** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM10-KSB/A**

 
| **ý** | **ANNUAL REPORT  UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR  THE FISCAL YEAR ENDED APRIL 30, 2005** |
|------------|-------------------------------------------------------------------------------------------------------------------------------|

** **
| **o** | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------|

** **

**CommissionFile Number 000-33295**

 

**MedicalCV, Inc.**

(Name of Small BusinessIssuer in Its Charter)

 

| **Minnesota**                                                    | ** ** | **41-1717208**                         |
|------------------------------------------------------------------|------------|----------------------------------------|
| (State or Other Jurisdiction of   Incorporation or Organization) |       | (I.R.S. Employer   Identification No.) |
| ** **                                                       | ** ** | ** **                             |
| **9725 South Robert Trail,   Inver Grove Heights, Minnesota**    | ** ** | **55077**                              |
| (Address of Principal Executive Offices)                         |       | (Zip Code)                             |

 

**(651) 452-3000**

(Issuer’s Telephone Number, Including Area Code)

** **

Securities registered under Section 12(b) of the Exchange Act:

**None**

 

Securities registered under Section 12(g) of the Exchange Act:

**CommonStock ($0.01 par value)**(Title ofClass)

 

Check whetherthe issuer is not required to file reports pursuant to Section 13 or 15(d) ofthe Exchange Act.  o

 

Checkwhether the issuer:  (1) filed allreports required to be filed by Section 13 or 15(d) of the Exchange Act duringthe past 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes ý  No o

 

Checkif there is no disclosure of delinquent filers in response to Item 405 ofRegulation S-B contained in this form, and no disclosure will be contained, tothe best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-KSB or anyamendment to this Form 10-KSB.  o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).Yes o  No  ý

 

The issuer’srevenues for its most recent fiscal year were $2,304,897.

 

Theaggregate market value of the common equity held by non-affiliates of theissuer as of July 20, 2005, was approximately $6,820,792, based upon the lastsale price of one share on such date.

 

As ofJuly 20, 2005 the issuer had outstanding 11,253,333 shares of common stock and17,835 shares of convertible preferred stock.

** **

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Certaininformation required by Part III of this document is incorporated by referenceto specified portions of the registrant’s definitive proxy statement for theannual meeting of shareholders held September 22, 2005.

 

**PURPOSE OF AMENDMENT**

 

The followingitems are being amended in this Form 10-KSB/A: Items 5, 6 and 7.  In addition toaddressing certain typographical errors, this amendment is being filed (1) toaddress a transposition error in the provision recorded during fiscal year 2005to reduce the carrying value of heart valves in MD&A, (2) to conform cashused in operating activities during fiscal year 2005 in MD&A to the entryin the financial statements, (3) to amend an MD&A reference to the increasein inventory during fiscal year 2005, (4) to amend a subtotal that does notproperly foot on the statement of operations, (5) to amend an erroneous captionon a discontinued operations chart within footnote 4 to the financialstatements, and (6) to amend various entries on a stock option chart withinfootnote 9 to the financial statements. The first and second of these matters were previously addressed on ourForm 10-KSB/A filed on August 25, 2005.

 

 

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**TABLEOF CONTENTS**

 
| PART  I           |   |                                                                                                              |   |
|-------------------|--------|-------------------------------------------------------------------------------------------------------------------|--------|
|              |   |                                                                                                              |   |
| ITEM 1            |   | DESCRIPTION  OF BUSINESS                                                                                          |   |
| ITEM 2            |   | DESCRIPTION  OF PROPERTY                                                                                          |   |
| ITEM 3            |   | LEGAL  PROCEEDINGS                                                                                                |   |
| ITEM 4            |   | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                               |   |
|              |   |                                                                                                              |   |
| PART II           |   |                                                                                                              |   |
|              |   |                                                                                                              |   |
| ITEM 5            |   | MARKET FOR COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND  SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES   |   |
| ITEM 6            |   | MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION                                                    |   |
| ITEM 7            |   | FINANCIAL STATEMENTS                                                                                              |   |
| ITEM  8           |   | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                             |   |
| ITEM 8A           |   | CONTROLS AND PROCEDURES                                                                                           |   |
| ITEM 8B           |   | OTHER INFORMATION                                                                                                 |   |
|              |   |                                                                                                              |   |
| PART III          |   |                                                                                                              |   |
|              |   |                                                                                                              |   |
| ITEM 9            |   | DIRECTORS, EXECUTIVE OFFICERS,  PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a)  OF THE EXCHANGE ACT |   |
| ITEM 10           |   | EXECUTIVE COMPENSATION                                                                                            |   |
| ITEM 11           |   | SECURITY OWNERSHIP OF CERTAIN  BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS                   |   |
| ITEM 12           |   | CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS                                                                   |   |
| ITEM 13           |   | EXHIBITS                                                                                                          |   |
| ITEM 14           |   | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                            |   |
|              |   |                                                                                                              |   |
| SIGNATURES        |   |                                                                                                              |   |
| INDEX TO EXHIBITS |   |

 

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*The following discussion containsvarious forward-looking statements within the meaning of Section 21E of theExchange Act.  Although we believe that,in making any such statement, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could causeactual outcomes and results to be materially different from thoseprojected.  When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements.  These forward-looking statements are subjectto numerous risks and uncertainties that could cause actual results to differmaterially from those anticipated. Factors that could cause actual results to differ materially from thoseanticipated, certain of which are beyond our control, are set forth under thecaption “Management’s Discussion and Analysis or Plan of Operation — CautionaryStatement.”*

* *

*Our actual results, performanceor achievements could differ materially from those expressed in, or implied by,forward-looking statements.  Accordingly,we cannot be certain that any of the events anticipated by forward-lookingstatements will occur or, if any of them do occur, what impact they will haveon us.  We caution you to keep in mindthe cautions and risks described in our Cautionary Statement and to refrainfrom attributing undue certainty to any forward-looking statements, which speakonly as of the date of the document in which they appear.*

* *

**PARTI**

** **

**ITEM 1**                   DESCRIPTION OF BUSINESS

** **

**Overview**

** **

MedicalCV, Inc. is acardiovascular surgery device manufacturer. Previously, our primary focus was on heart valve disease.  We developed and marketed mechanical heartvalves known as the Omnicarbon® 3000 and 4000 heart valves.  In November 2004, after an exhaustiveevaluation of the heart valve business, we discontinued all heart valve relatedproduction and began to pursue options for exiting the heart valve business.  On April 8, 2005, we announced that our effortsto find a buyer for the heart valve business were unsuccessful and that wewould stop selling heart valves and were exiting the heart valve business.  At that time, we also determined to directour resources to the development and introduction of products targeting thetreatment of atrial fibrillation, or AF.

 

Atrial fibrillation is themost commonly occurring cardiac arrhythmia. It reduces cardiac output, is a major precursor to congestive heartfailure and is associated with an increased incidence of stroke.  The incidence of AF increases with age.  Approximately 5.5 million people worldwideare afflicted with AF.  There are 320,000new diagnoses annually worldwide. Approximately 2.5 million Americans are afflicted with AF, with 160,000new diagnoses each year in the U.S.

 

In August 2003, we enteredinto an agreement with LightWave Ablation Systems, Inc. (“LightWave”), topurchase technology for the treatment of atrial fibrillation.  We believe this technology will provide animportant growth platform.  On December1, 2004, we received FDA 510(k) clearance to market our ATRILAZETM SurgicalAblation System, which is a medical device designed for ablating cardiac tissueduring surgery.

 

The ATRILAZE system was usedby two cardiovascular surgeons to ablate cardiac tissue in five humanconcomitant open-heart surgical procedures during January and February2005.  We did not generate any revenuefrom these procedures.  The ATRILAZEsystem was provided at no cost to these surgeons for proof-of-concept in the clinicalsetting, prior to commencing clinical sales of the ATRILAZE system.  We expect to continue validating ourtechnology with key cardiovascular surgeons 

 

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during concomitant open-heartprocedures.  We expect to begin sellinghand-held devices for these procedures on a limited basis beginning in fiscalyear 2006.  We do not expect significantrevenue until we introduce a version of the ATRILAZE system for stand-alone,minimally invasive (closed-chest, beating heart) ablation of cardiac tissue.

 

During the second and thirdquarters of fiscal year 2005, we experienced a significant decline in sales ofour heart valves, which we believe was the result of our decision to requireprepayment or letters of credit for all sales to distributors to protect us againstcollection risks and our focus on exiting the heart valve business.  As a result of these factors, we determined,during the second quarter of fiscal year 2005, that these sales trendsindicated that we had excess inventories as well as inventories with carryingvalues in excess of their realizable values. Accordingly, during fiscal year 2005, we recorded a $2,573,656 reductionin the carrying value of certain heart valve inventories.  This reduction in carrying value was recordedas a charge to discontinued operations.

 

MedicalCV was incorporatedin Minnesota on March 30, 1992, under the name CV Dynamics, Inc.

 

**AF Treatment Options**

** **

The AF market remains alarge, undefined market opportunity. Because of the various success rates of the below-described currenttreatments for AF this market is referred to by some as a “chaotic market” withsubstantial opportunity for treatment solutions.

 

•              *Medical Treatment* – Antiarrhythmic and anticoagulant drugs areused initially to treat AF and are administered by cardiologists.  This first line treatment is a palliativetreatment and has a failure rate of 50 percent at 1 year and 84 percent at 2years.  Cardioversion is another treatmentoption and it is separated into two types, electrical and chemical.  The major concern with medical treatment isthat there are significant quality of life issues in regards to the sideeffects of the various drugs.  Inparticular, the anticoagulant drugs that are administered to prevent a strokefrom occurring significantly alters the lifestyle of those patients due to theincreased risk of uncontrolled bleeding.

 

•              *Interventional* – The interventional approach is thesecondary treatment of AF and is performed by electrophysiologists, aspecialized type of cardiologist.  Theinterventional techniques consist of percutaneous approaches utilizingcatheter-based technologies with various energy sources to form lesions ofablation to mirror the curative surgical procedure known as the Maze.  This second line treatment is also consideredto be palliative treatment and has a success rate of 40 to 60 percent.

 

•              *Surgical* – The Maze procedure is the final approachto treat AF.  The procedure is performedin the operating room and it is described as “maximally invasive.”  This cut and sew/disassemble and reassemblesurgical procedure is curative and has a success rate of 97 percent.  However, this procedure is still associatedwith the morbidity and mortality risks that are true of any open-heart surgicalprocedure.  More importantly, very fewcardiovascular surgeons perform this time-consuming and technically difficultprocedure.

 

The AF annual market foropen-chest surgical procedures is expected to reach $250 million worldwide by2008.  The AF annual market forstand-alone, minimally invasive (closed-chest, beating heart) surgicalprocedure revenue is expected to reach $1.5 billion worldwide by 2008,according to Health Research International’s October 2002 market report.

 

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We launched our coretechnology for proof-of-concept in the human clinical setting in January2005.  With our presence in thecardiovascular surgery market, we intend to move during the next 12 to 18months to define the market and develop a stand-alone, minimally invasive(closed-chest, beating heart) surgical procedure for ablating cardiac tissueand as a means to treat AF.

 

**The ATRILAZE Solution To Address Large and GrowingMarket**

** **

We believe that our ATRILAZETMSurgical Ablation System, when configured for stand-alone, minimally invasive(closed-chest, beating heart) surgical procedures, meets a needed solution incardiovascular surgery and the atrial fibrillation market.  The prevalence of AF grows markedly with anaging population.  Two-thirds of allpeople afflicted with AF are more than 70 years of age.  This growing market is in need of atechnology that provides an improved procedure with better outcomes.  Laser technology is already being used in numeroussurgical procedures.  Laser energy isbeing used extensively in cosmetic and aesthetic procedures including:  cosmetic skin resurfacing, psoriasis andeczema treatment (skin disorders), hair removal, tattoo removal and varicosevein treatment.  These procedures can beperformed in a physician’s office and represent a completely outpatientapplication of similar underlying laser technology, although our solution willbe used in operating rooms and not in physicians’ offices.  In addition, cardiovascular surgeons haveimplemented trans-myocardial revascularization (“TMR”) in their open-chestprocedures.  The diode laser we utilizeto treat AF is small and we expect it to be more readily accepted in theoperating room setting than existing TMR laser systems.  We believe our most significant near-termopportunity is in the concomitant open-heart and open-chest settings.  Conservatively, there are 300,000 open-chestprocedures done in the U.S. annually. Twenty percent, or 60,000, of those open-chest patients are afflictedwith AF and require AF treatment.  Inaddition, approximately 25 percent of all patients undergoing heart valvesurgery are also afflicted with AF.

 

**Minimally Invasive Cardiovascular Surgery –Stand-Alone Procedure**

** **

The standard for curativetreatment of atrial fibrillation is known as the Maze procedure.  This is a “maximally invasive” procedure thatis routinely done as a concomitant procedure that requires cracking thesternum; opening the patient’s chest; placing the patient on the heart-lungmachine; stopping the heart; and disassembling and reassembling the atrialchambers of the heart.  This is done tocreate lesion lines via the surgeon’s scalpel to interrupt the erraticelectrical energy that causes AF.  Thisis a technically difficult and time-consuming procedure.  The postoperative recovery times as well asthe morbidity and mortality risks of this procedure are significant.

 

During the last severalyears, newer minimally invasive techniques have gained momentum as they havebeen proven to lower costs, have higher reimbursements, reduce patient traumaand provide better outcomes.  We believethat as a result, these procedures are being used more frequently and representone of the fastest growing segments within the cardiovascular surgerymarket.  In particular, we seesignificant opportunities in minimally invasive (closed-chest, beating heart)surgical procedures.  Closed-chestprocedures are done utilizing robotic and thoracoscopic techniques.  The technology of robotic and thoracoscopicinstrumentation has allowed the cardiovascular surgeon access through ports withthree-dimensional visualization.  Thistechnology allows the cardiovascular surgeon’s hands to be placed inside thepatient’s closed-chest cavity via instrumentation and view the cardiac anatomyas in an open-chest setting.  Our coretechnology incorporates a low-profile, ergonomic hand-held laser deliverydevice or probe for cardiac tissue ablation that we are developing into a minimallyinvasive product.  Based upon benchtesting by several leading surgeons, anecdotal feedback indicates that ourATRILAZE Surgical Ablation System can deliver high quality ablation lesionsthat mimic that of a surgeon’s scalpel. We believe that an ideal stand-alone, minimally invasive surgicalprocedure demands an outcome that mimics that of the standard Maze, takeslittle time and is easy to perform.

 

3

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**Alternative Energy Sources for Ablation**

** **

There are currently a widevariety of energy sources that are used to ablate cardiac tissue.  These different energy sources are availableto both the interventional and surgical treatments of AF:

 

•              *Cryothermy* – also referred to as cryoenergy or simply “cryo.”  This type of energy uses either a catheter orhand-held probe to ablate cardiac tissue by freezing at extreme temperatures(up to negative 160oC).

 

•              *Radiofrequency* – Unipolar – also referred to as RF.  This type of energy uses either a catheter orhand-held probe or pen to ablate cardiac tissue by using heat from radio waves,the same radio waves used in A.M. radios.

 

•              *Radiofrequency* – Bipolar – also referred to as BPRF.  This type of energy uses a hand-held clampdevice with two poles to ablate cardiac tissue by using heat from radio waves,the same radio waves used in A.M. radios.

 

•              *Microwave* – This type of energy uses either a catheteror hand-held probe to ablate cardiac tissue by using heat from microwaves, thesame energy produced in the household microwave.

 

•              *Ultrasound* – sometimes referred to as high-intensity,focused ultrasound, or HIFU.  This typeof energy uses either a catheter or hand-held probe to ablate cardiac tissue byusing heat from ultrasonic energy.

 

•              *Laser* – also referred to as light energy orphotocoagulation.  This type of energyfunctions at varying wavelengths and uses either a catheter or hand-held deviceto ablate cardiac tissue by using volumetric heating.

 

**The MedicalCV Solution**

** **

Our ATRILAZE system uses thesurgeon’s skill, experience and judgment to perform surgical cardiac tissueablation procedures, thus creating lines of electrical blockage for thetreatment of AF.  The precision,placement and control of the surgical cardiac tissue ablation process remainsentirely in the surgeon’s hands.  Webelieve that our ATRILAZE system will eliminate the inherent flaws ofalternative energy sources, including lateral thermal spread, lack of precisecontrol of the energy, and cumbersome surgical tools with bulky, intrusiveenergy sources.  The table below setsforth the features and what we believe to be the benefits and advantages of ourATRILAZE Surgical Ablation System.

