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: June 30, 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 August 14, 2007
Common Stock, without par value		30,405,236 shares

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

FORM 10-Q

CONTENTS


		Page
PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets at June 30, 2007 (unaudited) and December 31, 2006	3

	Consolidated Statements of Operations (unaudited) for the three months ended June 30, 2007 and 2006	4

	Consolidated Statements of Operations (unaudited) for the six months ended June 30, 2007 and 2006	5

	Consolidated Statement of Changes in Shareholders’ Equity for the six months ended June 30, 2007 (unaudited)	6

	Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2007 and 2006	7

	Notes to Consolidated Financial Statements (unaudited)	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19

Item 4.	Controls and Procedures	19

PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	20

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	20

Item 3.	Defaults Upon Senior Securities	20

Item 4.	Submission of Matters to a Vote of Security Holders	20

Item 5.	Other Information	20

Item 6.	Exhibits	20

Signatures		21

Exhibit Index		22

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS


	June 30, 2007			December 31, 2006
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	5,298,789		$	7,743,239
Accounts receivable, net of allowances for doubtful accounts of $220,000 and $308,000 as of June 30, 2007 and December 31, 2006, respectively		4,592,881			4,808,225
Inventories, net of reserves		3,639,782			2,859,677
Prepaid expenses and other current assets		365,722			419,411

Total current assets		13,897,174			15,830,552
Property, plant and equipment, net		1,846,252			1,937,131
Goodwill		341,730			341,730
Other intangible assets, net		152,283			187,081
Other assets		21,078			14,851

Total assets	$	16,258,517		$	18,311,345

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Secured convertible note, current		1,994,269			—
Accounts payable		1,866,734			1,531,799
Accrued expenses		1,558,375			1,722,944
Deferred revenue		636,264			542,351

Total current liabilities		6,055,642			3,797,094
Deferred warranty revenue, non-current		405,695			335,658
Secured convertible note, non-current		—			1,989,760

Total liabilities	$	6,461,337		$	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 30,405,236 and 30,365,236 shares issued at June 30, 2007 and December 31, 2006, respectively		30,406			30,366
Additional paid-in capital		67,883,587			67,423,769
Accumulated other comprehensive loss		(419,178	)		(352,628	)
Treasury stock, 50,000 shares at cost		(100,000	)		(100,000	)
Accumulated deficit		(57,597,635	)		(54,812,674	)

Total shareholders’ equity		9,797,180			12,188,833

Total liabilities and shareholders’ equity	$	16,258,517		$	18,311,345

The accompanying notes are an integral part of these statements.

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)


	For the Three Months Ended
	June 30, 2007			June 30, 2006
Net sales	$	4,346,787		$	3,311,858
Cost of products sold		1,564,275			1,244,252

Gross profit		2,782,512			2,067,606
Operating costs and expenses:
Sales and marketing expenses		2,519,723			2,555,588
General and administrative expenses		784,292			1,093,407
Research and development expenses		757,722			680,620

Total operating expenses		4,061,737			4,329,615

Loss from operations		(1,279,225	)		(2,262,009	)
Interest and other income		67,704			112,015
Interest expense		(64,631	)		(63,421	)

Net loss	$	(1,276,152	)	$	(2,213,415	)

Basic and diluted loss per share	$	(.04	)	$	(.07	)

Weighted average shares outstanding used to compute basic and diluted loss per share		30,385,456			30,365,236

The accompanying notes are an integral part of these statements.

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)


	For the Six Months Ended
	June 30, 2007			June 30, 2006
Net sales	$	7,891,033		$	7,389,969
Cost of products sold		2,721,037			2,832,488

Gross profit		5,169,996			4,557,481
Operating costs and expenses:
Sales and marketing expenses		4,829,781			4,969,986
General and administrative expenses		1,730,374			1,956,643
Research and development expenses		1,423,171			1,378,712

Total operating expenses		7,983,326			8,305,341

Loss from operations		(2,813,330	)		(3,747,860	)
Interest and other income		157,495			164,374
Interest expense		(129,126	)		(124,126	)

Net loss	$	(2,784,961	)	$	(3,707,612	)

Basic and diluted loss per share	$	(.09	)	$	(.13	)

Weighted average shares outstanding used to compute basic and diluted loss per share		30,375,402			28,277,500

The accompanying notes are an integral part of these statements.

