Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations – “Liquidity and Capital Resources”).

4.  INVENTORIES

Inventories are stated at the lower of cost or market.  Cost is based on actual costs computed on a first-in, first-out basis.  Inventories consist of the following (in thousands):

		June 30, 2007				December 31, 2006
Raw Materials		$				$
Work-In-Process
Finished Goods
		$				$

Inventories shown above are computed using the FIFO cost method and are adjusted to the lower of cost or market.  The Company had allowances for excess and obsolete inventory of $721,000 and $579,000 at June 30, 2007 and December 31, 2006, respectively.  As of June 30, 2007, the Company has approximately: (i) $56,000 of inventories located in its warehouse facility in Netherlands. Additionally, $52,000 of inventory is being used by physicians in clinical testing in China,, the United Kingdom, and Germany.  For the six months ended June 30, 2007, net inventory increased by $156,000 which primarily due to the Company’s plan to increase sales both in the surgical and EP diagnostic areas in the upcoming quarters.

5. DEFERRED EXPENSES

In connection with the June 2007 loan financing with Apix, the Company accrued an additional $2,010,000 loan-related fees.  The Company used the interest rate method to amortize it over the life of the loan. As of June 30, 2007, the deferred expenses account balance was $1,746,000, which included $1,730,000 deferred Apix loan fees and $16,000 deferred insurance expenses.

6. PROPERTY AND EQUIPMENT

Property and equipment, including equipment under capital leases, are carried at cost less accumulated depreciation and amortization.  Property and equipment are depreciated using the straight-line method over the estimated useful lives, generally three to five years.  Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the remaining term of the lease.  Depreciation expense includes amortization of capital leases and leasehold improvements. Depreciation expense was $28,000 and $28,000 for the three months ended June 30, 2007 and 2006, respectively. Depreciated expense was $49,000 and $62,000 for the six months ended June 30, 2007 and 2006, respectively. For the six months ended June 30, 2007, a total of $2,000 fully depreciated equipments were disposed.

Property and equipment consist of the following (in thousands):

		June 30, 2007				December 31, 2006
Equipment		$	1,913			$	1,888
Leasehold improvements
			2,172			$	2,147
Less accumulated depreciation and amortization			(1,914	)			(1,867	)
		$				$
Idle Equipment		$	1,290			$	1,290
Less accumulated depreciation and amortization			(1,290	)			(1,290	)
		$	-			$	-

7. LOANS PAYABLE

On August 28, 2005, the Company entered into a $3,000,000 Secured Loan Agreement with Apix International Limited (Apix).  The term of the loan was six months.  All the loan-related fees were amortized over the period from August 2005 to February 2006. On February 14, 2006, the Company entered into a new loan facility term sheet with Apix, which provided for the rollover of the original loan agreement and the grant of an additional loan facility in the amount of $660,000 at an interest rate of 10% per annum.  The term of this new loan facility was three months.  All the additional new facility-related fees were amortized over the period from February 2006 to May 2006.  In addition, the Company and Apix have agreed to the following terms: (i) the maturity date of the original loan facility is extended from February 28, 2006 to May 18, 2006; (ii) the exercise price of the original warrant has been adjusted to $0.06 per share. Moreover, the Company has granted Apix a new warrant to purchase 23,800,000 shares of our common stock at an exercise price of $0.06 per share for a term of ten years. Furthermore, upon completion of the full funding under the new loan facility, the Company has granted Apix warrants to purchase an additional 8,000,000 shares of its common stock at an exercise price of $0.06 per share for a term of ten years; (iii) the Company has granted Apix the right to convert the loan principal, interest, facility fees and exit fees into shares of its common stock at a conversion price of $0.06 per share; (iv) the facility fee has been increased from $60,000 to $80,000. In addition, the exit fee has been increased from $900,000 to $1,300,000; (v) upon completion of the full funding under the new loan facility, the exit fee would be increased by $260,000; (vi) the Company agrees to register the shares underlying the loan principal, facility fees, and warrants on a registration statement as soon as practicable after the date of issuing the warrant, but in any event no later than May 31, 2006.  The Company filed a registration statement Form SB-2 on May 31, 2006 and it was withdrawn on October 26, 2006.  The Company used the interest method to amortize all the loan fees over the life of the loan.  The Company received funding under this agreement of $200,000 and $460,000 in February and March 2006, respectively.