** **
| **Features**           | ** ** | **Benefits**                                                                                         | ** ** | **Advantages**                            |
|------------------------|------------|------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|
| **Narrow  Beam**       | ** ** | **Accurate  Lesion (3mm)***Scapel  Precision*                                                        | ** ** | **Mimics  surgical Maze**                 |
| ** **             | ** ** | ** **                                                                                           | ** ** | ** **                                |
| **Directed  Energy**   | ** ** | **Surgeon  precision   Control of** *Laser Scalpel*  **remains in   surgeon’s hands** | ** ** | **No  collateral damage**                 |
| ** **             | ** ** | ** **                                                                                           | ** ** | ** **                                |
| **Contact  Forgiving** | ** ** | **Easy  to use**                                                                                     | ** ** | **Excellent  transmurality   Atraumatic** |
| ** **             | ** ** | ** **                                                                                           | ** ** | ** **                                |
| **Ideal  Wavelength**  | ** ** | **Depth  control**                                                                                   | ** ** | **Transmurality    Target ablation**      |
| ** **             | ** ** | ** **                                                                                           | ** ** | ** **                                |
| **Coherent  Light**    | ** ** | **Beating  heart**                                                                                   | * *   | *Minimally  Invasive Procedure*           |
| ** **             | ** ** | ** **                                                                                           | * *   | * *                                  |
| **Rapid**              | ** ** | **Stopped  heart / Less pump time  Beating heart / Less procedure time**                             | * *   | *Minimally  Invasive Procedure*           |
| ** **             | ** ** | ** **                                                                                           | * *   | * *                                  |
| **Low-Profile**        | ** ** | **Closed-chest**                                                                                     | * *   | *Minimally  Invasive Procedure*           |
| ** **             | ** ** | ** **                                                                                           | * *   | * *                                  |
| **Cost  Effective**    | ** ** | **Hospital  pressure sensitivity**                                                                   | ** ** | **Low  barriers to entry**                |

 

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**The MedicalCV Strategy**

** **

MedicalCV intends torevolutionize the atrial fibrillation market by establishing its products asthe standard of care for targeted stand-alone, minimally invasive(closed-chest, beating heart) surgical procedures addressing atrialfibrillation treatment.  Key elements ofthis strategy are:

 

•              **Capitalize on the large,undefined, chaotic atrial fibrillation market. **During the pastdecade, more and more interventional and surgical technologies have gainedmarket acceptance as they all promote the promise of achieving better than 80percent success rates or curing atrial fibrillation completely.  As a result, this is one of largest growingsegments in cardiovascular surgery and interventional cardiology.  Our ATRILAZE system allows the surgeon toachieve a high quality result with the creation of cardiac tissue ablationlesions and to mimic the surgical (cut and sew/disassemble and reassemble) Mazeprocedure.  The similarity of the laserto the surgical scalpel ensures the effectiveness of the technology.  We believe that this will lead to rapidacceptance and adoption in concomitant open-chest procedures during theproof-of-concept phase, which, in turn, will lead to penetration and definitionof minimally invasive cardiac surgery and evolve to a stand-alone(closed-chest, beating heart) surgical procedure to treat and cure atrialfibrillation as cardiovascular surgeons become increasingly familiar with our ATRILAZEsystem.

 

•              **Focus on leading surgeons todrive initial market acceptance. **We will focus our efforts on surgeons whohave active open-heart practices, which include high volume valve repair orreplacement and existing atrial fibrillation procedures, and are considered tobe “thought leaders” in cardiovascular surgery and in minimally invasiveprocedures.  As these leading surgeonsincorporate our ATRILAZE system into their standard practices, we believe thesesurgeons will help accelerate broader awareness within the medical communitythrough peer communication, the presentation of results at surgical conferencesand the publication of results in leading surgical and medical journals.  As we go to proof-of-concept in the humanclinical setting and define the market during the next 12 to 18 months, we planto educate, inform and heighten awareness of our ATRILAZE system and theanticipated superior outcomes in the cardiovascular surgical space.

** **

•              **Expand clinical marketing andproduct development focus to create a stand-alone, minimally invasive procedureto treat atrial fibrillation. **Our product development efforts are directedtoward enhancing our technology platforms and modifying them to promote astand-alone, minimally invasive procedure to treat and cure atrialfibrillation.  We anticipate that ourproprietary position in channeling laser light energy for the ablation ofcardiac tissue will allow the technology to be widely adopted in the minimallyinvasive setting.

 

•              **Manufacturing to control costs andproduce high quality products. **Through qualified vendors in conjunction withour propriety technologies and patent applications, we expect that the diodelaser and all-future designs of our ATRILAZE system will be developed,manufactured, tested and packaged to produce high quality products at low 

 

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cost.  Ourhistorical excellence in quality, reliability and product performance, combinedwith in-house manufacturing or contract outsourcing, will, we believe, assurethat these attributes of high quality carry forward to our future products.

** **

•              **Leverage existing supportinfrastructure for immediate and long-term growth and profitability. **We are evaluating alternatives for relocation of our research and administrativeoperations in order to manage our facility cost, with the goal of fostering ahigh awareness of cost consciousness throughout the organization.

 

**MedicalCV’s Technology and Products**

** **

We acquired a surgicalablation system technology platform from LightWave in August 2003.  We filed a 510(k) application with the FDA onMarch 22, 2004, and received 510(k) clearance on December 1, 2004.  Our ATRILAZE Surgical Ablation System, ourfirst product based upon this technology, consists of a laser unit and ahand-held device or probe.

 

Proof-of-concept in thehuman clinical setting commenced in January 2005.  In January and February 2005, fiveconcomitant open-heart surgical procedures were performed using our ATRILAZEsystem.  Two cardiovascular surgeons atrespected medical centers in Texas performed the surgical procedures.  All of the procedures were performed in thestandard fashion with the heart-lung machine, and the cardiac tissue ablationportion of the procedure was performed prior to the valve repair or replacementand coronary artery revascularization. Overall, the procedures were deemed successful by the surgeons.  Our strategy is to develop this coretechnology into products for stand-alone, minimally invasive surgicalprocedures.

 

**Regulatory Clearance**

** **

As noted above, our ATRILAZESurgical Ablation System has received 510(k) clearance in the United States andis indicated for delivery of 810nm laser light to soft tissue, includingcardiac tissue, during surgical procedures. Indications include the incision, excision, dissection, vaporization,ablation, or coagulation of soft tissue. We also intend to seek regulatory approval in the next two years toinitiate a human clinical study designed to allow us to support FDA approvalfor the promotion of “for use in the treatment of atrial fibrillation.”  We intend to conduct this study when ourATRILAZE system has evolved cardiac tissue ablation to a stand-alone, minimallyinvasive (closed-chest, beating heart) surgical procedure.  Filing for the CE mark in the European Unionis scheduled for fiscal year 2006.  Nextgeneration products will require similar regulatory filings.

 

**Manufacturing**

** **

We intend that manufactureof the first generation of the ATRILAZE system, including the diode laser, willbe outsourced to qualified vendors.  Thisstrategy is expected to provide quick time to market and early adoption of thetechnology with the approved ATRILAZE designs. We intend that future ATRILAZE designs with enhanced features forsurgical applications will be designed in-house and either manufacturedin-house or outsourced in whole or in part to qualified vendors.  Components will be supplied in a similarmanner.  Product sterilization andrelated testing will be outsourced.  Ourhistorical excellence in quality, reliability and product performance, combinedwith our flexibility to pursue both in-house and outsourced manufacturing will,we believe, assure that these attributes carry forward to our future productsand enable us to control costs of manufacture.

 

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**Intellectual Property**

** **

We intend to aggressivelydocument and protect our intellectual property by obtaining U.S. and foreignpatents to protect technology important to the development of our business.  We have filed eight patent applications withthe U.S. Patent Office, as well as a related patent application withinternational patent authorities. Obtaining patent protection for our cardiac tissue ablation productswill be critical to our commercial success. We regularly conduct patent searches of third party patents.  This includes a review of patents owned bythird parties and patent applications pending known to us as attempting toaddress treatment of atrial fibrillation using a laser to ablate cardiactissue.  From time-to-time, we searchpublicly available records for relevant patents assigned to othercompanies.  During one of these searches,we identified one issued patent in our field relating to the use of lasertechnology and for which we deemed it advisable to seek the advice of patentcounsel.  Based upon advice from ourpatent counsel, we believe that the sale and use of our ATRILAZE cardiac tissueablation product using infrared laser energy would not infringe any valid claimof the patent.

 

We cannot assure you thatany patents issued to us will be valid, enforceable or otherwise be of value tous in relation to products of our competitors or the market in general, or thatany patent for which we have applied or may apply will be granted.

 

On May 2, 2005, we receiveda letter from Edwards Lifesciences, LLC (“Edwards”) concerning our ATRILAZEsoft tissue ablation products, which are the subject of some of our patentapplications.  Edwards does not claimthat our products infringe any of its patents. Edwards’ letter calls to our attention six of its patents and requestsus to comment on how our products differ from the claimed methods and apparatusof the six specified Edwards patents.  Wehave reviewed the specified Edwards patents and discussed them with our patentcounsel, and believe that our ATRILAZE system does not infringe on any of thesepatents.  While Edwards does not claim inits letter that our products infringe its patents, it is likely that in thefuture, Edwards or others will continue to inquire regarding our products andpatents and possibly make intellectual property claims relating to our tissueablation devices.  Our defense of anyclaims made by Edwards, or of any other intellectual property claims made inthe future, regardless of the merits of such claims, could divert the attentionof our technical and management personnel away from developing and marketingour products for significant periods of time. Further, the cost incurred to defend such claims could be substantialand adversely affect us, even if we are ultimately successful in defending suchclaims.  An adverse determination inconnection with any of such claims in the future could affect our ability tosell our products, subject us to significant liabilities to third parties, orrequire us to modify our products to be non-infringing or seek licenses fromthird parties.  There can be no assurancethat we could be able to so modify our products or obtain licenses on satisfactoryterms.

 

We also rely upon trade secretsand proprietary know-how.  We require ourtechnical employees and consultants to agree in writing to keep our proprietaryinformation confidential and, with certain limitations, to assign allinventions relating to our business to us.

 

We have limited proprietaryrights covering our mechanical heart valve materials.  We have one U.S. patent on our pyrolyticcarbon coating apparatus and two foreign patent applications.  Our current patents will begin to expire in2015.  We have no patents covering the designof our Omnicarbon heart valves.

 

We have used, and thereforeclaim common law rights in, the following trademarks: GLIDETHRU, ULTRAPURE andATRILAZE.  We have filed an applicationfor a U.S. federal registration for the mark: ATRILAZE.  We also have a federalregistration for the marks: MEDICALCV and OMNICARBON.

 

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**Competition**

** **

As discussed above, theatrial fibrillation market is being addressed three fold.  The first line approach is drug therapy.  Drug therapy is associated with a poorquality of life and the failure rate at 1 year is 50 percent and at 2 years itis 84 percent.  The second line approachis catheter-based technologies via the electrophysiologist.  This is a time consuming procedure of four tosix hours with a success rate of 40 percent to 60 percent.  The final treatment option is concomitantopen-heart surgery.  In the operatingroom, the cardiovascular surgeon performs a surgical procedure known as theMaze.  This cut and sew/disassemble andreassemble technique of the atrial chambers of the heart via the surgeon’sscalpel creates lesion lines that interrupt the erratic electrical energy thatcauses AF.  This procedure has a successrate of 97 percent.  However, thisprocedure is associated with morbidity and mortality rates that are true of anyopen-heart surgical procedure.  Moreimportantly, very few cardiovascular surgeons are able to perform this timeconsuming and technically difficult procedure. The space of a stand-alone, minimally invasive (closed-chest, beatingheart) surgical procedure for the treatment of atrial fibrillation has yet tobe defined.  The following is a breakoutof the interventional and surgical technologies of which we are aware that arebeing marketed by competitors for the treatment of atrial fibrillation:

 

*Electrophysiology Technologies* – Catheter-based technologies with variousenergy sources and catheter end effectors include those offered by CathEffectsLLC, St. Jude Medical, Inc., CyroCor, Inc., ProRhythm, Inc. and CardioFocus,Inc.

 

*Surgical Technologies* – Surgical instruments with various energysources and delivery devices include those offered by Boston ScientificCorporation, Medtronic, Inc., Cardiac Surgery Technologies Division, AtriCure,Inc., CryoCath Technologies, Guidant Corporation, St. Jude Medical, Inc. andEdwards Lifesciences, LLC.

 

In 2004, two major medicaldevice companies made significant investments in the atrial fibrillation marketby acquiring emerging device companies and their technologies:

 

St. Jude Medical announcedthat it was investing in three acquisitions: (1) Epicor Medical, Inc.,Sunnyvale, CA was acquired for $185 million in June 2004; (2) EndocardialSolutions, St. Paul, MN was acquired for $272 million in August 2004; and (3)Irvine Biomedical, Inc., Irvine, CA was acquired for $47 million in October2004.

** **

Guidant Corporationannounced in 2004 its proposed acquisition of AFx, Inc., a companymanufacturing devices which apply microwave energy for cardiac tissue ablation,for $54 million plus milestone payments of up to an additional $10 million.

** **

**Technology Purchase Agreement**

** **

In August 2003, we enteredinto a technology purchase agreement with LightWave and its principals relatingto the acquisition of LightWave’s interests in technology consisting of acatheter/probe containing elements of optical fiber, coolant passages and otherfeatures for the purpose of delivering laser energy to the epicardial surfaceof the heart for treatment of atrial fibrillation.  We paid LightWave an initial standstillpayment consisting of 15,000 shares of our common stock, $10,000 upon closingand an additional $30,000 to LightWave in installments in 2004 and 2005.  We will be obligated to pay $125,000 toLightWave within 45 days after the first commercial sale of our product in theUnited States or Europe to two or more parties and $385,000 within 45 daysfollowing our achievement of $1,500,000 of cumulative gross sales of disposableproducts.  In addition, during fiscalyear 2004, we issued to LightWave a warrant for the purchase of 25,000 sharesof common stock at closing and, during fiscal year 2005, a warrant for thepurchase of 25,000 shares of common stock upon receiving FDA 510(k)clearance.  In addition, we are 

 

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obligated to issue a warrant for the purchaseof 25,000 shares of common stock upon a receipt of a U.S. utility patentcovering the product and a warrant for the purchase of 25,000 shares of commonstock upon the first commercial sale of our product.

 

Following the firstcommercial sale, we have agreed to pay LightWave payments equal to 6 percent ofnet sales of the LightWave product in countries in which we obtain patentprotection and 4 percent of net sales of the LightWave product in territoriesin which there is no patent protection. Commencing with the second year following our first commercial sale, wehave agreed to make minimum annual payments as follows:

 
| **Year Following**    | ** ** | ** **                 | ** ** |
|-----------------------|------------|----------------------------|------------|
| **Commercialization** | ** ** | **Minimum Annual Payment** | ** ** |
| 2                     |       | $                          | 50,000     |   |
| 3                     |       | $                          | 75,000     |   |
| 4                     |       | $                          | 100,000    |   |
| 5                     |       | $                          | 200,000    |   |
| 6                     |       | $                          | 300,000    |   |
| 7                     |       | $                          | 350,000    |   |
| 8                     |       | $                          | 350,000    |   |
| 9                     |       | $                          | 400,000    |   |
| 10                    |       | $                          | 500,000    |   |

 

We are obligated to makesuch payments for a period of ten years following the first commercialsale.  Our technology purchase agreementwith LightWave contains other customary conditions, including mutualindemnification obligations.  LightWaveand two of its principals have agreed to certain noncompetition obligations,nondisclosure obligations, certain obligations to assign new developments orinventions relating to the acquired technology to our company.  We have agreed to use our reasonablecommercial efforts to commercialize the technology within three years followingthe acquisition of the technology from LightWave.  If we fail in any year to pay minimum annualpayments, we may be obligated to grant LightWave a nonexclusive right to usethe technology acquired from LightWave, or pay LightWave the difference betweenpayments actually made and minimum payments due for a given year.

 

**Heart Valves**

** **

In November 2004, we ceasedthe manufacture of mechanical heart valves; and in May 2005, we made our finalcommercial sale of mechanical heart valves. Prior to the decision to discontinue the heart valve business, we soldthe Omnicarbon® 3000 heart valve in the U.S. and Japan, and the Omnicarbon®4000 heart valve internationally.  TheOmnicarbon 3000 was manufactured using pyrolytic carbon components manufacturedby a third party, with the remaining manufacturing completed by ourcompany.  The Omnicarbon 4000 wascompletely manufactured by us.  More than50,000 Omnicarbon heart valves have been sold or implanted worldwide.

 

Our Omnicarbon heart valveswere designed to replace heart valves that have been made defective by diseaseor congenital origin.  A worldwide marketfor mechanical heart valves and other cardiovascular devices has existed forseveral decades, but we were not able to fully capitalize on thoseopportunities.  Large multinationalmanufacturers and industry consolidation characterize these global markets forcardiovascular surgery devices.  Amongthe major product segments are heart valves, pacemakers, angioplasty products,coronary stents and the emerging market of atrial fibrillation products.  A number of the major manufacturers, such asMedtronic, Inc., St. Jude Medical, Inc., Guidant Corp. and Boston Scientific,Inc., have medical device lines which include all or most of these products.

 

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**ATRILAZE System Marketing and Clinical Sales Strategy**

** **

Our mission is to developand introduce products for improving patient outcomes by early treatment ofcardiovascular disorders and disease, including products targeting thetreatment of atrial fibrillation.  Ourinitial focus is on our ATRILAZE Surgical Ablation System for use in cardiactissue ablation in concomitant open-heart surgical procedures for continuedproof-of-concept, as a means to treat atrial fibrillation.  Our on-going focus is to continue our researchand development efforts on the ATRILAZE system for a stand-alone, minimallyinvasive (closed-chest, beating heart) surgical procedure as a means to treatatrial fibrillation.  The key elements ofour strategy in support of this mission are to:

 

•              *Continue to Penetrate the CardiacTissue Ablation and Atrial Fibrillation Markets Using a Clinical SalesTeam. *Over the next 12 to 18 months we intend to conduct clinical salesactivities via a limited release in a minimum of four hospitals/medical centersacross the United States.  We intend toleverage our extensive clinical sales experience of our clinical sales team toidentify key cardiovascular surgeons and provide effective customer assistanceto accelerate market definition and adoption, thereby evolving our ATRILAZEsystem products.