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2007


	Common Stock Shares	Common 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	—		—		407,058		—			—			—			407,058
Foreign currency translation	—		—		—		(66,550	)		—			—			(66,550	)
Issuance of common stock upon exercise of employee stock options	40,000		40		52,760		—			—			—			52,800
Net loss	—		—		—		—			—			(2,784,961	)		(2,784,961	)

Balance, June 30, 2007	30,405,236	$	30,406	$	67,883,587	$	(419,178	)	$	(100,000	)	$	(57,597,635	)	$	9,797,180

The accompanying notes are an integral part of this statement.

EP MEDSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	For the Six Months Ended
	June 30, 2007			June 30, 2006
Cash flows from operating activities:
Net loss	$	(2,784,961	)	$	(3,707,612	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		500,943			374,554
Accretion of note discount		4,509			4,864
Amortization of beneficial conversion feature		9,431			10,181
Non cash expenses in connection with issuance of options to consultant		—			196,480
Share-based compensation		407,058			384,360
Bad debt (recovery) expense		(88,000	)		26,000
Changes in assets and liabilities:
Decrease in accounts receivable		303,344			191,085
Increase in inventories		(966,410	)		(248,388	)
Decrease in prepaid expenses and other assets		38,031			38,572
Increase (decrease) in accounts payable		334,935			(343,953	)
(Decrease) Increase in accrued expenses and deferred revenue		(619	)		56,398

Net cash used in operating activities	$	(2,241,739	)	$	(3,017,459	)

Cash flows from investing activities:
Capital expenditures		(159,154	)		(86,469	)
Patent costs		(29,807	)		(27,336	)

Net cash used in investing activities	$	(188,961	)	$	(113,805	)

Cash flows from financing activities:
Proceeds from issuance of common stock, net of offering expenses		—			9,479,149
Proceeds from exercised stock options		52,800			—

Net cash provided by financing activities	$	52,800		$	9,479,149

Effect of exchange rate changes		(66,550	)		(118,929	)
Net (decrease) increase in cash and cash equivalents		(2,444,450	)		6,228,956
Cash and cash equivalents, beginning of period		7,743,239			5,180,001

Cash and cash equivalents, end of period	$	5,298,789		$	11,408,957

Supplemental cash flow information
Cash paid for interest	$	56,416		$	93,069

The accompanying notes are an integral part of these statements.

EP MEDSYSTE MS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Note 1. Basis of Presentation

General

The terms “we,” “our,” “us,” “Company” and “EP MedSystems” refer to EP MedSystems, Inc., a New Jersey corporation, and its subsidiaries unless the context suggests otherwise.

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 accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent liabilities, and the reported amounts of revenues and expenses. Significant estimates affecting amounts reported or disclosed in the financial statements include allowances for doubtful accounts receivable and sales returns, net realizable value of inventories, estimates of future cash flows associated with long-lived asset valuations, depreciation and amortization periods for long-lived assets and fair value estimates of stock-based compensation awards, among others. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the current circumstances. Actual results could differ from these 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission.

Our cash and cash equivalents were approximately $5.3 million and $7.7 million as of June 30, 2007 and December 31, 2006, respectively. 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 through December 31, 2007. We will continue to rely on outside sources of financing to meet our long-term capital needs, including the repayment of $2,000,000 face amount of convertible debt which matures on February 28, 2008. However, 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 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 June 30, 2007 and December 31, 2006:


	June 30, 2007 (unaudited)			December 31, 2006
Raw materials	$	1,530,000		$	1,488,000
Work in process		262,000			166,000
Finished goods		2,096,000			1,492,000
Reserve for obsolescence		(248,000	)		(286,000	)

	$	3,640,000		$	2,860,000

Note 3. Notes payable

The Company has a $2,000,000 Secured Convertible Note (the “Convertible Note”) payable to Laurus Master Fund Ltd. (“Laurus”) which matures on February 28, 2008. The loan is a revolving asset-based credit facility secured by the accounts receivable, inventory, real property and other assets of the Company, excluding intellectual property. The Convertible Note bears interest at the prime rate, 8.25% at June 30, 2007. The interest rate will increase if the Company’s allowable accounts receivable are not sufficient to satisfy the advance requirements under the loan agreement.

