferred revenue. Current liabilities increased by $1,852,000 at March 31, 2007 primarily associated with the classification of the secured convertible debt as current. This debt is due at the end of February 2008.

We evaluate the collectability of our receivables quarterly. The allowance for bad debts is based upon specific identification of customer accounts for which collection is doubtful and our estimate of the likelihood of potential loss. To date, we have experienced only modest credit losses with respect to our accounts receivable. To date, we have experienced minor inventory write-downs, and the reserve is consistent with management’s expectations.

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We have a history of operating losses and we expect to continue to incur operating losses in the near future as we continue to expend substantial funds for research and development, increased manufacturing activity, expansion of sales and legal and other costs associated with the SEC inquiry. The amount and timing of future losses will depend upon, among other things, volume of sales of our existing products, market acceptance of the ultrasound products, and developmental, regulatory and market success of new products under development, as well as our ability to establish, preserve and enforce intellectual property rights related to our products and favorable resolution of the SEC inquiry. There can be no assurance that any of our development projects will be successful or that if development is successful, the products will generate any sales or that material cost, or in the case of the government investigations, material fines and possible civil or criminal penalties will not be imposed. Based upon our current plans and projections, we believe that our existing capital resources will be sufficient to meet our anticipated capital needs through at least the end of December 2007.

We have incurred significant expenses associated with the recently concluded governmental investigations and we are still subject to a confidential informal inquiry by the SEC. The Company cannot assure that the ongoing informal inquiry by the SEC will not result in other significant costs, fines or penalties that could, in the aggregate, have a material adverse effect on our business, financial condition, prospects or results of operations. We have made no provision for any future costs associated with these investigations or any costs associated with the Company’s defense or negotiations with the SEC entities to resolve this final outstanding issue. Any such costs or payments could have a material adverse effect on our liquidity and capital resources.

Off-Balance Sheet Arrangements

As of March 31, 2007, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

Summary of Contractual Obligations

The following table summarizes our contractual cash obligations at March 31, 2007, and the effects such obligations are expected to have on liquidity and cash flow in future periods. We do not have any other commercial commitments.

	Payments Due by Period
Contractual Obligations	Total		Less than 1 year		1-3 years		4-5 years		After 5 years
Long-Term Debt (1)	$	2,000,000	$	2,000,000	$	0	$	0	$	0
Operating Lease Obligations (2)	$	161,000	$	110,000	$	51,000	$	0	$	0
Other Long Term Obligations (3)	$	0	$	0	$	0	$	0	$	0
Total Contractual Cash Obligations	$	2,161,000	$	2,110,000	$	51,000	$	0	$	0

(1) We are also contractually obligated to pay variable interest on the Long-Term Debt, the principal of which comes due February 2008.

(2) The Company leases facility, storage and equipment under operating leases. As these leases expire the Company intends to renew certain leases as necessary to operate the business. In addition, the Company has operating leases on a month-to-month basis.

(3) The Company also has contractual obligations for certain licensing contracts. We have signed a license agreement with Biosense Webster that provides for a license payment on sales of MapMate units. This license is payable upon sales of the units. We also have other license agreements which the Company may terminate unilaterally in the event that the technology is no longer deemed relevant.

Cautionary Statement Regarding Forward-Looking Statements

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements relating to such matters as anticipated financial and operational performance, business prospects, technological developments, results of clinical trials, new products, research and development activities and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. We emphasize to you that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. When we use the words or phrases “believe,” “anticipate,” “expect,” “intend,” “will likely result,” “estimate,” “project” or similar expressions in this Quarterly Report on Form 10-Q, we intend to identify such forward-looking statements, but they are not the exclusive means by which such statements are made. The forward-looking statements are only expectations and/or predictions which are subject to risks and uncertainties, including the significant factors discussed under “Risk Factors” in our most recent Form 10-K, and general economic, market or business conditions, opportunities or lack of opportunities that may be presented to us, competitive actions, changes in laws and regulations and other matters discussed herein in the section entitled “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections herein.

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We caution readers to review the cautionary statements set forth in this Quarterly Report on Form 10-Q and in our other reports filed with the Securities and Exchange Commission and caution that other factors may prove to be important in affecting our business and results of operations. We caution you not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to a variety of risks, including changes in interest rates affecting our outstanding debt balance and fixed rate investments of our cash and cash equivalents and foreign currency fluctuations. The Company does not have any market risk with respect to such factors as commodity prices or equity prices. We do not invest in, or otherwise use, foreign currency or other derivative financial or derivative commodity instruments, and we do not engage in hedging transactions for speculative or trading or any other purposes.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio for our debt obligations and our cash and cash equivalents.