 

•              *Establish Stand-alone, MinimallyInvasive (Closed-chest, Beating heart) Surgical Procedures Using the ATRILAZESystem as the Standard of Care for the Ablation of Cardiac Tissue for Treatmentof Atrial Fibrillation. *Our primary marketing objective is to definethe atrial fibrillation market via having cardiovascular surgeons recognizethat the ATRILAZE laser is the “ideal” technology for ablating cardiactissue.  We believe that the ATRILAZElaser, due to its micro-nature, is an ideal platform to establish thestand-alone, minimally invasive surgical procedure of the future.

 

•              *Educate Physicians and Patientsabout our ATRILAZE Surgical Ablation System Procedures. *We believe education of physicians and patients about alternativeenergy sources to ablate cardiac tissue as a means to treat atrial fibrillationwill be critical to adoption of the ATRILAZE system.  We intend to develop cardiovascular surgeonand electrophysiologist training and education programs, which will emphasizethe clinical efficacy and ease of use of the ATRILAZE system.  We also intend to increase ourpatient-oriented marketing materials for use by cardiovascular surgeons toinform patients of the availability and potential benefits of our ATRILAZE system.

 

•              *Conduct Clinical Studies toSupport our Marketing Definition Initiatives and R & D Evolving OurATRILAZE System. *We intend to begin a human clinical registryin our initial centers.  Additionally, wewill be conducting additional animal studies to support the efficacy of ourATRILAZE system.  We also intend to seekregulatory approval in the next two years to initiate a human clinical studydesigned to allow us to support FDA 

 

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approval for the promotionof “for use in the treatment of atrial fibrillation.”  We intend to conduct this study when ourATRILAZE system has evolved cardiac tissue ablation to a stand-alone, minimallyinvasive (closed-chest, beating heart) surgical procedure.  We believe the results of this and otherstudies, if successful, will allow us to expand our marketing and clinicalsales efforts.

 

**Government Regulation**

** **

The medical devices wemanufacture and market are subject to regulation by the FDA and, in mostinstances, by state and foreign authorities or their designatedrepresentatives.  Under the U.S. FederalFood, Drug and Cosmetic Act and the regulations promulgated thereunder, as amanufacturer of medical devices, we must comply with policies and proceduresthat regulate the manufacturing, composition, labeling, testing, packaging anddistribution of medical devices.  Inaddition, medical devices are subject to different levels of governmentapproval requirements, the most comprehensive of which requires the completionof an FDA approved clinical evaluation program and submission, and approval ofa premarket approval application before a device may be commerciallymarketed.  The FDA also conductsinspections before approving a premarket approval application to determine compliancewith the quality system regulations which cover manufacturing and design.

 

After premarket approval isreceived, the FDA may require testing and surveillance programs to monitor theeffectiveness of approved products which have been commercialized.  It has the power to prevent or limit furthermarketing of a product based on the results of such post-marketingprograms.  In addition, the FDA may, atany time after the approval of a premarket approval application, conductperiodic inspections to determine compliance with good manufacturing practiceregulations and current medical device reporting regulations.  If the FDA concludes that we are not incompliance with applicable laws or regulations, it can institute proceedingsto:

 

•              Seize our products;

 

•              Require a product recall;

 

•              Withdraw previously granted marketclearances;

 

•              Implement procedures to stop futureviolations; and/or

 

•              Seek civil and criminal penalties against us.

 

The FDA also regulatesrecordkeeping for medical devices and reviews hospital and manufacturers’required reports of adverse experiences to identify potential problems withFDA-authorized devices.

 

Some of the products that wemarket, including our ATRILAZE system, can be cleared under Section 510(k) ofthe Federal Food, Drug and Cosmetic Act. If a new or significantly modified device is “substantially equivalent”to an existing legally marketed device, the new device can be commerciallyintroduced after filing a 510(k) premarket notification with the FDA and thesubsequent issuance by the FDA of an order permitting commercialdistribution.  Changes to existingdevices that do not significantly affect safety or effectiveness may be madewithout an additional 510(k) notification. We received Section 510(k) clearance for our ATRILAZE Surgical AblationSystem on December 1, 2004.  The processof obtaining Section 510(k) clearance typically requires less time and expensethan the premarket approval process. Section 510(k) clearance normally takes from six to twelve months, but cantake years, and generally requires the submission of supporting data, which insome cases can be 

 

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extensive. In addition, the FDA may require review by an advisory panel as acondition for Section 510(k) clearance. We intend to rely on the Section 510(k) process with regard to futureproducts that add to or enhance our current cardiac tissue ablationtechnology.  However, we may develop oracquire technology that will require clearance under the FDA’s lengthier andexpensive premarket approval process, which can take a number of years and canrequire extensive supporting documentation. If we encounter difficulties in the premarket approval process, thecommercial marketing of a product could be substantially delayed or prevented.

** **

International sales ofmedical devices are also subject to extensive regulation.  Foreign regulatory bodies have establishedvarying regulations governing product standards, packaging requirements,labeling requirements, import restrictions, tariff regulations, duties and taxrequirements.  Generally, the extent andcomplexity of the regulation of medical devices is increasing worldwide, withregulations in some countries already nearly as extensive as those in theU.S.  This trend may continue, and thecost and time required to obtain marketing approval in any given country thusmay increase.  We cannot assure you thatany foreign approvals will be allowed on a timely basis, or at all.

 

To market our products incountries of the European Union, we are required to obtain CE markcertification.  CE mark certification isthe international symbol of adherence to certain quality assurance standardsand compliance with European medical device directives.  We intend to apply for CE mark certificationfor our ATRILAZE product in fiscal year 2006.

 

**Product Liability and Insurance**

** **

The development and sale ofmedical devices entails significant risk of product liability claims and,sometimes, product failure claims.  Weface an inherent business risk of financial exposure to product liabilityclaims if the use of our products results in personal injury or death.  We also face the possibility that defects inthe design or the manufacturing of our products could necessitate a productrecall.  We have not, to date,experienced significant product liability claims, and we have never had aproduct recall.  We cannot assure you,however, that we will not experience losses in the future due to productliability claims or recalls.

 

If patients allege that theuse of our cardiovascular surgery devices injured them, we may face substantialproduct liability claims.  Substantialproduct liability litigation exists within the medical device industry.  Our products are used in cardiovascularsurgery, and their failure may result in patient injury or death.  We have had product liability claims assertedagainst us in the past, which were resolved under our insurance coveragewithout significant financial cost to us. We cannot assure you, however, that future product liability claims willnot exceed the limits of our insurance coverage or that such insurance willcontinue to be available to us on commercially reasonable terms, or atall.  Consequently, a product liabilityclaim or other claim with respect to uninsured liabilities, or in excess ofinsured liabilities, could have a material adverse effect on our business,financial condition, operating results and cash flows.  In addition, adverse publicity resulting fromproduct liability litigation may materially adversely affect us regardless ofwhether the claims are valid or whether we are liable.  Furthermore, these claims would likely divertour financial and management resources that would otherwise be used to benefitthe future performance of our operations.

 

In addition to new products,we sold more than 50,000 mechanical heart valves between 1992 and 2005.  We assume that a majority of the patients whoreceived our heart valves are still alive. If any of these patients were to have a problem with a heart valve, theycould assert claims for damages against us. In April 2005, we placed our products liability insurance with a newinsurance carrier.  Our new policyprovides us with potential coverage for claims of up to $5,000,000 peroccurrence and in the aggregate per policy year.  Concurrently, we purchased a three-yearextended reporting coverage endorsement from 

 

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our former carrier, which was unwilling torenew our coverage on the previous terms. The extended reporting period coverage will allow us to seek coverageunder the prior policy for products claims arising from occurrences which tookplace during such policy period but which were not asserted against us duringthe previous policy period.

 

In March 2005, it wasreported to us that one of our valves implanted in a patient did not performand was replaced.  The patientsubsequently died.  This event has beenreported to our insurer.  If a claim isasserted against us, we intend to rely upon the policy with the extendedreporting period endorsement described above. We believe any claim brought will be covered by such policy after ourpayment of the deductible, although there can be no assurance that any coveragewill be available or adequate if a claim is asserted.

 

**Employees**

** **

As of April 30, 2005, we had17 full-time employees, including six who support or were in research anddevelopment, and the remainder of whom were in administration,regulatory/clinical and sales/marketing. We are not a party to any collective bargaining agreement and believethat our relations with employees are good.

 

**Executive Officers of the Registrant**

** **

The following table providesinformation with respect to our executive officers as of April 30, 2005.  Each executive officer has been appointed toserve until his successor is duly appointed by the board or his earlier removalor resignation from office.  Eachexecutive officer’s position with MedicalCV represents such person’s principaloccupation.

 
| **Name**           | ** ** | **Age** | ** ** | **Position with MedicalCV**                          | ** ** | **Director Since** |
|--------------------|------------|---------|------------|------------------------------------------------------|------------|--------------------|
| Marc P.  Flores    |       | 40      |       | President,  Chief Executive Officer and Director     |       | 2004               |
| John H.  Jungbauer |       | 56      |       | Vice  President, Finance and Chief Financial Officer |       | N/A                |

 

*Marc P. Flores. *Mr. Flores joined MedicalCV in September 2004 as President, ChiefExecutive Officer and Director.  Mr.Flores has extensive experience and long standing relationships within thecardiac surgery industry.  He formerlyheld the title of Vice President of Sales and Marketing at Coalescent Surgical,Inc., a Sunnyvale, California company, whose assets were acquired by Medtronic,Inc.  Prior to that, he was in uppermanagement with CardioThoracic Systems, Inc. in Cupertino, California, whichwas ultimately acquired by the Guidant Corporation.  Mr. Flores has also held various managementpositions with Boston Scientific, GE Medical Systems and the Xerox Corporation.

 

*John H. Jungbauer. *Mr. Jungbauer joined MedicalCV in February 2004 as Vice President,Finance and Chief Financial Officer.  Mr.Jungbauer came to our company with more than 26 years of experience infinancial management and long-range planning, international financial/treasuryoperations, information technology systems. From 1990 to 2002, Mr. Jungbauer was Vice President of Finance and ChiefFinancial Officer with ATS Medical, Inc. During 1988 and 1989, he was Executive Vice President of Titan Medical,Inc.  From 1977 to 1987, he held severalfinancial management positions at St. Jude Medical, Inc., including VicePresident of Finance and Chief Financial Officer from 1981 to 1987.

 

**ITEM 2**                   DESCRIPTION OF PROPERTY

 

We lease a 55,000 squarefoot production and administrative facility located in Inver Grove Heights, asuburb of Saint Paul, Minnesota.  Ourfacility has approximately 8,000 square feet of general office space and morethan 41,000 square feet of manufacturing space. Our facility is subject to inspection by the FDA and foreign regulatoryagencies as part of their product marketing clearance and 

 

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surveillance programs.  In April 2003, we sold and leased back thisfacility in a refinancing transaction with PKM Properties, LLC, an entitycontrolled by Paul K. Miller, one of our directors and the largest beneficialowner of our securities.  We signed alease with an initial 10-year lease term, with options to renew or repurchasethe facility.  See “Management’sDiscussion and Analysis or Plan of Operation – Commitments and ContingentLiabilities” and the notes to our Financial Statements for the fiscal yearended April 30, 2005, for more information regarding such lease.

 

**ITEM 3**                   LEGAL PROCEEDINGS

** **

As of July 20, 2005, we werenot a party to any material litigation.

 

**ITEM 4**                   SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

** **

Not applicable.

 

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**PART II**

** **

**ITEM5**                  MARKET FOR COMMON EQUITY, RELATED SHAREHOLDERMATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

 

Previously, units of oursecurities, consisting of common stock and Class A Warrants, were listed on TheNasdaq SmallCap Market under the symbol “MDCVU” following completion of ourinitial public offering in November 2001. In March 2003, our units were delisted from The Nasdaq SmallCap Marketbecause we failed to satisfy the minimum shareholders’ equity requirement forcontinued listing and because the bid price of our units had fallen below $1.00for 30 consecutive trading days. Thereafter, our units traded on the OTC Bulletin Board, until theexpiration of the Class A Warrant component of such units on November 20,2004.  Due to lack of market makers, ourcommon stock did not trade between November 19, 2004 and December 20,2004.  Our common stock resumed tradingon the OTC Bulletin Board under the symbol “MDCV” on December 21, 2004.  

 

The following table setsforth the approximate high and low closing prices as reported by The NasdaqSmallCap Market and the approximate high and low bid prices as reported by theOTC Bulletin Board for our units and common stock, as applicable, for theperiods indicated.  Such quotationsreflect inter-dealer prices, without retail mark-up, mark-down or commission,and may not represent actual transactions.

 
| **Period**       | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------|------------|----------|------------|---------|------------|
| Fiscal Year 2004 |       |     |       |    |       |
| First Quarter    |       | $        | 1.55       |    | $          | 0.30 |   |
| Second Quarter   |       | $        | 2.45       |    | $          | 1.40 |   |
| Third Quarter    |       | $        | 2.60       |    | $          | 1.15 |   |
| Fourth Quarter   |       | $        | 2.30       |    | $          | 1.10 |   |
| Fiscal Year 2005 |       |     |       |    |       |
| First Quarter    |       | $        | 2.05       |    | $          | 1.30 |   |
| Second Quarter   |       | $        | 2.50       |    | $          | 0.75 |   |
| Third Quarter    |       | $        | 1.89       |    | $          | 0.50 |   |
| Fourth Quarter   |       | $        | 1.25       |    | $          | 0.71 |   |

 

As of April 30, 2005, we hadapproximately 235 shareholders of record and approximately 331 beneficialowners.

 

We have never declared orpaid cash dividends.  We currently intendto retain future earnings, if any, to operate and expand our business, and we donot anticipate paying cash dividends on our common stock in the foreseeablefuture.  Any payment of cash dividends inthe future will be at the discretion of our board of directors and will dependupon our results of operations, earnings, capital requirements, contractualrestrictions and other factors deemed relevant by our board.  We are required to pay a 5 percent annualdividend (approximately $900,000 per year) on our 5% Series A ConvertiblePreferred Stock.

 

**Sales of Unregistered Securities during the FourthQuarter of Fiscal Year 2005**

** **

On March 3, 2005, we enteredinto a February 2005 Credit Agreement with PKM Properties, LLC (“PKM”), anentity controlled by Paul K. Miller, one of our directors and the largestbeneficial owner of our securities.  TheAgreement provided for a $500,000 discretionary credit facility under which PKMmade available to us up to $500,000 in the form of loans bearing interest in 10percent per year.  Principal and interestwere due on the amounts borrowed no later than June 16, 2005.  This debt and the 

 

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other amounts we borrowed from PKM werecollateralized by substantially all of our assets.  A February 2005 Discretionary Credit Notereflected this indebtedness.  As additionalconsideration, we issued to PKM a ten-year warrant for the purchase of 750,000shares of our common stock at an exercise price of $0.50 per share.  We also acknowledged a fourth amendment tothe first amended and restated subordination and intercreditor agreement by andbetween PKM and Peter L. Hauser (“Hauser”). We also paid legal and administrative expenses of $19,142 incurred byPKM in this transaction.  We repaid thisnote plus accrued interest in April 2005.

** **

On March 21, 2005, wegranted a stock option for the purchase of 50,000 shares of common stock toDavid B. Kaysen and we granted a stock option for the purchase of 50,000 sharesof common stock to Susan L. Critzer.  Theseoptions were granted toMr. Kaysen and Ms. Critzer in their roles as two of our non-employeedirectors.  These options were grantedoutside our shareholder-approved plans, they were 100 percent vested at thedate of grant, and they are exercisable at $1.00 per share, which was the closingprice of our common stock on the OTC Bulletin Board on March 21, 2005.  These options expire on March 21, 2015.

 

On April 1, 2005, under theterms of a Securities Purchase Agreement with accredited investors, we issued18,035 shares of 5% Series A Convertible Preferred Stock to such investors,warrants for the purchase of 27,052,500 shares of common stock to suchinvestors, and warrants for the purchase in the aggregate of 1,635,960 sharesof common stock to our placement agent and finder.  Each share of preferred stock is convertibleinto the number of shares of common stock equal to the $1,000 stated valuedivided by $0.50, subject to anti-dilution adjustments.  As a result, the 18,035 preferred shares soldmay be converted into 36,070,000 shares of common stock, subject toanti-dilution adjustments.  The terms ofthe preferred stock include dividend, protective, liquidation and conversionrights.  The preferred stock was soldalong with warrants to purchase a number of shares of common stock equal to 75percent of the number of shares of common stock initially issuable uponconversion of the preferred shares.  Thewarrants have a term of five years and are exercisable at $0.50 per share,subject to anti-dilution adjustments.  Ifthe shares issuable upon exercise of the warrants are not registered for resaleat the time of exercise, each warrant allows the holder to convert the warrantsinto common stock without any cash consideration in exchange for the surrenderof the remaining shares of common stock otherwise purchasable upon exercise ofthe warrant.  We obtained gross cashproceeds of $13,603,000 at the closing (net of $30,000 in legal fees which werewithheld by the lead investor).  We alsoconverted $4,402,000 of indebtedness into the above-referenced securities.  We paid our placement agent cash commissionsof $573,000, we repaid an outstanding debt obligation to PKM of $502,708, andwe paid a finder’s fee of $244,980.  Wealso paid legal and administrative expenses of $18,086 incurred by PKM in thistransaction.

** **

Effective April 1, 2005, thecompensation committee of our board of directors awarded (1) a non-qualifiedstock option for the purchase of 3,440,348 shares of common stock to Marc P.Flores, our President and Chief Executive Officer, (2) a non-qualified stockoption for the purchase of 1,290,131 shares of common stock to John H.Jungbauer, our Vice President, Finance and Chief Financial Officer, and (3)non-qualified stock options for the purchase of an aggregate of 1,935,196shares of common stock to other key employees. The foregoing options were issued outside our employee benefitplans.  Such options vest to the extentof 25 percent per year, commencing on the first anniversary of the date ofgrant.  They are exercisable at $0.89 pershare, which was the closing price of our common stock on the OTC BulletinBoard on April 1, 2005.  These optionsexpire on April 1, 2012.