The Convertible Note was originally issued on August 28, 2003 in the face amount of $4,000,000 with an initial term of three years. On November 9, 2005, the Convertible Note’s maturity date was extended to February 28, 2008. The net proceeds of the Convertible Note were used for working capital purposes and payment of outstanding debt.

Subject to certain volume limitations and other conditions, 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 exceeded $2.55 per share for 11 consecutive trading days. On December 15, 2004, the first $2,000,000 of the principal amount was converted into approximately 694,000 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. In March of 2006, the 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, in connection with a private placement consummated by the Company. The anti-dilution provisions allow for further adjustment of the conversion price in the event of additional dilution.

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 30,405,236 and 30,365,236 shares were issued and 50,000 shares were held in Treasury Stock at June 30, 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 interest rate of 4.82%, expected volatility percentage of 84.23% and an expected life of 10 years.

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.

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 transactions 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. Stock options issued under the plans become exercisable over specified periods, generally within five years from the date of grant and generally expire ten years from the grant date. Share-based compensation of $193,000 and $192,000 or $0.01 per share was recognized for the three months ended June 30, 2007 and 2006, respectively. Additionally, share based compensation of $407,000 and $384,000 or $0.01 per share was recognized for the six month period ended June 30, 2007 and 2006, respectively. The Company anticipates that share-based compensation for its employees will not exceed $1,000,000 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 during the three months ended June 30, 2007: expected volatility of 82%; risk-free interest rate of 4.96% and an expected life of 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 region for the three and six months ended June 30, 2007 and 2006.


	For The Three Months Ended June 30,				For The Six Months Ended June 30,
	2007		2006		2007		2006
United States	$	3,573,000	$	2,256,000	$	6,051,000	$	4,921,000
Europe/Middle East		583,000		762,000		1,347,000		1,125,000
Asia and Pacific Rim		191,000		294,000		493,000		1,344,000

	$	4,347,000	$	3,312,000	$	7,891,000	$	7,390,000

The following table sets forth product sales by product line for the three and six months ended June 30, 2007 and 2006.


	For The Three Months Ended June 30,				For The Six Months Ended June 30,
	2007		2006		2007		2006
EP-WorkMate^® platform	$	3,644,000	$	2,782,000	$	6,802,000	$	6,402,000
ViewFlex^TM catheters and ViewMate^® II ultrasound systems		485,000		275,000		684,000		526,000
ALERT^® System		168,000		168,000		293,000		303,000
Diagnostic EP catheters and other		50,000		87,000		112,000		159,000

	$	4,347,000	$	3,312,000	$	7,891,000	$	7,390,000

EP MedSystems’ long-lived assets are primarily located in the United States. One customer accounted for 13% of the Company’s sales for the three months ended June 30, 2007. Two customers accounted for 14% and 12% of the Company’s sales for the six months ended June 30, 2006, respectively. One customer accounted for 14% of the gross outstanding accounts receivables at June 30, 2007 and 2006, respectively.

Net sales for the six months ended June 30, 2007 were billed in two currencies: $7,474,000 in U.S. dollars and the equivalent of $417,000 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 $419,000 as of June 30, 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 each period presented, 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 4,204,000 and 3,277,000 as of June 30, 2007 and 2006, respectively, have been excluded from the diluted per share calculation.

Note 8. Comprehensive Income/Loss

For the three and six months ended June 30, 2007 and 2006, EP MedSystems’ comprehensive loss consisted of net loss and foreign currency translation adjustments. The comprehensive losses for the three and six months ended June 30, 2007 were approximately $1,347,000 and $2,852,000, and for the three and six months ended June 30, 2006, $2,322,000 and $3,827,000, respectively.

Note 9. Income Taxes

EP MedSystems accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (SFAS No. 109). SFAS 109 requires the Company to recognize income tax benefits for the loss carryforwards, which have not previously been recorded. At June 30, 2007, a valuation allowance has been recognized to offset all deferred tax assets related to these carryforwards. At December 31, 2006, the Company had approximately $49,000,000 of federal net operating loss carryforwards available to offset future income. The federal carryforwards expire between 2009 and 2026. Due to ownership changes that occurred, as defined by Section 382 of the Internal Revenue Code, the Company may be limited in the use of net operating losses.