At March 31, 2007, we had a Convertible Note outstanding in the approximate amount of $2,000,000. Interest on the Convertible Note is based on the prime rate. This floating rate debt may lead to additional interest expense if interest rates increase. Because management does not believe that our exposure to interest rate market risk is material at this time, we have not developed or implemented a strategy to manage this market risk through the use of derivative financial instruments or otherwise. We will assess the significance of interest rate market risk from time to time and will develop and implement strategies to manage that market risk as appropriate.

We invest our excess cash in money market funds and government securities, which creates a degree of interest rate risk. Our primary exposure to market risk relates to changes in interest rates on our cash and cash equivalents. Our primary investment objective with respect to our cash and cash equivalents is to preserve principal, while at the same time maximizing yields without significantly increasing risk.

Our portfolio includes money markets funds and/or government securities. The diversity of our portfolio helps us to achieve our investment objective. As of March 31, 2007, 100% of our investment portfolio matures less than 90 days from the date of purchase. Due to the short-term nature of these investments, we believe that we are not subject to any material market risk exposure, and as a result, the estimated fair value of our cash and cash equivalents approximates their principal amounts. If market interest rates were to increase immediately and uniformly by 10% from levels at March 31, 2007, we estimate that the fair value of investment portfolio would decline by an immaterial amount.

Foreign Currency Risk

Our international revenues were 30% and 35% of our total revenues in the quarters ended March 31, 2007 and 2006, respectively. Our international sales are made through international distributors, our direct sales force and sales to alliance partners, with payments to the Company typically denominated in United States dollars and the Euro. For the three months ended March 31, 2007, approximately 11% of our foreign sales are denominated in the Euro. Management has determined that the impact of foreign currency risk is minimal since a majority of our sales are billed in United States dollars. Our international business is subject to risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors. We do no hedge our foreign currency exposure at present.

Item 4. Controls and Procedures

As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15 and 15d-15 of the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the

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Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

There was no change in the Company’s internal control over financial reporting during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially effect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

During the second quarter of 2005, the Company announced it was under investigation with the United States Department of Commerce, the United States Attorney’s Office for the District of New Jersey and the United States Department of the Treasury in connection with the sale of certain of its products to Iran. In addition, the Company announced the SEC was conducting a confidential, informal inquiry into the Company’s financial and accounting reporting regarding there investigations.

In March of 2006, the Company announced the U.S. Attorney’s office informed the Company that it would not prosecute the Company in connection with this matter. In the third quarter of 2006, we announced a settlement agreement with the Department of Commerce for $244,000 in which the Company did not admit or deny guilt. The Company also announced that it had made an offer to settle with the Department of the Treasury. In the first quarter of 2007, the Company announced it had signed a settlement agreement with the Department of the Treasury without admitting or denying guilt for a payment of $33,000, which had been accrued in 2006.

The Company cannot assure that the ongoing informal inquiry by the SEC will not result in other significant costs, fines or penalties that could, in the aggregate, have a material adverse effect on our business, financial condition, prospects or results of operations. The Company has made no provision for any future costs associated with these investigations or any costs associated with the Company’s defense or negotiations with the SEC entities to resolve this final outstanding issue.

Item 1A. Risk Factors.

None.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

(a) Not applicable

(b) Not applicable.

(c) Not applicable.

Item 3. Defaults Upon Senior Securities.

None.

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

None.

Item 5. Other Information.

(b) None.

Item 6. Exhibits.

The exhibits are listed in the Exhibit Index appearing at page 33 herein.

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SIGNATURES

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

	EP MEDSYSTEMS, INC. (Registrant)
Date: May 8, 2007	By:	/s/ David I. Bruce
		David I. Bruce
		President and Chief Executive Officer (Principal Executive Officer)
Date: May 8, 2007	By:	/s/ Matthew C. Hill
		Matthew C. Hill
		Chief Financial Officer (Principal Financial and Accounting Officer)

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Index to Exhibits

Exhibit Number	Description
31.1*	Certification Pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended.
31.2*	Certification Pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended.
32.1*	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Filed herewith.

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