** **

On April 22, 2005, we issued6,500 shares of common stock to Mid-South Capital, Inc. and 26,000 shares ofcommon stock to Baxter Capital Advisers, Inc. These shares were issued as consideration for services rendered pursuantto the terms of a financial consulting agreement between our company andMid-South Capital, Inc., dated February 3, 2005.

 

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On April 25, 2005, we issueda warrant for the purchase of 68,000 shares of common stock to Tower Finance,Ltd. (“Tower”).  This warrant was issuedas consideration for services rendered in connection with our December 2004 andJanuary 2005 bridge financing pursuant to the terms of a letter agreementbetween our company and Tower, dated December 8, 2004.  The warrant is exercisable at $0.625 pershare, which was 125 percent of the price at which our common stock equivalentswere sold in the bridge financing.  Thiswarrant expires on January 13, 2010.

 

On April 28, 2005, we issued80,000 shares of common stock to ROI Group Associates, Inc.  These shares were issued as consideration forinvestor relations services rendered pursuant to the terms of a serviceagreement between our company and ROI Group Associates, Inc., dated January 24,2005.

 

Each of the foregoingissuances was made in reliance upon the exemption provided in Section 4(2)and/or the safe harbor provided by Rule 506 of the Securities Act.  Such securities are restricted as to sale ortransfer, unless registered under the Securities Act, and certificatesrepresenting such securities contain restrictive legends preventing sale,transfer or other disposition unless registered under the Securities Act.  In addition, the recipients of suchsecurities received, or had access to, material information concerningMedicalCV, including, but not limited to, our reports on Form 10-KSB, Form10-QSB and Form 8-K, as filed with the SEC, including amendments to suchreports.  Other than as noted above, nounderwriting commissions or discounts were paid with respect to the issuancesof such securities.

 

**ITEM 6**                   MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLANOF OPERATION

** **

*The following discussion containsvarious forward-looking statements within the meaning of Section 21E of theExchange Act.  Although we believe that,in making any such statement, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could causeactual outcomes and results to be materially different from thoseprojected.  When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements.  These forward-looking statements are subjectto numerous risks and uncertainties that could cause actual results to differmaterially from those anticipated. Factors that could cause actual results to differ materially from thoseanticipated, certain of which are beyond our control, include those discussedin our Cautionary Statement as well as those discussed elsewhere in thisdocument.*

* *

*Our actual results, performanceor achievements could differ materially from those expressed in, or implied by,forward-looking statements.  Accordingly,we cannot be certain that any of the events anticipated by forward-lookingstatements will occur or, if any of them do occur, what impact they will haveon us.  We caution you to keep in mindthe cautions and risks described in our Cautionary Statement and to refrainfrom attributing undue certainty to any forward-looking statements, which speakonly as of the date of the document in which they appear.*

* *

**Overview**

** **

MedicalCV, Inc. is acardiovascular surgery device manufacturer. Previously, our primary focus was on heart valve disease.  We developed and marketed mechanical heartvalves known as the Omnicarbon® 3000 and 4000 heart valves.  In November 2004, after an exhaustive evaluationof the heart valve business, we discontinued all heart valve related productionand began to pursue options for exiting the heart valve business.  On April 8, 2005, we announced that ourefforts to find a buyer for the heart valve business were unsuccessful and thatwe would stop selling heart valves and were exiting the heart valvebusiness.  At that time, we alsodetermined to direct our resources to the development and introduction ofproducts targeting the treatment of atrial fibrillation, or AF.

 

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In August 2003, we enteredinto an agreement with LightWave to purchase technology for the treatment ofatrial fibrillation.  We believe thistechnology will provide an important growth platform.  On December 1, 2004, we received FDA 510(k)clearance to market our ATRILAZETM Surgical Ablation System, which is a medicaldevice designed for ablating cardiac tissue during surgery.

 

The ATRILAZE system was usedby two cardiovascular surgeons to ablate cardiac tissue in five humanconcomitant open-heart surgical procedures during January and February2005.  We did not generate any revenuefrom these procedures.  The ATRILAZEsystem was provided at no cost to these surgeons for proof-of-concept in theclinical setting, prior to commencing clinical sales of the ATRILAZEsystem.  We expect to continue validatingour technology with key cardiovascular surgeons during concomitant open-heartprocedures.  We expect to begin sellinghand-held devices for these procedures on a limited basis beginning in fiscalyear 2006.  We do not expect significantrevenue until we introduce a version of the ATRILAZE system for stand-alone,minimally invasive (closed-chest, beating heart) ablation of cardiac tissue.

 

During the second and thirdquarters of fiscal year 2005, we experienced a significant decline in sales ofour heart valves, which we believe was the result of our decision to requireprepayment or letters of credit for all sales to distributors to protect us againstcollection risks and our focus on exiting the heart valve business.  As a result of these factors, we determined,during the second quarter of fiscal year 2005, that these sales trendsindicated that we had excess inventories as well as inventories with carrying valuesin excess of their realizable values. Accordingly, during fiscal year 2005, we recorded a $2,573,656 reductionin the carrying value of certain heart valve inventories.  This reduction in carrying value was recordedas a charge to discontinued operations.

 

**Critical Accounting Policies**

** **

*The preparation of our financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe amounts reported in the financial statements and accompanying notes.  We believe our estimates and assumptions arereasonable; however, actual results and the timing of the recognition of suchamounts could differ from those estimates. We have identified the following critical accounting policies andestimates utilized by management in the preparation of our financialstatements: revenue recognition, accounts receivable allowance, inventoryobsolescence and deferred income tax assets. Actual amounts could differ significantly from management’s estimates.*

* *

**Revenue Recognition. **We recognize revenue using guidance from SEC Staff Accounting BulletinNo. 104 “Revenue Recognition in Financial Statements.”  Revenue from the sale of our products isrecognized provided that we have received a written order, the price is fixed,title has transferred, collection of the resulting receivable is probable andthere are no remaining obligations. Transfer of title occurs for substantially all international sales uponshipment.  Our products are not subjectto any customer acceptance process. There are no rights of return unless the product does not performaccording to specifications.  In priorperiods, we paid marketing support to distributors in some markets.  Such payments were reported as a reduction inour revenues in accordance with EITF 01-9.

 

**Accounts ReceivableAllowance. **In determining the adequacy of our allowancefor doubtful accounts, management considers a number of factors, including theaging of our receivable portfolio, customer payment trends, the financialcondition of our customers and economic conditions in our customers’countries.  Our analysis in determiningthe allowance for doubtful accounts is performed by management on acustomer-by-customer basis.  Although ourrecorded allowance includes our best estimates, we cannot predict theresolution of these matters with certainty. As of April 30, 2005 and 2004, our allowance for doubtful accounts was$196,521 and $102,869, respectively. Because our 

 

18

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accounts receivable all resulted from salesof heart valves, all accounts receivable and the allowance are reported as acomponent of our current assets of discontinued operations.

 

**Inventory Obsolescence. **In determining the appropriate carrying value of our inventories,management considers a number of factors, including the aging of our inventory,recent sales trends, industry market conditions and economic conditions.  Although adjustments to the carrying value ofour inventories reflect our best estimates, the estimates require a largedegree of judgment.  At April 30, 2005,the carrying value of our heart valve inventories reflected the cost of onlythe heart valves that we subsequently sold in May 2005.  These inventories are reported as a componentof our current assets of discontinued operations.  All other inventories of the discontinuedheart valve business have been reduced to a carrying value of zero.

 

**Deferred Income Tax Assets. **In assessing the realizability of our deferred tax assets, managementconsiders whether it is more likely than not that our deferred income taxassets will be realized.  The ultimaterealization of deferred income tax assets is dependent on the generation offuture taxable income, which must occur prior to the expiration of our netoperating loss and credit carryforwards, which comprise the majority of thedeferred tax assets.  As of April 30,2005, we had established a valuation allowance of $10,778,935 to fully offsetour deferred tax assets due to uncertainty about generating sufficient futuretaxable income necessary to realize these deferred tax assets, particularly inlight of our history of significant operating losses.  In addition, future utilization of availablenet operating loss carryforwards may be limited under Internal Revenue CodeSection 382 as a result of changes in ownership.

 

**Recent AccountingDevelopments**

** **

In December 2004,the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” whichrevises SFAS No. 123 and supersedes APB Opinion No. 25.  Among other items, SFAS No. 123Reliminates the use of the intrinsic value method of accounting, and requirescompanies to recognize compensation cost for share-based payment awards withemployees, based on the grant date fair value of those awards, in the financialstatements.  We are required to adopt theprovisions of this standard effective May 1, 2006.  We have not yet determined which of theadoption methods prescribed by SFAS No. 123R we will elect, nor have wedetermined the impact of adopting this statement.  In March 2005, the SEC issued SAB No. 107,“TOPIC 14: Share-Based Payment,” which addresses the interaction between SFAS No. 123Rand certain SEC rules and regulations and provides views regarding thevaluation of share-based payment arrangements for public companies.  This bulletin is effective immediately.

 

In November 2004,the FASB issued SFAS No. 151, “Inventory Costs – an amendment of ARB No. 43,Chapter 4.”  This statement clarifiesthat abnormal amounts of idle facility expense, freight, handling costs, andwasted materials (spoilage) should be recognized as current-period charges andrequires the allocation of fixed production overheads to inventory be based onnormal capacity of the production facilities. We are required to adopt the provisions of this standard effective May 1,2006.  We have not yet determined theimpact of adopting this statement.

 

**Results of Operations for the Fiscal Years Ended April30, 2005 and 2004**

** **

*Sales and Marketing, ContinuingOperations. *For fiscal year 2005, sales and marketingexpenses of continuing operations totaled $1,109,801, compared to $0 in fiscalyear 2004.  The increase in sales andmarketing expenses was attributable to spending related to marketing theATRILAZE system which began in fiscal year 2005.  Sales and marketing expenses in fiscal year2004 related entirely to the heart valve business.

 

*General and Administrative. *For fiscal year 2005, general and administrative expenses totaled $4,070,123compared to $2,395,062 in fiscal year 2004. The major contributors to the increase in general and administrativeexpenses were expenses related to debt and convertible preferred stock fundraisingactivities and severance costs incurred in fiscal year 2005.  Increases in costs related to fundraisingactivities included an increase in legal fees of $324,558, an increase in otherprofessional fees of $815,664 and an increase in travel costs of $164,502.  Severance and expenses related to changes inpersonnel totaled $325,150.

 

*Engineering and Regulatory.* Engineering and regulatory expenses increased to $1,581,016 for fiscalyear 2005, compared to $910,646 for fiscal year 2004.  The increase in these costs reflectedincreased development efforts related to the atrial fibrillation technologypurchased during fiscal year 2004. Payroll, consulting and travel expense increases aggregating $347,339,along with increased patent prosecution and defense expenses of $144,000, werethe major contributors to the increased engineering expenses for fiscal year2005.

 

*Loss from ContinuingOperations. *For fiscal year 2005, our loss fromcontinuing operations totaled $18,071,523. For fiscal year 2004, our loss from continuing operations totaled $5,448,566.  The increase in loss from continuingoperations resulted from the increase in operating expenses discussed above.

 

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*Other Income (Expense). *Other expense, net, consisting primarily of interest expense and losseson extinguishment of debt (in fiscal year 2004), increased to $11,310,583 forfiscal year 2005 from $2,142,858 for fiscal year 2004.  The increase included a non-cash charge of $9,987,609related to the issuance of warrants in connection with our April 2005 sale ofconvertible preferred stock and warrants. The warrants, which under certain circumstances can be put to us by theholders for cash equal to their fair value, have been recorded as a liabilityat their aggregate fair value which resulted in the interest charge referred toabove.  See “Financing Activities” belowfor a more detailed discussion of our accounting for these warrants.  During fiscal year 2004, we recorded a$1,235,813 loss from the extinguishment of certain debt.

 

*Loss from Discontinued Operations*.  Forfiscal year 2005, we recorded a loss from our discontinued heart valveoperations of $1,023,349, compared to a loss of $790,424 for fiscal year2004.  Revenues included in the loss fromdiscontinued operations totaled $2,304,897 and $3,410,975 for fiscal years 2005and 2004, respectively.  Theincrease in the loss from discontinued operations resulted primarily from thedecline in revenues and a $2,573,656 provision recorded during fiscal year 2005to reduce the carrying value of heart valves. This inventory provision wasprimarily related to a decrease in sales and our decision to discontinue thesale of heart valves.

 

*Income Tax Provision. *In light of our history of operating losses, we recorded a valuationallowance to fully offset our deferred tax assets in fiscal year 2000.  We have continued to provide a full valuationallowance throughout fiscal year 2005 due to uncertainty about our ability togenerate sufficient future taxable income necessary to realize our deferred taxassets.  We have recorded no tax provisionin fiscal years 2005 or 2004 due to net operating losses generated for incometax reporting purposes.

 

**Liquidity and Capital Resources**

** **

Cash and cash equivalentsincreased to $10,637,796 at April 30, 2005, representing an increase from$659,856 at April 30, 2004.  Thisincrease in cash and cash equivalents of $9,977,940 was due to the following:

 
| Net cash used in operating activities     |   | $          | (5,538,337 | )      |
|-------------------------------------------|--------|------------|------------|--------|
| Net cash used in investing activities     |   | (195,543   | )          |
| Net cash provided by financing activities |   | 15,711,820 |       |
|                                      |   |       |       |
| Net increase                              |   | $          | 9,977,940  |   |

 

Net cash used in operatingactivities increased $1,821,745 from $3,716,592 in fiscal year 2004 to $5,538,337in fiscal year 2005.  The use of cash inoperations in both fiscal years was primarily due to net losses of $19,094,872in fiscal year 2005 and $6,238,990 in fiscal year 2004.  The cash effect of the net loss for fiscalyear 2005 was partially offset by non-cash expenses of $10,373,158 associatedwith the issuance of warrants to purchase common stock in fiscal year 2005 asdescribed below, non-cash charges related to depreciation of $315,225,stock-based compensation of $249,729, an increase in the provision for bad debtof $220,281, and a provision for inventory excess/obsolescence of $2,573,656 and common stock issued for services of$128,075.  The provisions for bad debtsand excess/obsolete inventories resulted from our decision, in the fourthquarter of fiscal year 2005, to discontinue the sale of heart valves.  Increases in inventory of $283,622 and a reductionin accounts receivable of $717,829, offset by decreases in accounts payable of$906,964 and increases in prepaid expenses of $271,928, were the other maincontributors to the net cash used in fiscal year 2005.  The decrease in accounts payable relateddirectly to our decision to discontinue the manufacture of heart valves and thefact that we raised sufficient capital in the fourth quarter of fiscal year2005 to pay balances that were past due. The increase in prepaid expenses related principally to our purchase ofadditional product liability insurance to continue our 

 

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coverage for heart valves sold prior to ourexit from the business.  The cash effectof the net loss for fiscal year 2004 was offset by non-cash expenses ofinterest expense related to issued warrants and amortization of loan costs of$1,726,268 and other non-cash expenses, including $314,056 for depreciation, a$125,563 increase in the provision for bad debt, stock-based compensation of$75,592 and stock issued for services of $34,000.  Increases in accounts payable of $603,443 andreductions in inventory of $138,352, offset by a decrease in accrued expensesof $546,868, were the other main contributors to the net cash used in fiscalyear 2004.

 

Net cash used in investingactivities was $195,543 in fiscal year 2005 and $81,434 in fiscal year2004.  In both fiscal years, this cashwas used for capital expenditures.  We expectour capital expenditures in fiscal year 2006 to be approximately $346,000.

** **

In fiscal year 2005, netcash provided by financing activities was $15,711,820, consisting of proceedsfrom the issuance of preferred stock, net of offering costs, of $13,603,000,proceeds from the issuance of common stock, net of offering costs, of$2,000,608, and borrowings of $1,425,000, all partially offset by payments onterm debt of $1,000,000 and payments made under related-party lease agreementsof $319,288.  Net cash provided byfinancing activities was $4,273,655 in fiscal year 2004, and consisted oflong-term borrowings of $3,150,000 and net proceeds from equity sales inFebruary 2004 and April 2004 of $1,618,424, partially offset by $291,084 ofpayments on related-party lease obligations and principal payments of $150,000on debt.

 

*Financing Activities*

* *

We invested a significantamount of cash to attempt to penetrate the U.S. heart valve market, build ourU.S. sales organization and improve our international distributioncapabilities, especially in Europe.  Wealso invested in new products and technologies in an effort to broaden ourproduct offerings.  During the last twofiscal years, to improve our capital structure and provide working capital foroperations, we completed the following transactions with accredited investors,including PKM Properties, LLC (“PKM”), an entity controlled by Paul K. Miller,one of our directors and the largest beneficial owner of our securities, andPeter L. Hauser (“Hauser”), a beneficial owner of our securities.

 

•              In July 2003, we established a $1.0 millionterm debt with PKM.  This term debt,which was amended in November 2003 to provide for an additional $500,000 ofborrowing, required the payment of interest at a rate of 10 percent per year,would have matured on June 30, 2005, and was collateralized by substantiallyall of our assets.  This debt wasconverted into convertible preferred stock and warrants in April 2005, asdescribed below.