Note 10. 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.

On February 15, 2007, the FASB issued SFAS Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (SFAS 159). 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.

Note 11. 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 these 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, the Company reached a settlement agreement with the Department of Commerce which required the Company to make a payment of $244,000 without admitting or denying guilt. In the first quarter of 2007, the Company reached a settlement agreement with the Department of the Treasury which required the Company to make a payment of $33,000 without admitting or denying guilt.

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. We have not received any communication from the SEC regarding this informal inquiry since February, 2006.

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. 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. On April 24, 2007, the Company was informed that the FDA had audited the recall and considered it terminated for the domestic units.

Income Taxes

The Company is 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.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes thereto appearing elsewhere in this report and our consolidated financial statements for the year ended December 31, 2006 included in our Annual Report on Form 10-K.

Overview

EP MedSystems develops, manufactures, markets and sells 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 in 1993, we have acquired technology and marketing rights, have developed new products and have begun marketing various electrophysiology products, including our EP-WorkMate^® computerized electrophysiology workstation, our EP-4™ Computerized Cardiac Stimulator, diagnostic electrophysiology catheters (including our unique one-piece catheter), the ALERT^® System (including the ALERT^® Companion II and ALERT^® family of internal cardioversion catheters), ViewMate^® and ViewMate II intracardiac ultrasound catheter system.

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 six months ended June 30, 2007 and 2006, the EP-WorkMate^® platform accounted for approximately 86% and 87%, respectively, of our total sales.

We have also developed an intracardiac echo (ultrasound or ICE) ultrasound catheter system, including the ViewFlex^TM intracardiac imaging catheters and ViewMate^® II ultrasound imaging console. These products offer high-resolution, real-time ultrasound imaging capability designed to improve a physician’s or clinician’s ability to visualize anatomy and devices inside the chambers of the heart. We believe the ViewFlex^TM catheters and ViewMate^® II Ultrasound systems may play an important role for a broad range of potential applications in electrophysiology and cardiology. Sales of the ViewFlex™ catheters and related ViewMate^® II systems accounted for approximately 9% and 7% of our total sales revenue in the six months ended June 30, 2007 and 2006, respectively. In April, 2007, we launched for sale 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, we have exclusive rights to sell this platform in hospital EP and Cath labs, and Philips may offer the ICE option to its customers in

cardiac ultrasound and other hospital departments on the HDII XE ultrasound system, providing additional platforms capable of using 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 4% of our total sales revenues for the six months ended June 30, 2007 and 2006, respectively. 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 six months ended June 30, 2007 and 2006, respectively.

We have three sales channels: Direct sales to customers, sales to independent distributors, and sales to alliance partners. We invest substantial resources and management effort in our sales organizations and sales and marketing expenses represent our largest cost center.

We manage our product groups and distribution channels on a centralized basis. Accordingly, we report our financial results under a single operating segment — the development, manufacturing and distribution of medical devices.

Results of Operations.

Six Months Ended June 30, 2007 versus June 30, 2006

The Company had net sales of $7,891,000 for the six months ended June 30, 2007, as compared to $7,390,000 for the comparable period in 2006. This $501,000 (or 7%) increase was primarily due to increased sales of our EP-WorkMate^® platform and new integrated NurseMate and MapMate product features. We also had higher sales of EP-4™ Stimulators and other EP-WorkMate^® warranties, upgrades and peripheral products as compared to the same period in 2006. Sales of ultrasound products increased by 30% to $684,000 during the six months ended June 30, 2007 as compared to the same period in 2006 due to the introduction of the ViewMate II ultrasound system based on Philips Medical Systems’ HDII XE platform in April, 2007. Overall sales to the Asia Pacific market declined by $850,000 during the six months ended June 30, 2007 as compared to June 30, 2006. This decline occurred because sales in the six month period ended June 30, 2006 were favorably impacted by a $705,000 one-time upgrade program by our Japanese distributor, which did not recur in 2007. Total domestic sales and European/Middle Eastern sales increased by approximately 22% and 20% during the six months ended June 30, 2007 as compared to 2006.