On May 18, 2006, the Company was not able to repay this Apix loan.  The Company’s failure to repay the principle and interest by the maturity date constituted an event of default pursuant to the loan agreement.  To secure the repayment of principle and interest to Apix under the loan agreement, the Company entered into a (i) Security Agreement, (ii) Trademark Security Agreement, (iii) Patent Security Agreement, and (iv) Patent, Trademark and Copyright Security Agreement with Apix, granting Apix a first priority security interest in all of the Company’s assets and intellectual property now owned or hereafter acquired.  Apix’s remedies upon default of the loan agreement include taking procession and selling the collateral, the occurrence of which would cause the Company to cease its operations indefinitely.

The Company had not received a notice of default from Apix, nor has Apix indicated to the Company that it intended to place the Company in default under the loan agreement.  In addition to the $3,660,000 loaned to the Company by Apix through March 31, 2006, Apix has made advances to the Company in the amount of $5,850,000 from April 1, 2006 through March 31, 2007.  The Company’s loans payable balance as of March 31, 2007 and December 31, 2006 was $9,510,000 and $8,160,000, respectively.

On January 15, 2007, the Company entered into a new term sheet with Apix, with the final financing agreements being executed on June 7, 2007, which provides for the rollover of prior loan facilities and subsequent advances (Prior Facilities) and an additional loan facility between the parties (the "New Facility"). The New Facility provides for the following terms and conditions:

·	Additional loan facility - Apix has granted the Company an additional loan facility in the amount of $5,625,000. Advances pursuant to the additional facility shall be made on a bi-weekly basis the Company’s discretion in denominations of $225,000 per advance;

·	New maturity date - the maturity date of the New Facility and Prior Facilities is the earlier of (a) December 31, 2007 or (b) the date that Apix makes a demand for payment;

·

Facility fee adjustment - the aggregate facility fee for the Prior Facilities and the New Facility shall be $500,000 (the “Facility Fee”) which is payable through the issuance of five million shares of our preferred stock with the following minimum preferences: (a) 2.8 votes per share (post-split) at any general or extraordinary meeting of the common shares of the company convened by the Company or its shareholders for a total of 14 million votes (post-split) at any such meeting; and (b) convertible into common shares of the Company at any time at the sole and absolute discretion of the holder on the basis of 0.2 common shares (post-split) for each preferred share tendered for conversion for a total of one (1) million common shares (post-split) in the event all preferred shares are tendered for conversion;

·

Exit fees - the aggregate exit fees for the Prior Facilities and the New Facility shall be $2,800,000 plus $80,000 for each advance made which shall be due and payable on the earliest to occur of: (1) the maturity date, (2) generally the sale of the company or substantially all of its assets, a reorganization or a new loan facility in excess of $1,000,000, or (3) an event of default;

·

Price adjustment to existing warrant and new warrants - pursuant to the Prior Facilities, the Company agreed to issue to Apix warrants to purchase 11,880,000 shares (post-split) of the Company's common stock at an exercise price of $0.60 per share (post-split) (the “Existing Warrants”). Pursuant to the New Facility, the exercise price of the Existing Warrants has been adjusted to $0.40 per share (post-split). In addition, the Company has agreed to issue to Apix additional warrants to purchase 2,000,000 shares (post-split) of the Company’s common stock at an exercise price of $0.30 per share (post-split) (the “New Warrants”). All warrants have a term of ten years;

·	Conversion price adjustment - the loan principal and exit fees are convertible into shares of the Company’s common stock at a conversion price of $0.40 per share (post-split); and

·	Registration rights - the Company agrees to register a percentage of the shares underlying the loan principal, facility fees, and warrants on a registration statement at its best efforts.

The final financing agreements were executed on June 7, 2007. With the loan agreement’s optional conversion clause on all or any portion of the principal, the facility fee, the exit fee and the accrued interest due under the loan, any gains or losses on the difference between the conversion price and the fair value of the stock at the time of conversion will be included in the Company's earnings during that period.  In addition, as the lender gave up all of it’s rights that might be net settled in cash, the Company reversed it’s previously accrued warrant liability as required under EITF 00-19, and conversion liability which was accrued in February 2006 as part of a loss on extinguishment of debt. The entry was charged to other income in the current quarter in the amount of $7,954,000.

On June 7, 2007, the Company issued to Apix 5,000,000 shares of its Series A Preferred Stock (the “Series A Preferred”) in payment of a facility fee of $500,000 in connection with the execution of a Loan Agreement between the Company and Apix on June 7, 2007.  Each share of Series A Preferred is convertible into 0.2 shares of common stock (post-split) at the option of the holder thereof.  The Series A Preferred may be redeemed by the Company at any time at $0.10 per share.  Each share of Series A Preferred may be voted as a single class with the common stock on 2.4 votes per shares basis (post-split).