 

•              In a simultaneous July 2003 transaction, weentered into a loan agreement and borrowed $1.0 million from Hauser pursuant tothe terms of a subordinated note with an interest rate of 10 percent peryear.  Pursuant to an intercreditoragreement with PKM, the loan was collateralized by substantially all of ourassets.  This loan, as amended, wouldhave matured on June 30, 2005.  This debtwas converted into convertible preferred stock and warrants in April 2005, asdescribed below.

 

•              We borrowed $500,000 in November 2003 fromDraft Co. (“Draft”), under a note that matured on June 30, 2004, which had aninterest at a rate of 10 percent per year. The Draft loan was collateralized by substantially all our assetspursuant to a restated intercreditor agreement among PKM, Hauser, andDraft.  This note was repaid on June 30,2004.

 

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•              In April 2004, we issued a short-termpromissory note to PKM in the principal amount of $150,000.  The note required the payment of interest ata rate of 10 percent per year.  This notewas repaid during April 2004.

 

•              During February, April and May, 2004, weconducted a private placement to accredited investors of units, with each unitconsisting of one share of common stock and one common stock purchasewarrant.  In this placement, we sold2,730,763 units for aggregate gross proceeds of $4,014,222.  During fiscal year 2004 we received grossproceeds from this private placement of $1,749,099.  The five-year warrants sold with the commonstock are exercisable to purchase an aggregate of 2,730,763 shares of commonstock at an exercise price of $1.60 per share. In connection with the placement, we issued our placement agent afive-year warrant to purchase 123,272 units at an exercise price of $1.8375 perunit, paid our placement agent cash commissions of $181,210 and paid ourplacement agent a non-accountable expense allowance of $67,954.  In addition, we issued a finder a five-yearwarrant to purchase 95,189 units at an exercise price of $1.8375 per unit, paida finder’s fee of $140,928 and reimbursed a finder for expenses of $4,163.  The warrants underlying the unit warrantsissued to the placement agent and the finder are exercisable for a period offive-years at an exercise price of $1.8375 per share.  As a result of anti-dilution adjustmentsthrough April 30, 2005, these unit warrants are exercisable in the aggregatefor 599,137 units at $0.67 per unit, with each unit consisting of one share ofcommon stock and one warrant exercisable for one share of common stock.

 

•              On November 17, 2004, we entered into adiscretionary credit agreement with PKM pursuant to which we borrowed$500,000.  This discretionary creditagreement had a maturity date of February 28, 2005, that was extended to June30, 2005.  It required the payment ofinterest at a rate of 10 percent per year. It also contained various representations and loan covenants as arecustomary in banking and finance transactions. We issued a credit note to PKM to evidence such indebtedness.  In connection with this discretionary creditagreement, we entered into an intellectual property security agreement withPKM, pursuant to which we granted PKM a security interest in all of ourintellectual property, and a security agreement which we entered into with PKMin May 2003.  We also acknowledged andaccepted a third amendment to the first amended and restated subordination andintercreditor agreement by and between PKM and Hauser.  Pursuant to this agreement, proceeds borrowedunder this discretionary credit agreement were deemed “senior debt.”  Further, PKM, pursuant to a waiver agreement,waived past defaults under the discretionary credit agreements from January2003 and November 2003.  As additionalconsideration for the discretionary credit agreement we entered into inNovember 2004, we issued to PKM a warrant with a ten-year term to purchase34,014 shares of our common stock at $1.47 per share.  As a result of anti-dilution adjustmentsthrough April 30, 2005, this warrant is exercisable for 80,646 shares at $0.62per share.  This debt was converted intoconvertible preferred stock and warrants in April 2005, as described below.

 

•              On December 31, 2004, we issued $225,000principal amount of convertible bridge notes due May 31, 2005, to certainaccredited investors.  On January 13,2005, we issued $200,000 principal amount of convertible bridge notes due May31, 2005, to an accredited investor.  Thenotes bore interest at the rate of 10 percent per year and were convertibleinto securities to be issued in our next equity financing.  In April 2005, these notes were converted inconnection with the preferred stock financing described below, at 100 percentof the issuance price of such securities. In consideration of converting at 100 

 

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percent rather than 80percent of the issuance price of the preferred stock, the note holders werepermitted to retain the warrants issued to them in connection with theconvertible bridge financing.

 

In connection with the issuance of these notes, weissued five-year warrants to the investors for the purchase of an aggregate of85,000 shares of common stock.  Suchwarrants are exercisable to purchase common stock at a price per share of$0.50.  The allocated fair value of thewarrants was $79,030 and was accounted for as a discount on theborrowings.  This discount, which wasinitially presented as a reduction of the carrying value of the debt, wasamortized as interest expense through the April 2005 conversion date of thenotes.

 

In connection with these issuances, we paid TowerFinance, Ltd. (“Tower”), a finder, a cash commission equal to 8 percent of thegross proceeds raised from investors introduced to us by Tower and we agreed toissue a five-year common stock purchase warrant to Tower for the purchase of anumber of shares equal to 8 percent of the total possible shares issuable toTower-introduced investors in this financing at an exercise price of $0.625 pershare.

 

These bridge notes were converted into preferredstock and warrants in April 2005 at 100 percent of the issuance price of suchsecurities, as described below.  Becausethe convertible bridge notes provided a contingent conversion option to thenote holders which resulted in a beneficial conversion price when converted, werecorded an interest charge of $68,000 upon conversion of these notes in April2005.

 

•              On April 1, 2005, we sold approximately $18.0million of 5% Series A Convertible Preferred Stock and common stock purchasewarrants to a group of private investors, including two major shareholders, oneof which, PKM, is controlled by a director of our company.  Included in this amount was the conversion ofapproximately $4.4 million of existing indebtedness.  On April 1, 2005, pursuant to this agreement,we issued 18,035 shares of 5% Series A Convertible Preferred Stock toaccredited investors, warrants for the purchase of 27,052,500 shares of commonstock to such investors, and warrants for the purchase in the aggregate of1,635,960 shares of common stock to our placement agent and a finder.  We agreed to register the shares underlyingthe preferred stock and the shares underlying the investor warrants underapplicable federal and state securities laws.

 

Each share of preferred stock is convertible intothe number of shares of common stock equal to the $1,000 stated value dividedby $0.50, subject to anti-dilution adjustments. As a result, the 18,035 preferred shares sold may be converted into36,070,000 shares of common stock, subject to anti-dilution adjustments.  The terms of the preferred stock includedividend, protective, liquidation and conversion rights.

 

In the event of a fundamental transaction, asdefined by the Certificate of Designation of Rights and Preferences of 5%Series A Convertible Preferred Stock, such as a merger or sale of our company,the preferred shareholders have the right to require us to redeem the preferredshares at their stated value, including any accrued but unpaid dividends.  In the event of certain defaults, thepreferred shareholders have the right to require us to redeem the preferredshares at 110 percent their stated value, including any accrued but unpaiddividends.  As a result of theseredemption provisions, the carrying value of these preferred shares areconsidered to be redeemable and are reported as a 

 

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“mezzanine” instrument on our balance sheet at April30, 2005.  The aggregate liquidationvalue of these redeemable preferred shares at April 30, 2005, was$18,109,116.  However, the carrying valueof this redeemable preferred stock at April 30, 2005, was zero, net of adiscount associated with the warrants issued to the preferred shareholders, theplacement agent and finder.

 

The preferred stock was sold along with warrants topurchase a number of shares of common stock equal to 75 percent of the number ofshares of common stock initially issuable upon conversion of the preferredshares.  The warrants have a term of fiveyears and are exercisable at $0.50 per share, subject to anti-dilutionadjustments.  If the shares issuable uponexercise of the warrants are not registered for resale at the time of exercise,each warrant allows the holder to convert the warrants into common stockwithout any cash consideration in exchange for the surrender of the remainingshares of common stock otherwise purchasable upon exercise of the warrant.

 

In the event of a fundamental transaction, asdefined by the warrant agreements, such as a merger or sale of our company, thewarrants issued to the preferred shareholders, the placement agent and finderprovide the warrant holders with the right to put the warrants to us for cashin an amount equal to the fair value of the warrants, as determined using theBlack Scholes option pricing model.  As aresult of this put right, the warrants are reported at their fair value as aliability on our balance sheet at April 30, 2005, and future changes in thefair value of the warrant will result in charges or benefits to our income orloss from continuing operations.  Thefair value of these warrants at April 30, 2005, was $27,992,609.  Because the fair value of these warrants atthe closing of the preferred stock sale exceeded the proceeds received in thepreferred stock and warrant issuances, we recognized the excess of the fairvalue of the warrants over the proceeds received (including converted debt) asan interest charge of $4,266,047 in the quarter and fiscal year ended April 30,2005.  We recognized an additional chargeof $5,721,562 to other expense during the fourth quarter and year ended April30, 2005, to reflect the increase in the fair value of the warrants from thedate of the closing through April 30, 2005.

 

We obtained gross cash proceeds of $13,603,000 atthe closing (net of $30,000 in legal fees which were withheld by the leadinvestor) and converted $4,402,000 of indebtedness into the above-referencedconvertible preferred stock and warrants. We paid a placement agent cash commissions of $573,000, we repaid anoutstanding debt obligation (including accrued interest) to PKM of $502,708,and we paid a finder’s fee of $244,980. We also paid legal and administrative expenses of $18,086 incurred byPKM in this transaction.

** **

*Analysis*

* *

We expect that our operatinglosses and negative operating cash flow will continue through at least fiscalyear 2007 as we continue adding staff to support the development and launch ofour atrial fibrillation technology.  Weanticipate that our sales and marketing and general and administrative expenseswill continue to constitute a material use of our cash resources.  The actual amounts and timing of our capitalexpenditures will vary significantly depending upon progress on our productdevelopment projects, the length of time required to obtain regulatoryapprovals, the speed at which we are able to expand our distribution capabilityin domestic and international markets and the availability of financing.

 

Our capital requirements mayvary depending upon the timing and the success of the implementation of ourbusiness plan, regulatory, technological and competitive developments, or if:

 

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•              Commercialsales of our ATRILAZE system and new products are not achieved;

 

•              Operatinglosses exceed our projections;

 

•              Ourmanufacturing and development costs or estimates prove to be inaccurate;

 

•              Wedetermine to acquire, license or develop additional technologies; or

 

•              Weexperience difficulty in gaining U.S. market acceptance or delays in obtainingFDA clearance.

 

We cannotassure you that our efforts to enter the cardiac tissue ablation market will:

 

•              Beattainable;

 

•              Beprofitable;

 

•              Reduce ourreliance upon financing transactions; or

 

•              Enableus to continue operations.

 

The amount ofcapital needed for fiscal years 2006 and 2007 is difficult to estimate and willbe dependent on the introduction of the ATRILAZE system for open-heart proceduresand development costs the ATRILAZE system for stand-alone, minimally invasiveprocedures.

 

We cannotassure you that we will be able to raise sufficient additional capital on termsthat we consider acceptable, or at all. The terms of any equity financing are expected to be highly dilutive toour existing security holders.  Thedelisting of our securities from the Nasdaq SmallCap Market that occurred inMarch 2003 negatively affects our ability to raise capital.  In addition, the report of our independentregistered public accounting firm for fiscal years 2004 and 2005 includes anexplanatory paragraph expressing doubt about our ability to continue as a goingconcern.  If we are unable to obtainadequate financing on acceptable terms, we will be unable to continueoperations.

 

**Commitments and Contingent Liabilities**

** **

*ProductLiability Contingency.* In March 2005, we became aware that a patient who was utilizing ourheart valve had died.  We have notreceived any claims related to this matter but believe that any such claimwould be covered by our existing liability insurance.  Based upon the expectation that insurancewill cover the cost of any claims after our payment of the deductible, we donot expect the ultimate resolution of this matter to have a material effect onour financial position, results of operations or cash flows.

 

*RelatedParty Lease Obligation. *OnApril 4, 2003, we sold our corporate headquarters, manufacturing facilityand surrounding land in Inver Grove Heights, Minnesota, to PKM.  In connection with the transaction, wereceived total consideration of $3.84 million consisting of (1) $1.0million in cash, (2) PKM’s assumption of our $2.5 million outstandingindebtedness to Associated Bank which eliminated our indebtedness to AssociatedBank, and (3) PKM’s assumption of our promissory note with Dakota ElectricAssociation and land special assessments payable to Dakota County aggregating$336,105.

 

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Wesimultaneously leased back our facility pursuant to a ten-year lease, withoptions to renew and an option to repurchase the facility.  We continue to utilize the facility as we didprior to the financing transaction.  Weare in discussions with PKM about seeking a buyer for the property to facilitateour release from the remaining eight years of the lease, thereby permitting usto relocate to a more cost-effective facility. In July 2005, PKM listed the building for sale.  We have an agreement with PKM that releasesus from our lease if the building sells above a certain price.  However, there can be no assurance thebuilding will be sold and that we will be successful in obtaining a releasefrom our lease.

 

*ClinicalStudies. *Weentered into agreements with several large institutions to conduct clinicalstudies regarding certain aspects of our Omnicarbon heart valve’s clinicalperformance.  The agreements run throughfiscal year 2006.  In general, recipientsof clinical study payments are required to utilize our products in order tocomplete their studies and collect and submit data according to a studyprotocol.  As of April 30, 2005, wehad accrued, but not paid, $10,300 for clinical study payments.  In April 2005, we announced our exitfrom the mechanical heart valve business. We have assigned any financial responsibility for studies outside theUnited States to our former distributors.

 

*AccruedSeverance. *Aspart of the change in our strategic plan, we have changed personnel andeliminated certain positions, we are making severance payments to formerofficers and employees.  As ofApril 30, 2005, our remaining obligations totaled $24,834.  We expect to complete making these severancepayments by August 2005.

 

| ** **                              | ** ** | **Total** | ** **  |
|-----------------------------------------|------------|-----------|-------------|
| Restructuring charges                   |       | $         | 214,000     |   |
| Cash usage                              |       | —    |        |
| **Balance as of July 31, 2004**    | ** ** | **$**     | **214,000** | ** ** |
| Adjustments to provision                |       | 46,000    |        |
| Cash usage                              |       | 93,239    |        |
| **Balance as of October 31, 2004** | ** ** | **$**     | **116,761** | ** ** |
| Adjustments to provision                |       | 48,000    |        |
| Cash usage                              |       | 116,808   |        |
| **Balance as of January 31, 2005** | ** ** | **$**     | **97,953**  | ** ** |
| Cash usage                              |       | 73,119    |        |
| **Balance as of April 30, 2005**   | ** ** | **$**     | **24,834**  | ** ** |

 

*AtrialFibrillation Technology Purchase Agreement. *In August 2003, we entered into atechnology purchase agreement with LightWave and its principals relating to theacquisition of LightWave’s interests in technology consisting of acatheter/probe containing elements of optical fiber, coolant passages and otherfeatures for the purpose of delivering laser energy to the epicardial surfaceof the heart for treatment of atrial fibrillation.  We paid LightWave an initial standstillpayment consisting of 15,000 shares of our common stock, $10,000 upon closingand an additional $30,000 to LightWave in installments in 2004 and 2005.  We will be obligated to pay $125,000 toLightWave within 45 days after the first commercial sale of our product in theUnited States or Europe to two or more parties and $385,000 within 45 daysfollowing our achievement of $1,500,000 of cumulative gross sales of disposableproducts.  In addition, during fiscalyear 2004, we issued to LightWave a warrant for the purchase of 25,000 sharesat closing and, during fiscal year 2005, a warrant for the purchase of 25,000shares upon receiving FDA 510(k) clearance. In addition, we are obligated to issue a warrant for the purchase of 25,000shares upon a receipt of a U.S. utility patent covering the product and awarrant for the purchase of 25,000 shares upon the first commercial sale of ourproduct.

 

Following thefirst commercial sale, we have agreed to pay LightWave payments equal to 6percent of net sales of the LightWave product in countries in which we obtainpatent protection and 4 percent of net sales of the LightWave product interritories in which there is no patent protection.

 

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Commencing with the second yearfollowing our first commercial sale, we have agreed to pay minimum annualpayments as follows:

 

| **Year Following  Commercialization** | ** ** | **Minimum Annual Payment** | ** ** |
|---------------------------------------|------------|----------------------------|------------|
| 2                                     |       | $                          | 50,000     |   |
| 3                                     |       | $                          | 75,000     |   |
| 4                                     |       | $                          | 100,000    |   |
| 5                                     |       | $                          | 200,000    |   |
| 6                                     |       | $                          | 300,000    |   |
| 7                                     |       | $                          | 350,000    |   |
| 8                                     |       | $                          | 350,000    |   |
| 9                                     |       | $                          | 400,000    |   |
| 10                                    |       | $                          | 500,000    |   |

 

We areobligated to pay payments for a period of ten years following the firstcommercial sale.  Our technology purchaseagreement with LightWave contains other customary conditions, including mutualindemnification obligations.  LightWaveand two of its principals have agreed to certain noncompetition obligations,nondisclosure obligations, certain obligations to assign new developments orinventions relating to the acquired technology to our company.  We have agreed to use our reasonablecommercial efforts to commercialize the technology within three years followingthe acquisition of the technology from LightWave.  If we fail in any year to pay minimum annualpayments, we may be obligated to grant LightWave a nonexclusive right to usethe technology acquired from LightWave, or pay LightWave the difference betweenpayments actually made and minimum payments due for a given year.