Gross profit on sales for the six months ended June 30, 2007 was $5,170,000, an increase of 13%, as compared with $4,557,000 for the same period in 2006. Gross profit as a percentage of sales was 66% as compared to 62% in the first six months of 2006. The increase in gross margin can be attributed to several factors including, the introduction of new product features which are integrated into our existing EP-WorkMate^® platform. In addition, the 2007 period included a higher percentage of domestic sales, which have a higher gross margin than international sales. Also, the June 30, 2006 period included approximately $50,000 in costs associated with our field action recall.

Sales and marketing expenses decreased $140,000, or 3%, to $4,830,000 for the six months ended June 30, 2007 as compared to the same period in 2006. Costs for our clinical affairs activities decreased by $591,000 versus the six month period ended June 30, 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 not pursuing additional clinical studies at this time. There was also a reduction of approximately $100,000 in bad debt expenses during the six months ended June 30, 2007 associated with the recovery of a previously written-off debt. The decreases in these costs were partially offset by increases of approximately $425,000 in compensation, benefits and travel costs for additional headcount and other sales activities, including increased sales and marketing efforts of the ViewMate II intracardiac ultrasound catheter system.

General and administrative expenses decreased $226,000, or 12%, to $1,730,000 for the six months ended June 30, 2007, as compared to the same period in 2006. The primary cause was a $215,000 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. Additionally, the six month period ended June 30, 2006 included an expense of approximately $345,000 for fines and penalties related to the Commerce Department settlement. These decreases in administrative costs were partially offset by increased compensation costs of $315,000, including stock option expense, related to the hiring of a new Chief Executive Officer in the third quarter of 2006 and Chief Financial Officer in the second quarter of 2007.

Research and development expenses increased $44,000 (or 3%) to $1,423,000 for the six months ended June 30, 2007 as compared to the same period in 2006. We expect the level of research and development spending to increase slightly as we continue to undertake projects to develop new products and make improvements to existing ones.

Interest and other income decreased by $7,000 or 4% to $157,000 for the six months ended June 30, 2007 as compared to the same period in 2006. The decrease was a result of lower cash balances in the second quarter of 2007 as compared to 2006.

Interest expense increased $5,000 or 4% to $129,000 for the six months ended June 30, 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.

Three Months Ended June 30, 2007 versus June 30, 2006

The Company had net sales of $4,347,000 for the three months ended June 30, 2007, as compared to $3,312,000 for the comparable period in 2006 representing an increase of $1,035,000, or 31%. During the three months ended June 30, 2007, we experienced increased sales of our EP-WorkMate^® platform and new integrated NurseMate and MapMate product features. We also had higher sales of EP WorkMate warranties, upgrades and peripheral products as compared to the same period in 2006. Sales of ultrasound products increased by 77% to $485,000 during the three months ended June 30, 2007 as compared to the same period in 2006 due to the launch of the ViewMate II ultrasound system based on Philips Medical Systems’ HDII XE platform in April, 2007. Overall sales to the Asia Pacific and European markets declined by $102,000 and $179,000, respectively during the three months ended June 30, 2007 as compared to June 30, 2006. Total domestic sales increased by approximately $1,300,000 during the three months ended June 30, 2007 as compared to 2006.

Gross profit on sales for the three months ended June 30, 2007 was $2,783,000 as compared with $2,068,000 for the same period in 2006. Gross profit as a percentage of sales was 64% during the three months ended June 30, 2007, as compared to 62% in the second quarter of 2006. The increase in gross margin can be attributed to several factors including, the introduction of new product features which are integrated into our existing EP WorkMate platform. The 2007 period also included a higher percentage of domestic sales, which have a higher gross margin than international sales.

Sales and marketing expenses decreased $36,000 (or 1%) to $2,520,000 for the three months ended June 30, 2007 as compared to the same period in 2006. Costs for our clinical affairs activities decreased by $274,000 versus the three month period ended June 30, 2007. We completed phase I of our ICE Chip study in 2006 and funded the data analysis in the first quarter of 2007. We are not pursuing additional clinical studies at this time. This decrease in costs was partially offset by increases of approximately $183,000 in compensation, benefits and travel costs for additional headcount and other sales activities, including increased sales and marketing efforts of the ViewMate II intracardiac ultrasound catheter system.