8. NOTE PAYABLE TO RELATED PARTIES

As previously disclosed in the Company’s June 30, 2006 Form 10-QSB, the Company’s former President and Chief Operating Officer, Mr. William K. Wheeler raised his defense against the Company’s collection efforts and he threatened to sue the Company for the recovery of his severance payment, accrued bonus, and employee benefits in the total amount of $418,000 plus interest, which he claimed was owed under the terms of his amended executive agreement.  He previously made a settlement proposal, in which his severance claim would be offset by his repayment obligation on the loan that he had received from the Company totaling $192,500, plus payment by the Company of all of his tax forgiveness liability of approximately $105,000.  The issues of accrued bonus and other unknown liabilities were excluded from the settlement offer.

As previously reported, in December 2006, a settlement agreement was reached in concept.  The final agreement with slightly different terms was signed in late April 2007, in which the Company

offset Mr. Wheeler's loan plus various additional amounts against all his claims against the Company, including a release for all unknown claims, over a 59 months period. The Company agreed to pay the following additional amounts to Mr. Wheeler or on his behalf in addition to the settlement of the loan amount: (i) the employer taxes relating to this settlement agreement during the offset period, (ii) an initial payment of $10,000 to Mr. Wheeler, and (iii) two additional payments of $5,000 each to Mr. Wheeler in months 58 and 59.

The total cash payments to be made by the Company under the agreement will be approximately $42,000 payable over five years.  In accordance with the Accounting Principle Board (“APB”) No. 21, “Interest on Receivables and Payables”, the $295,000 note payable is discounted at 10% (same as the interest rate on the current loan financing) and the $192,500 note receivable is discounted at 6% (the original note’s interest rate).  The discounted value of the note payable and note receivable is $232,287 and $162,022, respectively.  As the receivable and the payable are ‘nettable’ that is subject to offset, they are considered as one ‘net loan payable’ under state law and accounted as such.

9. ACCRUED INTEREST AND FEE

In conjunction with the Apix loan financings in August 2005, February 2006, and June 2007, the Company had accrued loan interest and fees with balance of $5,412,000 and $2,308,000 as of June 30, 2007 and December 31, 2006, respectively. The accrued interest and fees, related to the Apix loans described in Note 7, are as follows:

 

·	Accrued interest	$1,067,000
·	Accrued exit fees	$2,800,000
·	Accrued drawdown fees	$1,120,000
·	Accrued legal and other fees	$425,000
	Total accrued interest and loan fees is	$5,412,000.

10. COMMITMENTS AND CONTINGENCIES

Commitments

The Company leases facilities under an operating lease, which has been extended through May 2010.  The Company also leases certain equipment under non-cancelable capital leases, which bear interest at the rate of 10% per annum. Following is a schedule of future minimum lease payments under both operating and capital leases (in thousands):

Fiscal Year		Operating Leases				Capital Leases
		$				$
							-
							-
Total minimum lease payments		$				$
Less amounts representing interest		N/A
Present value of net minimum lease payments		$				$

Contingencies

The Company is subject to numerous risks and uncertainties because of the nature and status of its operations and could be subject to claims and legal actions arising in the ordinary course of business. The Company maintains insurance coverage for events in amounts that it deems appropriate. Management believes that uninsured losses, if any, will not be materially adverse to the Company’s financial position or results of operations.

11. OTHER INCOME/(EXPENSES)

 

The Company reported other income of $7,959,000 for the quarter ended June 30, 2007.  The other income is attributable to the June 2007 Apix financing which no longer required the treatment of the Apix warrants as a liability as described in EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”.

12. INCOME TAXES

On July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued Financial Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109 (“SFAS 109”), “Accounting for Income Taxes,” and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.

The Company adopted the provisions of FIN 48 on January 1, 2007. The implementation of FIN 48 did not result in a cumulative effect adjustment to retained earnings. At January 1, 2007, the Company did not have unrecognized tax liabilities.  During the first two quarters of 2007, no additional income tax expense was recorded as a result of FIN 48 implementation.

13. CONCENTRATIONS OF RISK

To date, product sales have been direct to customers in the United States and to distributors primarily in Europe and Japan. The geographic distribution of net sales was as follows (in thousands):

		Three Months Ended June 30,
		2007								2006
United States		$						%		$						%
Europe								%								%
Asia -- Japan			(85	)			-33	%								%
Others			-					%								%
Total Net Sales		$								$
		Six Months Ended June 30,
		2007								2006
United States		$						%		$						%
Europe								%								%
Asia -- Japan			(85	)			-15	%								%
Others								%								%
Total Net Sales		$								$