 

The followingtable summarizes our contractual obligations as of April 30, 2005:

 
| ** **                              | ** ** | **Payments Due By Period** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|
| **Summary of Contractual  Obligations** | ** ** | **TOTAL**                  | ** ** | **Less than  One Year** | ** ** | **Two to  Three Years** | ** ** | **Four or  More Years** | ** ** |
|                                    |       |                       |       |   |   |   |   |   |   |
| Related Party Lease Obligation(1)       |       | $                          | 3,059,100  |   | $ | 370,800 |   | $ | 741,600 |   | $ | 1,946,700 |   |
| Clinical Studies                        |       | 10,300                     |       | 10,300 |   |   |   |   |   |
| Accrued Severance                       |       | 24,834                     |       | 24,834 |   |   |   |   |   |
| TOTAL CONTRACTUAL OBLIGATIONS           |       | $                          | 3,094,234  |   | $ | 405,934 |   | $ | 741,600 |   | $ | 1,946,700 |   |

 

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(1)           Future payments includeinterest due.

** **

**Qualitative and Quantitative Disclosures about Market Risk**

** **

We develop ourproducts in the U.S. and market our products globally.  Substantially all of our sales aredenominated in U.S. dollars.  Astrengthening of the U.S. dollar could make our products less competitive inforeign markets.  We do not currentlyparticipate in any currency hedging activities to mitigate this risk.  We assess the need to use financialinstruments to hedge our exchange rate exposure on an ongoing basis.  Our interest income is sensitive to changesin the general level of U.S. interest rates. All of our outstanding debt instruments have fixed interest rates andare, therefore, not sensitive to changes in market interest rates.  Based on the current nature and levels of ourinvestments and debt, we believe that we currently have no material market riskexposure.

 

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Our generalinvesting policy is to limit market and credit risk and the risk of principalloss.  All liquid investments withoriginal maturities of three months or less are considered to be cashequivalents.  Our cash equivalents atApril 30, 2005, consisted only of cash and money market funds.

 

**Cautionary Statement**

** **

*MedicalCV, Inc.,or persons acting on our behalf, or outside reviewers retained by us makingstatements on our behalf, or underwriters of our securities, from time to time,may make, in writing or orally, “forward-looking statements” as defined underthe Private Securities Litigation Reform Act of 1995.  This Cautionary Statement, when used inconjunction with an identified forward-looking statement, is for the purpose ofqualifying for the “safe harbor” provisions of the Litigation Reform Act and isintended to be a readily available written document that contains factors whichcould cause results to differ materially from such forward-lookingstatements.  These factors are inaddition to any other cautionary statements, written or oral, which may bemade, or referred to, in connection with any such forward-looking statement.*

* *

*Thefollowing matters, among others, may have a material adverse effect on ourbusiness, financial condition, liquidity, results of operations or prospects,financial or otherwise.  Reference tothis Cautionary Statement in the context of a forward-looking statement orstatements shall be deemed to be a statement that any one or more of thefollowing factors may cause actual results to differ materially from those insuch forward-looking statement or statements.*

* *

**We have ahistory of losses and no assurance of future profitability. **We have incurredlosses in each of the last nine fiscal years. We had net losses of $19,094,872 for the fiscal year endedApril 30, 2005, and $6,238,990 for the fiscal year ended April 30,2004.  We expect to continue to incursubstantial losses for fiscal year 2006 as we exit the heart valve business andcontinue development of new products.  Asof April 30, 2005, we had an accumulated deficit of $42,406,957.  In April 2005, we completed a privatesale of $13.6 million of 5% Series A Convertible Preferred Stock andconverted approximately $4.4 million of debt into shares of preferredstock.  We estimate that this new fundingwill provide us with sufficient capital for operations through the secondquarter of fiscal year 2007 to develop and launch products within our ATRILAZEsystem for ablation of cardiac tissue, a procedure used for surgical treatmentof atrial fibrillation.  Substantialadditional financing will be needed beginning in the second half of fiscal year2007 to build market share for our ATRILAZE system and to respond tocompetitive pressures or unanticipated requirements.  Our failure to obtain such financing whenrequired could adversely affect our competitive position and results ofoperations.  We will incur additionallosses until we are able to introduce new products and generate substantialrevenues, while maintaining reasonable expense levels, all of which involveuncertainty.  In addition, the report ofour independent registered public accounting firm for fiscal years 2004 and2005 includes an explanatory paragraph expressing doubt about our ability tocontinue as a going concern.

 

**As aresult of our exit from the mechanical heart valve business, our revenue infiscal year 2005 substantially decreased. We do not expect to realize significant revenue until we introduce newproducts to the marketplace. **InNovember 2004, we decided to cease manufacture of mechanical heartvalves.  In April 2005, we decidedto exit the mechanical heart valve business. As a result, our revenues from heart valve sales, our primary source ofsales to date have declined significantly and ceased in the second quarter ofcalendar year 2005.  Due to our recententry into the atrial fibrillation market, we do not expect to generate substantialrevenues until the third quarter of fiscal year 2007, at the earliest.  Even if we begin to recognize revenues fromour ATRILAZE system, it may be several years, if ever, before we achieveprofitability and positive cash flow.  Ifwe do achieve profitability, we cannot assure you that we would be able tosustain or increase profitability on a quarterly or annual basis in thefuture.  

 

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**Our 2005private placement of convertible preferred stock and warrants has resulted in aconcentration of ownership. **Investorsin our April 2005 private placement own preferred stock and warrants that,if all such securities were converted into, or exercised for the purchase of,common stock, would represent aggregate ownership of more than 85 percent ofthe outstanding common shares of our company. A major portion of the equity securities sold in the private placementwere acquired by PKM Properties LLC (“PKM”), an entity controlled by Paul K.Miller, one of our directors and the largest beneficial owner of oursecurities.  Should these shareholdersconvert their preferred shares or exercise their rights to acquire our commonstock pursuant to warrants and agree to vote in concert, they would control ourcompany.  To our knowledge, theseinvestors have not acted as a group in seeking, negotiating or making theirinvestment in our company and consider themselves independent investors.  Even though each investor, other than PKM, iscontractually precluded from acquiring more than 9.999 percent of our commonstock at any one time, should the investors seek to convert their preferredstock or exercise their warrants, they could act in concert with respect to thecommon shares they would acquire, and would thus control our company.

 

**Theconversion of our preferred stock or the exercise of warrants issued toinvestors in the April 2005 private placement may depress the price of ourcommon stock and substantially dilute the ownership interests of existingcommon shareholders. **Ifthe holders of our preferred stock were to convert their preferred stock andexercise their warrants, as of April 30, 2005, they would own an aggregateof more than 85 percent of our common stock, in addition to any shares they maynow or in the future own.  If theyconvert their preferred stock into shares of common stock or exercise theirwarrants and sell their shares into the market, these sales could lower themarket price of our common stock and dilute the holdings of existing commonshareholders.  In addition, in certaincircumstances we may choose to pay the 5 percent per year dividend on thepreferred shares, which is payable on a quarterly basis, by adding the same tothe stated value of preferred stock, in which case additional dilution wouldresult.  Dilution or the potential fordilution could also materially impair our ability to raise capital through thefuture sale of equity securities.

 

**Theissuance of additional equity securities in a future financing could triggerthe anti-dilution provisions of our outstanding convertible preferred stock andwarrants.** If wewere to issue additional equity securities at a per share price lower than thecurrent conversion price of the preferred stock, or the exercise price of thewarrants issued with the preferred stock, then the conversion price of thepreferred stock and the exercise price of such warrants would automaticallyadjust downward to be equal to the common stock equivalent price of suchnewly-issued securities and an additional charge would be recorded.  While we have no plans to issue securities ina manner that would trigger these anti-dilution provisions, we could elect todo so in the future or be required to do so in order to finance thecompany.  The full details of theseanti-dilution provisions are contained in the Certificate of Designation ofRights and Preferences of 5% Series A Convertible Preferred Stock, whichis a part of our Restated Articles of Incorporation.

 

**Holders ofour preferred shares have certain rights to require us to redeem theirpreferred shares and warrants, and the placement agent and finder who receivedwarrants in our April 2005 private placement also have rights to requireus to redeem those warrants, thereby resulting in a liability related to thewarrants on our balance sheet.  Futureincreases in the fair value of the foregoing warrants will result in charges toour results of operations. **Inthe event of certain fundamental transactions such as a sale or merger, thepreferred shareholders have the right to require us to redeem the preferredshares at their stated value, including any accrued but unpaid dividends.  In the event of certain defaults, thepreferred shareholders have the right to require us to redeem the preferredshares at 110 percent of their stated value, including any accrued but unpaiddividends.  As a result of theseredemption provisions, these preferred shares are considered to be redeemableand are reported as a “mezzanine” instrument on our balance sheet.  The expected carrying value of this

 

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redeemable preferred stock atApril 30, 2005, was reduced by the carrying value of the warrantsdescribed below.  The aggregateliquidation value of these preferred shares at April 30, 2005, was $18,109,116.  In the event of a sale or merger transaction,the warrants issued to the preferred shareholders and the placement agent andfinder provide them with the right to put the warrants to us for cash in anamount equal to the fair value of the warrants, as determined using the BlackScholes option pricing model.  As aresult of this put right, the warrants are reported at their fair value of$27,992,609 as a liability on our balance sheet at April 30, 2005, andfuture changes in the fair value of the warrants will result in charges orbenefits to our results of operations.

 

**If we failto register and maintain registration for the common stock issuable uponconversion of the preferred stock and exercise of warrants sold with thepreferred stock, including shares issuable pursuant to the anti-dilutionprovisions of such securities, we face substantial monetary charges. **In connection withour April 2005 private placement, we entered into a registration rightsagreement in which we agreed to prepare and file with the SEC by a certainfiling date, a registration statement which registers common stock issuableupon conversion of the preferred stock and exercise of the warrants, whichregistration statement must be made effective by certain specific dates andmaintained effective throughout a period of up to five years.  We may also be obligated to file additionalregistration statements with respect to our shares and, potentially, additionalshares issuable pursuant to the terms of the preferred stock.  If we fail to file any registration statementby a required filing date, or a registration statement is not declaredeffective by a specified effectiveness date, or after an effective date, theregistration statement ceases to be effective and available to the holders ofthe securities that were registered for more than an aggregate of 40 tradingdays in any consecutive 12 month period, then in addition to other rights whichsuch holders may have against us under applicable law, we are obligated to payas liquidated damages to such holders for each calendar month or portionthereof an amount equal to 1.5 percent of the aggregate amount originallyinvested by these investors until we satisfy the requirements of theregistration rights agreement.  Forexample, a failure to maintain a registration statement effective in accordancewith the requirements of the registration rights agreement would cost ourcompany approximately $9,000 per day for each day we fail to satisfy ourobligations under such agreement.  Inaddition, if we fail to file and maintain such registration statements, ourpreferred shareholders may be able to require us to redeem their preferredstock for cash at 110 percent of the stated value of the preferred stock.

 

**Weestimate that our current capital resources will fund our operations throughmid-fiscal year 2007, but we will require substantial additional financing,which may be difficult to obtain.  Ourfailure to obtain necessary financing or doing so on unfavorable terms couldadversely affect our product development program and marketing efforts. **Our future capitalrequirements will depend on many factors, including:

 

•              Thecost of product development, such as outsourced design and engineeringservices, and product prototyping;

 

•              Thetiming of, and the costs involved in, obtaining regulatory approvals;

 

•              Thecost of enhancing and protecting our intellectual property portfolio;

 

•              Thecost of manufacturing and related outsourced services;

 

•              Thecost of commercialization, including product demonstration, promotion andmarketing;

 

•              Theneed to upgrade corporate systems and hardware;

 

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•              Thecost of building inventory to support sales;

 

•              Thecosts involved in any patent infringement actions that we initiate or that arebrought against us by third parties;

 

•              Ourability to establish and maintain collaborative arrangements;

 

•              Ouradvancement of other product candidates into development;

 

•              Potentialacquisition or licensing of other products or technologies; and

 

•              Thecost of cash payments of quarterly dividends due to holders of our preferredstock.

 

Additionalfinancing may not be available to us when we need it and it may not beavailable on favorable terms.  If we areunable to obtain adequate financing on a timely basis, we may be required tosignificantly curtail or cease product development.  We could be required to seek funds througharrangements with collaborators or others that may require us to relinquishrights to some of our technologies, product candidates or products which wewould otherwise pursue on our own.  If weraise additional funds by issuing equity securities, our then-existingshareholders will experience ownership and/or share price dilution and theterms of any new equity securities may have preferences over our common stock.

 

**We may beunsuccessful in our efforts to shift our business model to target high growthmarkets in cardiovascular surgery. **Bychanging our focus from mechanical heart valves to cardiac ablation products,we hope to reduce our reliance upon financing transactions, which may not beavailable to us in the future.  Wecannot, however, assure you that our efforts to change our product offeringswill:

 

•              Beattainable;

 

•              Beprofitable;

 

•              Reduceour reliance upon future financing transactions; or

 

•              Enableus to continue operations.

 

**Ourproducts under development for the stand-alone, minimally invasive treatment ofatrial fibrillation are critical to our success. **We acquiredtechnology for the ablation of cardiac tissue to treat atrial fibrillation inthe open-heart surgery setting in August 2003.  During the next 12 to 18 months we intend todevelop products for minimally invasive (closed-chest, beating heart) ablationof cardiac tissue to treat atrial fibrillation. We cannot assure you that we will be able to design, develop andcommercialize such products.  We may needto secure or license technology from other companies in order to complete ourproducts.  There can be no assurance thatif such licenses are needed, they will be available on satisfactory economicterms.

 

**We cangive no assurance that our ATRILAZE system will be equal to or superior toother systems for the ablation of cardiac tissue. **Our ATRILAZE systemis based upon the use of laser energy to ablate cardiac tissue.  Although laser energy has been used widely invarious cardiac procedures, and we have obtained FDA 510(k) clearance to usethe ATRILAZE system for cardiac tissue ablation, we have not yet conductedcomparative studies in a human clinical setting.  Accordingly, these can be no assurance thatthe ATRILAZE system will be clinically effective or commercially accepted.

 

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**We cannotassure you that use of the ATRILAZE system for the treatment of atrialfibrillation will gain physician acceptance. **A limited number of cardiovascular surgeons andcardiologists can influence medical device selection and purchase decisions fora large portion of the target cardiovascular surgery patient population.  We cannot assure you that ATRILAZE will gainany significant degree of physician acceptance, or that users will accept oursystem as preferable to alternative products or methods of treatment.  Physician acceptance of ATRILAZE depends uponour ability to demonstrate the clinical advantages of such system.

 

**Severalmajor corporations have announced business acquisitions and programs to developproducts to treat atrial fibrillation. **Thesecorporations include Guidant Corp, St. Jude Medical, Inc., Edwards Lifesciences,LLC and Medtronic, Inc.  Thesecorporations have resources significantly greater than MedicalCV to aid intheir product development efforts.  Thesecorporations are well known in the cardiovascular surgery market and havelarge, well-trained sales forces.  One ormore of these corporations could introduce successful products before we do orintroduce more innovative products.  Wecannot assure you that even if we introduce a product for minimally invasivetreatment of atrial fibrillation that we will be able to effectively competeagainst these or other corporations.

 

**Ablationof cardiac tissue is one approach to treating atrial fibrillation. **Large pharmaceuticalcompanies market drugs for the treatment of atrial fibrillation.  There may be other surgical,electro-physiological or biological treatments developed for atrialfibrillation.  We cannot assure you thateven if we introduce a product for minimally invasive treatment of atrialfibrillation that drug, biopharmaceutical, or other alternative technologieswill not be introduced that would make our product noncompetitive or obsolete.

 

**We may beunable to establish and protect our proprietary rights which are critical toour success in developing products for the treatment of atrialfibrillation. **Wehave no patents issued to us covering our soft tissue ablation products.  We have submitted eight U.S. patentapplications and one foreign patent application as of April 30, 2005,covering products we have designed for use in treating atrialfibrillation.  We expect to seek patentprotection for additional products that we may develop in the future.  Our success will depend, in part, on ourability to protect our products and to manufacture and sell them withoutinfringing the rights of third parties. The validity and breadth of claims covered in medical technology patentsinvolve complex legal and factual questions and, therefore, are highlyuncertain.  In addition, the laws of manycountries may not afford protection for our proprietary rights to the sameextent as U.S. laws.  We cannot assureyou that:

 

•              Anypending patent applications or any future patent applications will result inthe issuance of patents;

 

•              Thescope of any patent protection will be effective to exclude competitors or toprovide competitive advantages to us;

 

•              We willbe able to commercially exploit any issued patents before they expire;

 

•              Any ofour patents will be held valid if subsequently challenged;

 

•              Otherswill not claim rights in, or ownership of, the patents and other proprietaryrights we hold;

 

•              Ourproducts and processes will not infringe, or be alleged to infringe, theproprietary rights of others; or

 

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•              We willbe able to protect meaningful rights in proprietary technology over which we donot hold patents.

 

Furthermore,we cannot assure you that others have not developed or will not developproducts that may duplicate our products or manufacturing processes, or thatothers will not design around our patents. Other parties may independently develop or otherwise acquiresubstantially equivalent techniques, gain access to our proprietary technologyor disclose such technology.  Inaddition, whether or not we obtain additional patents, others may hold orreceive patents covering components of products we independently develop in thefuture.

 

**We may besubject to claims that we infringe the intellectual property rights of thirdparties, which could adversely affect the sale of our products and ourfinancial condition. **Themedical device industry has been characterized by extensive litigationregarding patents and other intellectual property rights.  Litigation, which would likely result insubstantial cost to us, may be necessary to enforce any patents issued orlicensed to us and/or to determine the scope and validity of others’proprietary rights.  Our competitors holdissued patents which may result in claims of infringement against us or otherpatent litigation.  We also may have toparticipate in interference proceedings declared by the United States Patentand Trademark Office, which could result in substantial cost to determine thepriority of inventions.