General and administrative expenses decreased $309,000 (or 28%) to $784,000 for the three months ended June 30, 2007, as compared to the same period in 2006. The primary cause was a $102,000 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. Additionally, the three month period ended June 30, 2006 included an expense of approximately $345,000 for fines and penalties related to the Commerce Department settlement. These decreases in administrative costs were partially offset by increased compensation costs of $160,000, including stock option expense, related to the hiring of a new Chief Executive Officer in the third quarter of 2006 and Chief Financial Officer in the second quarter of 2007.

Research and Development costs increased $77,000 (or 11%) to $758,000 for the three months ended June 30, 2007 as compared to the same period in 2006. We expect the level of research and development spending to increase modestly as we continue to undertake projects to develop new products and make improvements to existing ones.

Interest and other income decreased by $44,000 (or 40%) to $68,000 for the three months ended June 30, 2007 as compared to the same period in 2006. The Company completed a private placement at the end of the first quarter of 2006 which led to higher interest income in the three months ended June 30, 2006.

Interest expense increased $1,000 to $65,000 for the three months ended June 30, 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 $57.6 million at June 30, 2007. Our cash and cash equivalents were approximately $5.3 million and $7.7 million as of June 30, 2007 and December 31, 2006, respectively. 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 will continue to rely on outside sources of financing to meet our long-term capital needs, including the repayment of $2,000,000 face amount of convertible debt which matures on February 28, 2008. However, 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 and general and administrative activities.

Financing Activities

During May, 2007, the Company received $52,800 in proceeds from the exercise of employee stock options.

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 and Investing Activities

Net cash used in operating activities for the six months ended June 30, 2007 was $2,242,000 as compared to a use of cash in operations of $3,017,000 during the same period in 2006. The decrease in our cash used in operations was primarily due to the decrease in our net loss, which was $2,785,000 for the six months ended June 30, 2007 as compared to $3,708,000 during the same period in 2006. Also, inventory increased by $966,000 as we have increased stock to support higher sales activity of our EP WorkMate and to support increased sales and marketing efforts of the ViewMate II intracardiac ultrasound catheter system. These uses of funds were offset by a decrease in accounts receivable of $215,000, an increase in accounts payable of $335,000, and we had non-cash share based compensation costs of $407,000.

Capital expenditures were $159,000 for the six months ended June 30, 2007 as compared to $86,000 for the same period in 2006. We do not expect the rate of capital equipment purchases to increase significantly during the remainder of 2007. We lease office space and certain office equipment under operating leases.

We evaluate the collectibility 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.

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.

Summary of Contractual Obligations

The following table summarizes our contractual cash obligations at June 30, 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)	$	191,000	$	111,000	$	80,000	$	0	$	0
Other Long Term Obligations (3)	$	0	$	0	$	0	$	0	$	0

Total Contractual Cash Obligations	$	2,191,000	$	2,111,000	$	80,000	$	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.

Off-Balance Sheet Arrangements

As of June 30, 2007, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

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.

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.

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 the Notes to the Consolidated Financial Statements filed on the Company’s Form 10-K 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. The critical accounting estimates included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 have not materially changed.

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.

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 the 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 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 June 30,						For The Six Months Ended June 30,
	2007			2006			2007			2006
Beginning balance	$	267,000		$	318,000		$	272,000		$	313,000
Warranties		52,000			49,000			131,000			147,000
Warranty payments		(58,000	)		(76,000	)		(142,000	)		(169,000	)

Ending balance	$	261,000		$	291,000		$	261,000		$	291,000

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. 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;

•

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.

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 June 30, 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 June 30, 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 June 30, 2007, we estimate that the fair value of investment portfolio would decline by an immaterial amount.

Foreign Currency Risk

Our international revenues were 23% and 33% of our total revenues in the six months ended June 30, 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 six months ended June 30, 2007, approximately 5% 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 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 reached a settlement agreement with the Department of the Treasury for a payment of $33,000 without admitting or denying guilt, which had been accrued in 2006.

Item 1A. Risk Factors.

None.

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

(a) Not applicable

(b) 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 22 herein.

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: August 14, 2007	By:	/s/ David I. Bruce
		David I. Bruce
		President and Chief Executive Officer (Principal Executive Officer)


Date: August 14, 2007	By:	/s/ James J. Caruso
		James J. Caruso Chief Financial Officer (Principal Financial and Accounting Officer)

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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EP MEDSYSTEMS INC 10-Q