 

We are awareof patents issued to our competitors and are aware that these competitors havepatent applications pending.  Thesepatents and applications could become the basis for infringement claims againstus.  On May 2, 2005, we received aletter from Edwards Lifesciences, LLC (“Edwards”) concerning our ATRILAZE softtissue ablation products, which are the subject of some of our patentapplications.  Edwards does not claimthat our products infringe any of its patents. Edwards’ letter calls to our attention six of its patents and requestsus to comment on how our products differ from the claimed methods and apparatusof the six specified Edwards patents.  Wehave reviewed the specified Edwards patents and discussed them with our patentcounsel, and believe that our ATRILAZE system does not infringe any of thesepatents.  Legal proceedings broughtagainst us by competitors alleging that our products infringed their patents,whether with or without merit, could be time-consuming for our management andemployees, result in costly litigation, cause product shipment delays, requireus to pay damages or settlement amounts, or require us to:

 

•              Ceasemanufacturing and selling the product in question, which could seriously harmour business;

 

•              Enterinto royalty-bearing licensing agreements; or

 

•              Designcommercially acceptable non-infringing alternative products.

 

We cannotassure you that we would be able to obtain licensing agreements, if required,on terms acceptable to us or at all, or that we would be able to developcommercially acceptable non-infringing alternative products.  Our failure to do so could have a materialadverse effect upon our business, financial condition, operating results andcash flows.

 

**Ifpatients allege that the use of our cardiovascular surgery devices injuredthem, we may face substantial product liability claims. **Substantial productliability litigation exists within the medical device industry.  Our products are used in cardiovascularsurgery, and their failure may result in patient injury or death.  We have had product liability claims assertedagainst us in the past, which were resolved under our insurance coveragewithout significant financial cost to us. We cannot assure you, however, that future product liability claims willnot exceed the limits of our insurance coverage or that

 

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such insurance will continue tobe available to us on commercially reasonable terms, or at all.  Consequently, a product liability claim orother claim with respect to uninsured liabilities, or in excess of insuredliabilities, could have a material adverse effect on our business, financialcondition, operating results and cash flows. In addition, adverse publicity resulting from product liabilitylitigation may materially adversely affect us regardless of whether the claimsare valid or whether we are liable. Furthermore, these claims would likely divert our financial andmanagement resources that would otherwise be used to benefit the futureperformance of our operations.

 

In addition tonew products, we sold more than 50,000 mechanical heart valves between 1992 and2005.  We assume that a majority of thepatients who received our heart valves are still alive.  If any of these patients were to have aproblem with a heart valve, they could assert claims for damages against us.  In April 2005, we placed our productsliability insurance with a new insurance carrier.  Our new policy provides us with potentialcoverage for claims of up to $5,000,000 per occurrence and in the aggregate perpolicy year.  Concurrently, we purchaseda three-year extended reporting coverage endorsement from our former carrierwhich was unwilling to renew our coverage on the previous terms.  The extended reporting period coverage willallow us to seek coverage under the prior policy for products claims arisingfrom occurrences which took place during such policy period but which were notasserted against us during the previous policy period.

 

InMarch 2005, it was reported to us that one of our valves implanted in apatient did not perform and was replaced. The patient subsequently died. This event has been reported to our insurer.  If a claim is asserted against us, we intendto rely upon the policy with the extended reporting period endorsementdescribed above.  We believe any claimbrought will be covered by such policy after our payment of the deductible, althoughthere can be no assurance that any coverage will be available or adequate if aclaim is asserted.

 

**Keyemployees could leave our company at any time, thereby adversely affecting ourproduct development and profitability. **Wedepend heavily on the technical knowledge and industry expertise of ourmanagement team.  The development andexecution of our business plan depends upon these individuals.  We do not have employment agreements withmost of our key employees.  The departureof key people could materially and adversely affect our business, financialcondition, operating results and cash flows.

 

**We may beunable to recruit, motivate and retain qualified employees. **Our success dependsin part upon our ability to attract, motivate and retain a sufficient number ofqualified employees, including those who concentrate in research anddevelopment, sales, marketing and manufacturing, to keep pace with our productdevelopment schedules.  Even though wehave not experienced shortages of qualified people to date, qualifiedindividuals needed to fill these positions could be in short supply in ourmarket.  Our inability to recruit,motivate and retain such individuals may delay the planned launch of newproducts, including the recruitment of individuals to develop our cardiacablation products, or result in high employee turnover, either of which couldhave a material adverse effect on our business, financial condition, operatingresults and cash flows.  Additionally, competitionfor qualified employees could require us to pay higher wages and provideadditional benefits to attract sufficient employees.

 

**Ourability to attract and retain our management team, research, development,clinical, medical device sales personnel and others depends to some extent onour continued ability to issue stock options or other forms of equitycompensation awards.  We will be requiredto record compensation expense in our financial statements beginning in ourfiscal year 2007, which could harm our future reported operating results andcause unexpected fluctuations in our expenses. **In April 2005, we issued options to keymembers of our management team for the purchase of an aggregate of 6,665,675shares of common stock.  These optionswill vest over a four-year period commencing April 1, 2006.  While we expect to grant additional stockoptions to current management personnel and

 

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other key employees after theirhire dates to provide additional incentives to remain with us, their initialgrants are usually much larger than subsequent grants.  The Financial Accounting Standards Board hasissued Statement of Financial Accounting Standards (“SFAS”) No. 123R,“Share-Based Payment,” which will apply to us after April 30, 2006.  SFAS No. 123R eliminates the ability toaccount for share-based compensation transactions using Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” andrequires such transactions be accounted for using a fair-value-based method andthe resulting cost to be recognized in the financial statements over the optionvesting periods.  Recording compensationexpense in the statement of operations for employee stock options using thefair value method could have a significant negative effect on our reportedfinancial results, particularly if we grant a significant number of options toour employees in future periods.

 

**We mayneed to fund multiple research studies throughout the lifecycle of each of ourproducts, providing statistically significant scientific data to regulatoryagencies and cost effectiveness data to third party payers. **The FDA, foreignregulatory agencies and third party health care payers may require scientificclinical outcomes data and cost effectiveness data.  We will need to provide this data throughoutour products’ lifecycles.  Payers andgovernmental agencies may change the frequency and breadth of clinical researchrequired, potentially significantly increasing our costs.  Without adequate positive outcomes data thatdemonstrate advantages from the use of our ATRILAZE system, we may not achieveany significant market penetration.  Wecannot assure you that our outcomes data will be adequate to meet present orfuture medical device utility requirements. If our outcomes data does not meet such requirements, we may be unableto sell our products or obtain third party reimbursement for the costs of ourproducts.

 

**Substantialgovernment regulation in the U.S. and abroad may restrict our ability to sellour ATRILAZE system, or other products. **TheFDA and comparable regulatory authorities in foreign countries extensively andrigorously regulate our products, product development activities andmanufacturing processes.  In the U.S.,the FDA regulates the introduction of medical devices as well as themanufacturing, labeling and record-keeping procedures for such products.  We are required to:

 

•              Obtainclearance before we can market and sell medical devices;

 

•              Satisfycontent requirements applicable to our labeling, sales and promotionalmaterials;

 

•              Complywith manufacturing and reporting requirements; and

 

•              Undergorigorous inspections.

 

The process ofobtaining marketing clearance for new medical devices from the FDA can becostly and time consuming.  For example,the premarket clearance process can require numerous years to complete.  We cannot assure you that our future productswill obtain FDA clearance on a timely basis, or at all.  Our products must also comply with laws andregulations of foreign countries in which we market such products.  In general, the extent and complexity ofmedical device regulation is increasing worldwide.  This trend may continue, and the cost andtime required to obtain marketing clearance in any given country may increaseas a result.  We cannot assure you thatour products will obtain any necessary foreign clearances on a timely basis, orat all.

 

**Oncemedical devices are cleared for sale, regulatory authorities may still limitthe use of such products, prevent the sale or manufacture of such products orrequire a recall or withdrawal of such products from the marketplace. **Following initialclearance from regulatory authorities, we continue to be subject to extensiveregulatory requirements.  Governmentauthorities can withdraw marketing clearance due to our failure to comply withregulatory standards or due to the occurrence of

 

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unforeseen problems followinginitial clearance.  Ongoing regulatoryrequirements are wide-ranging and govern, among other things:

 

•              Annualinspections to retain CE mark for sale of products in the European Union;

 

•              Productmanufacturing;

 

•              Suppliersubstitution;

 

•              Productchanges;

 

•              Processmodifications;

 

•              Medicaldevice reporting; and

 

•              Productsales and distribution.

 

The FDA andvarious government agencies inspect our facilities from time to time todetermine whether we are in compliance with applicable laws andregulations.  If we fail to comply ormaintain compliance with medical device laws or regulations, regulatoryauthorities may fine us and bar us from selling our products.  If the FDA believes we are not in compliancewith such laws or regulations, it can:

 

•              Seizeour products;

 

•              Requirea recall;

 

•              Withdrawpreviously granted market clearances;

 

•              Implementprocedures to stop future violations; and/or

 

•              Seekcivil and criminal penalties against us.

 

**We may besubject to fines, penalties or injunctions if we are determined to be promotingthe ATRILAZE system for unapproved, “off-label,” or new uses, or making false,misleading or unsubstantiated claims, which would harm our operating resultsand reduce the value of your investment. **Our promotional materials and training methodsfor physicians must be in compliance with FDA and other applicable regulations.  FDA regulations prohibit us from promoting oradvertising the ATRILAZE system for uses not within the scope of our clearancesand from making unsupported safety or effectiveness claims.  These determinations can be subjective andthe FDA may disagree with our promotional claims.  The ATRILAZE system has been cleared for theablation of soft tissue, including cardiac tissue, and for no otherindication.  If the FDA determines thatour promotional materials or training constitutes promotion of an unapproveduse, or makes false or misleading claims or claims not supported by adequatescientific data, the agency could subject us to serious enforcement sanctionsand/or limit the promotional claims that we are permitted to make for theATRILAZE system.  The FDA typically doesnot permit promotional claims for a device based upon physician reports andother anecdotal data.  There can be noassurance, therefore, that the FDA would agree that any independentpeer-reviewed studies are scientifically adequate to support the claims we makefor the ATRILAZE system, such as low complication rates and minimalpost-surgical pain and bruising. Furthermore, the FDA may require that we obtain a new 510(k) clearanceor PMA approval in order to make performance or clinical outcome claims for theATRILAZE system.  The FDA also may limitor prohibit claims based on comparison of the ATRILAZE system versus othersurgical cardiac tissue ablation technologies and

 

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devices in the absence of ascientifically valid head-to-head clinical trial or other adequate supportingdata.  Any legal limitations on thepromotional claims we may make for the ATRILAZE system could adversely affectour sales.

 

**As amedical device manufacturer, we are subject to federal and state lawsprohibiting “kickbacks” and false or fraudulent claims, which, if violated,could subject us to substantial penalties. A challenge to or investigation into our practices under these lawscould cause adverse publicity, be costly to respond to, and harm ourbusiness. **Afederal law commonly known as the Medicare/Medicaid anti-kickback law, andseveral similar state laws, prohibit payments that are intended to inducephysicians or others either to refer patients or to acquire or arrange for orrecommend the acquisition of healthcare products or services.  These laws limit the kinds of financialarrangements, including sales programs, we are allowed to have with physicians,surgery centers, hospitals or other potential purchasers of the ATRILAZEsystem.  Other federal and state lawsgenerally prohibit individuals or entities from knowingly presenting, orcausing to be presented, claims for payment from Medicare, Medicaid or otherthird-party payers that are false or fraudulent, or for items or services thatwere not provided as claimed. Anti-kickback and false claims laws prescribe potentially substantialcivil and criminal penalties for noncompliance. Even an unsuccessful challenge or investigation into our practices couldcause adverse publicity and be costly to respond to, and thus could harm ourbusiness and results of operations.

 

**Theuncertainty of third party reimbursements and possible health care reforms mayadversely affect us. **Ourability to market products successfully in the U.S. depends in part on theextent to which reimbursement for the cost of such products and relatedtreatment will be available from government health administration authorities,private health insurers, health maintenance organizations and other third partypayers.  Payers may challenge the needfor, and prices of, medical products and services.  Payers may deny reimbursement for proceduresthat they deem experimental or for devices used in ways other than as clearedby the FDA or stated in their indications for use.  With respect to our products, some payerscould deny coverage until the medical profession generally accepts thedevices.  The inability of hospitals andother providers to obtain reimbursement from third party payers for ourproducts would have a material adverse impact on our business, financialcondition, operating results and cash flows. Health care reform may also impact sales of new products in the U.S.Reforms may include:

 

•              Mandatedbasic health care benefits;

 

•              Controlson health care spending through limiting the growth of private health insurancepremiums and Medicare and Medicaid spending; and

 

•              Fundamentalchanges to the health care delivery system.

 

We anticipatethat the U.S. Congress and state legislatures will continue to review andassess alternative health care delivery systems and payment methodologies, andthat public debate of these issues will likely continue in the future.  Due to uncertainties regarding the ultimatefeatures of reform initiatives and their enactment and implementation, wecannot predict which, if any, of such reform proposals will be adopted, whenthey may be adopted or what impact they may have on our ability to market ourcurrent and future products.  Lawsresulting from such reform initiatives could adversely impact our business,financial condition, operating results and cash flows.

 

**We may beexposed to potential risks relating to our internal controls over financialreporting and our ability to have those controls attested to by our independentregistered public accounting firm. **Asdirected by Section 404 of the Sarbanes-Oxley Act, the SEC adoptedrules requiring public companies to include a report of management oninternal control over financial reporting

 

37

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in their annual reports,including Annual Reports on Form 10-KSB, which we file.  In addition, the independent registeredpublic accounting firm auditing a public company’s financial statements mustattest to and report on management’s assessment of the effectiveness of thecompany’s internal control over financial reporting as well as the operatingeffectiveness of the company’s internal controls over financial reporting.  We do not expect to be subject to theserequirements for the fiscal years ending April 30, 2005 or April 30,2006, so long as our market capitalization does not exceed $75 million as ofthe end of the second quarter of fiscal year 2006.  We are evaluating our internal controls overfinancial reporting in order to allow our management to report on, and ourindependent registered public accounting firm to attest to, our internalcontrols, as a required part of our Annual Report on Form 10-KSB beginningwith our report for the fiscal year ending April 30, 2007.

 

While weexpect to expend significant resources during fiscal years 2006 and 2007 indeveloping the necessary documentation and testing procedures required bySection 404 of the Sarbanes-Oxley Act, there is a risk that we will notcomply with all of the requirements imposed thereby.  At present, there is no precedent availablewith which to measure compliance adequacy. Accordingly, there can be no assurance that we will not receive anadverse report on our assessment of our internal controls over financialreporting and/or the operating effectiveness of our internal controls overfinancial reporting from our independent registered public accounting firm.

 

In the eventwe identify significant deficiencies or material weaknesses in our internalcontrols over financial reporting that we cannot remediate in a timely manneror we receive an adverse report from our independent registered publicaccounting firm with respect to our internal controls over financial reporting,investors and others may lose confidence in the reliability of our financialstatements and our ability to obtain equity or debt financing could beadversely affected.

 

In addition tothe above, in the event that our independent registered public accounting firmis unable to rely on our internal controls over financial reporting inconnection with their audit of our financial statements, and in the furtherevent that they are unable to devise alternative procedures in order to satisfythemselves as to the material accuracy of our financial statements and relateddisclosures, it is possible that we could receive a qualified or adverse auditopinion on those financial statements. In that event, the market for our common stock could be adverselyaffected.  In addition, investors andothers may lose confidence in the reliability of our financial statements andour ability to obtain equity or debt financing could be adversely affected.

 

**Fluctuationsin our operating results may result in decreases in the price of oursecurities. **Ouroperating results have and will continue to fluctuate significantly because ofseveral factors, including the timing of FDA clearance, government policiesregarding payment for our products and new technology.  Consequently, our operating results may fallbelow the expectations of public market analysts and investors.  In that event, the price of our securitieswould likely decrease.

 

**A limitedpublic market exists for our common stock. **We cannot assure you that there will be anactive public market for our common stock. Previously, units of our securities, consisting of common stock andClass A Warrants, were listed on The Nasdaq SmallCap Market under thesymbol “MDCVU” following completion of our initial public offering in November 2001.  In March 2003, our units were delistedfrom The Nasdaq SmallCap Market because we failed to satisfy the minimumshareholders’ equity requirement for continued listing and because the bidprice of our units had fallen below $1.00 for 30 consecutive trading days.  Thereafter, our units traded on the OTCBulletin Board until the expiration of the Class A Warrant component ofsuch units on November 20, 2004. Due to lack of market makers, our common stock did not trade betweenNovember 19, 2004 and December 20, 2004.  Our common stock resumed trading on the OTCBulletin Board under the symbol “MDCV” on December 21, 2004.

 

38

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**You mayhave difficulty reselling our common stock. **Our securities are subject to certainrules of the SEC relating to “penny stocks.”  Such rules require broker-dealers tomake a suitability determination for purchasers and to receive the purchaser’sprior written consent for a purchase transaction, thus restricting the abilityto purchase or sell our securities in the open market.  In addition, trading in our securities isconducted in the over-the-counter market on the OTC Bulletin Board, which wasestablished for securities that do not meet Nasdaq listing requirements.  Selling our securities may be difficultbecause of the quantity of securities that may be bought and sold, thepossibility that transactions may be delayed, and the low level of securityanalyst and news media coverage given to over-the-counter stocks.  These factors could contribute to lowerprices and larger spreads in the bid and ask prices for our securities.

 

**Minnesotalaw, our outstanding preferred stock and our ability to issue additionalpreferred stock could deter a take-over or acquisition of our company. **Our articles ofincorporation authorize the issuance of shares of preferred stock.  Our board of directors, without any action byour shareholders, is authorized to designate and issue the preferred stock insuch classes or series, as it deems appropriate and establish the rights andprivileges of such shares, including liquidation and voting rights.  In March 2005, our board of directorscreated and designated 19,000 shares of 5% Series A Convertible PreferredStock, of which 18,035 shares were issued on April 1, 2005.  The outstanding preferred stock, coupled withour ability to designate and issue additional preferred stock havingpreferential rights over our common stock, could adversely affect the votingpower and other rights of holders of common stock.  We are also subject to the Minnesota BusinessCorporation Act, which includes provisions that limit the voting rights ofpersons acquiring specified percentages of shares of an issuing publiccorporation in a “control share acquisition” and restrict “businesscombinations” between issuing public corporations and specified personsacquiring their securities.  Theoutstanding preferred stock, coupled with our ability to issue additionalpreferred stock and the application of the provisions of Minnesota lawdiscussed above, could impede or deter another party from making a tender offeror other proposal to acquire our company.

 

**Ouraffiliated shareholders have significant control over our company, which couldreduce your ability to receive a premium for your securities through a changein control. **Asof July 14, 2005, officers and directors of our company beneficially ownedapproximately 62.5 percent of our outstanding common stock.  As a result, they can control our company anddirect our affairs, including the election of directors and approval ofsignificant corporate transactions.  Thisconcentration of ownership could also delay, defer or prevent a change incontrol of our company, and make some transactions more difficult or impossiblewithout their support.  Thesetransactions might include proxy contests, tender offers, open market purchaseprograms or other share purchases that could give our shareholders theopportunity to realize a premium over the then prevailing market price of oursecurities.  As a result, thisconcentration of ownership could depress the price of our securities.

 

39

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** **

**ITEM 7**           FINANCIALSTATEMENTS

** **

**INDEX TO FINANCIAL STATEMENTS**

 
| **MedicalCV, Inc.**                                     | ** ** |
|--------------------------------------------------------------|------------|
| Report of Independent Registered Public Accounting Firm      |       |
| Financial Statements                                         |       |
| Balance  Sheets                                              |       |
| Statements  of Operations                                    |       |
| Statements  of Cash Flows                                    |       |
| Statements of Changes in Shareholders’ Equity (Deficit) |       |
| Notes to Financial Statements                                |       |

 

40

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Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of MedicalCV, Inc.:

 

In our opinion, the accompanying balance sheets and the relatedstatements of operations, shareholders’ equity (deficit) and cash flows presentfairly, in all material respects, the financial position ofMedicalCV, Inc. at April 30, 2005 and April 30, 2004, and theresults of its operations and its cash flows for the years then ended inconformity with accounting principles generally accepted in the United Statesof America.  These financial statementsare the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.  We conducted our audits of these statementsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company hassustained losses and negative cash flows from operations in recent years andwill require additional funds to finance its working capital and capitalexpenditure needs. These factors raise substantial doubt about the Company’sability to continue as a going concern. Management’s plans in regard to these matters are also described in Note1.  The financial statements do not includeany adjustments that might result from the outcome of this uncertainty. 

 
| /s/ PricewaterhouseCoopers LLP |   |
|--------------------------------|--------|
|                           |
| PricewaterhouseCoopers LLP     |
| Minneapolis, Minnesota         |
| July 8, 2005              |

 

41

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**MEDICALCV, INC.**

**Balance Sheets**

 
| ** **                                                                                                                                                                                                                                     | ** ** | **April 30,** | ** **  |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|
| ** **                                                                                                                                                                                                                                     | ** ** | **2005**           | ** **  | **2004** | ** ** |
| ** **                                                                                                                                                                                                                                     | ** ** | ** **         | ** **  | ** ** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                     |       |               |        |   |   |
| Current assets:                                                                                                                                                                                                                                |       |               |        |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                      |       | $                  | 10,637,796  |   | $ | 659,856 |   |
| Prepaid expenses and other assets                                                                                                                                                                                                              |       | 199,978            |        | 160,520 |   |
| Current assets of discontinued operations                                                                                                                                                                                                      |       | 875,648            |        | 4,065,395 |   |
| Total current assets                                                                                                                                                                                                                           |       | $                  | 11,713,422  |   | $ | 4,885,771 |   |
|                                                                                                                                                                                                                                           |       |               |        |   |   |
| Property, plant and equipment, net                                                                                                                                                                                                             |       | 827,791            |        | 921,445 |   |
| Deferred financing costs, net                                                                                                                                                                                                                  |       | 58,226             |        | 74,605 |   |
| Other long-term assets                                                                                                                                                                                                                         |       | 30,798             |        | — |   |
| Non-current assets of discontinued  operations                                                                                                                                                                                                 |       | 367,799            |        | 214,173 |   |
| Total assets                                                                                                                                                                                                                                   |       | $                  | 12,998,036  |   | $ | 6,095,994 |   |
|                                                                                                                                                                                                                                           |       |               |        |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIT**                                                                                                                                                                                                |       |               |        |   |   |
| Current liabilities:                                                                                                                                                                                                                           |       |               |        |   |   |
| Accounts payable                                                                                                                                                                                                                               |       | $                  | 399,588     |   | $ | 175,833 |   |
| Current portion of related party lease  obligations                                                                                                                                                                                            |       | 311,155            |        | 288,995 |   |
| Note payable                                                                                                                                                                                                                                   |       | —             |        | 485,708 |   |
| Accrued expenses                                                                                                                                                                                                                               |       | 179,095            |        | 226,414 |   |
| Current liabilities of discontinued  operations                                                                                                                                                                                                |       | 202,595            |        | 1,363,272 |   |
| Total current liabilities                                                                                                                                                                                                                      |       | $                  | 1,092,433   |   | $ | 2,540,222 |   |
| Long-term debt with related parties                                                                                                                                                                                                            |       | —             |        | 3,443,333 |   |
| Fair value of puttable warrants                                                                                                                                                                                                                |       | 27,992,609         |        | — |   |
| Related party lease obligations, less  current portion                                                                                                                                                                                         |       | 2,824,977          |        | 3,166,425 |   |
| Total liabilities                                                                                                                                                                                                                              |       | $                  | 31,910,019  |   | $ | 9,149,980 |   |
|                                                                                                                                                                                                                                           |       |               |        |   |   |
| Commitments and contingencies                                                                                                                                                                                                                  |       |               |        |   |   |
|                                                                                                                                                                                                                                           |       |               |        |   |   |
| 5% series A, convertible preferred stock;  $.01 par value; 19,000 shares authorized; 18,035 and 0 shares issued and  outstanding as of April 30, 2005 and 2004, respectively. Aggregate  liquidation value, $18,109,116 at April 30, 2005 |       | —             |        | — |   |
|                                                                                                                                                                                                                                           |       |               |        |   |   |
| Shareholders’ deficit:                                                                                                                                                                                                                    |       |               |        |   |   |
| Common stock; $.01 par value; 95,000,000  shares authorized; 10,849,583 and 9,189,933 shares issued and outstanding as  of April 30, 2005 and 2004, respectively                                                                          |       | $                  | 108,496     |   | $ | 91,899 |   |
| Additional paid-in capital                                                                                                                                                                                                                     |       | 23,386,478         |        | 20,168,133 |   |
| Deferred stock-based compensation                                                                                                                                                                                                              |       | —             |        | (1,933 | ) |
| Accumulated deficit                                                                                                                                                                                                                            |       | (42,406,957        | )           | (23,312,085 | ) |
| Total shareholders’ deficit                                                                                                                                                                                                               |       | $                  | (18,911,983 | ) | $ | (3,053,986 | ) |
| Total liabilities, convertible preferred  stock and shareholders’ deficit                                                                                                                                                                 |       | $                  | 12,998,036  |   | $ | 6,095,994 |   |

 

The accompanying notes are an integral partof these financial statements.

 

42

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**MEDICALCV, INC.**

**Statementsof Operations**

 
| ** **                                                                      | ** ** | **Year Ended April 30,** | ** **  |
|---------------------------------------------------------------------------------|------------|--------------------------|-------------|
| ** **                                                                      | ** ** | **2005**                 | ** **  | **2004** | ** ** |
| Operating expenses, continuing operations:                                      |       |                     |        |   |   |
| Sales and marketing                                                             |       | $                        | 1,109,801   |   | $ | — |   |
| General and administrative                                                      |       | 4,070,123                |        | 2,395,062 |   |
| Engineering and regulatory                                                      |       | 1,581,016                |        | 910,646 |   |
| Total operating expenses                                                        |       | $                        | 6,760,940   |   | $ | 3,305,708 |   |
| Loss from operations                                                            |       | $                        | (6,760,940  | ) | $ | (3,305,708 | ) |
| Other (expense) income:                                                         |       |                     |        |   |   |
| Interest expense                                                                |       | (5,618,230               | )           | (918,027 | ) |
| Interest income                                                                 |       | 22,994                   |        | 4,993 |   |
| Other (expense) income                                                          |       | (5,715,347               | )           | (1,229,824 | ) |
| Total other expense                                                             |       | $                        | (11,310,583 | ) | $ | (2,142,858 | ) |
|                                                                            |       |                     |        |   |   |
| Loss from continuing operations                                                 |       | $                        | (18,071,523 | ) | $ | (5,448,566 | ) |
| Loss from discontinued operations                                               |       | (1,023,349               | )           | (790,424 | ) |
| Net Loss                                                                        |       | $                        | (19,094,872 | ) | $ | (6,238,990 | ) |
|                                                                            |       |                     |        |   |   |
| Basic and diluted loss per share-Continuing  Operations                         |       | $                        | (1.70       | ) | $ | (0.68 | ) |
| Basic and diluted loss per  share-Discontinued Operations                       |       | (0.09                    | )           | (0.10 | ) |
| Basic and diluted net loss per share                                            |       | (1.79                    | )           | (0.78 | ) |
|                                                                            |       |                     |        |   |   |
| Weighted average shares used in computing  basic and diluted net loss per share |       | 10,653,492               |        | 8,046,736 |   |

 

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** **

**MEDICALCV, INC.**

**Statementsof Cash Flows**

 
| ** **                                                                                        | ** ** | **Year Ended April 30,** | ** **  |
|---------------------------------------------------------------------------------------------------|------------|-------------------------------|-------------|
| ** **                                                                                        | ** ** | **2005**                      | ** **  | **2004** | ** ** |
| Cash flows from operating activities:                                                             |       |                          |        |   |   |
| Net loss                                                                                          |       | $                             | (19,094,872 | ) | $ | (6,238,990 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                      |       | 0                             |        |   |   |
| Depreciation                                                                                      |       | 315,225                       |        | 314,056 |   |
| Provision for doubtful accounts                                                                   |       | 220,281                       |        | 12,649 |   |
| Provision for inventory obsolescence                                                              |       | 2,573,656                     |        | 125,563 |   |
| Common stock sold below market value to  director                                                 |       | —                        |        | 63,428 |   |
| Warrant expense related to purchase of  technology                                                |       | 18,373                        |        | 38,930 |   |
| Common stock issued for services                                                                  |       | 128,075                       |        | 34,000 |   |
| Stock-based compensation                                                                          |       | 249,729                       |        | 75,592 |   |
| Interest and other expense related to  issued warrants and amortization of loan origination costs |       | 5,117,929                     |        | 1,726,268 |   |
| Increase in fair value of puttable warrants                                                       |       | 5,721,562                     |        | — |   |
| Changes in assets and liabilities:                                                                |       |                          |        |   |   |
| Accounts receivable                                                                               |       | 717,829                       |        | (35,055 | ) |
| Inventories                                                                                       |       | (283,622                      | )           | 138,352 |   |
| Prepaid expenses and other assets                                                                 |       | (271,928                      | )           | (27,960 | ) |
| Accounts payable                                                                                  |       | (906,964                      | )           | 603,443 |   |
| Accrued expenses                                                                                  |       | (43,610                       | )           | (546,868 | ) |
| Net cash used in operating activities                                                             |       | $                             | (5,538,337  | ) | $ | (3,716,592 | ) |
|                                                                                              |       |                          |        |   |   |
| Cash flows from investing activities:                                                             |       |                          |        |   |   |
| Purchase of property, plant and equipment                                                         |       | $                             | (218,666    | ) | $ | (81,434 | ) |
| Proceeds from the sale of property, plant  and equipment                                          |       | 23,123                        |        | — |   |
| Net cash used in investing activities                                                             |       | $                             | (195,543    | ) | $ | (81,434 | ) |
|                                                                                              |       |                          |        |   |   |
| Cash flows from financing activities:                                                             |       |                          |        |   |   |
| Borrowing on long-term debt                                                                       |       | 1,425,000                     |        | 3,150,000 |   |
| Payments of term debt                                                                             |       | (1,000,000                    | )           | (150,000 | ) |
| Deferred financing costs                                                                          |       | —                        |        | (11,616 | ) |
| Proceeds from the issuance of common stock  and warrants                                          |       | 2,000,608                     |        | 1,618,424 |   |
| Proceeds from the issuance of preferred  stock and warrants                                       |       | 13,603,000                    |        | — |   |
| Proceeds from option exercise                                                                     |       | 2,500                         |        | — |   |
| Principal payments under capital lease  obligations                                               |       | —                        |        | (42,069 | ) |
| Principal payments under related party  lease obligations                                         |       | (319,288                      | )           | (291,084 | ) |
| Net cash provided by financing activities                                                         |       | $                             | 15,711,820  |   | $ | 4,273,655 |   |
|                                                                                              |       |                          |        |   |   |
| Net increase in cash and cash equivalents                                                         |       | 9,977,940                     |        | 475,629 |   |
| Cash and cash equivalents at beginning of  year                                                   |       | 659,856                       |        | 184,227 |   |
| Cash and cash equivalents at end of period                                                        |       | $                             | 10,637,796  |   | $ | 659,856 |   |
|                                                                                              |       |                          |        |   |   |
| Supplemental disclosure of cash flow  information:                                                |       |                          |        |   |   |
| Cash paid for interest                                                                            |       | $                             | 457,342     |   | $ | 396,442 |   |
| Non-cash financing services:                                                                      |       |                          |        |   |   |
| Related party and other debt converted to  preferred stock                                        |       | 4,368,333                     |        | — |   |
| Accrued interest converted to preferred  stock                                                    |       | 33,667                        |        | — |   |

 

The accompanying notes are an integral partof these financial statements.

 

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**MEDICALCV, INC.**

**Statements of Changes in Shareholders’ Equity (Deficit)**

 
| ** **                                                      | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**  | ** ** | **Deferred**     | ** ** | ** **   | ** ** | ** **  | ** ** |
|-----------------------------------------------------------------|------------|------------------|------------|-------------|------------|-----------------|------------|------------------|------------|--------------|------------|-------------|------------|
| ** **                                                      | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Stock Based** | ** ** | **(Accumulated** | ** ** | ** **   | ** ** |
| ** **                                                      | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Compensation** | ** ** | **Deficit)** | ** ** | **Total**   | ** ** |
|                                                            |       |             |       |        |       |            |       |             |       |         |       |        |       |
| Ending Balance, April 30, 2003                                  |       | 7,843,834        |       | $           | 78,438     |            | $          | 16,613,337       |       | $            | (4,610     | )           | $          | (17,073,095 | ) | $ | (385,930 | ) |
|                                                            |       |             |       |        |       |            |       |             |       |         |       |        |       |
| Net Loss                                                        |       |             |       |        |       |            |       |             |       | (6,238,990   | )          | (6,238,990  | )          |
| Amortization of stock-based compensation                        |       |             |       |        |       |            |       | 2,677            |       |         |       | 2,677       |       |
| Common stock issued to board member                             |       | 85,714           |       | 857         |       | 122,571         |       |             |       |         |       | 123,428     |       |
| Issuance of stock options to non-employees                      |       |             |       |        |       | 72,915          |       |             |       |         |       | 72,915      |       |
| Warrants issued to related parties                              |       |             |       |        |       | 1,740,560       |       |             |       |         |       | 1,740,560   |       |
| Warrants issued for technology purchase                         |       |             |       |        |       | 31,280          |       |             |       |         |       | 31,280      |       |
| Issuance of common stock for technology  purchase               |       | 15,000           |       | 150         |       | 7,500           |       |             |       |         |       | 7,650       |       |
| Issuance of common stock for financial  services                |       | 55,522           |       | 555         |       | 33,445          |       |             |       |         |       | 34,000      |       |
| Common stock issued in connection with  private placement       |       | 1,189,863        |       | 11,899      |       | 1,546,525       |       |             |       |         |       | 1,558,424   |       |
|                                                            |       |             |       |        |       |            |       |             |       |         |       |        |       |
| Total, April 30, 2004                                           |       | 9,189,933        |       | $           | 91,899     |            | $          | 20,168,133       |       | $            | (1,933     | )           | $          | (23,312,085 | ) | (3,053,986 | ) |
|                                                            |       |             |       |        |       |            |       |             |       |         |       |        |       |
| Net Loss                                                        |       |             |       |        |       |            |       |             |       | (19,094,872  | )          | (19,094,872 | )          |
| Amortization of stock based compensation                        |       |             |       |        |       |            |       | 1,933            |       |         |       | 1,933       |       |
| Issuance of common stock and warrants, net  of offering costs   |       | 1,540,900        |       | 15,409      |       | 1,985,199       |       |             |       |         |       | 2,000,608   |       |
| Stock option exercises                                          |       | 6,250            |       | 63          |       | 2,437           |       |             |       |         |       | 2,500       |       |
| Warrants issued in connection with  technology purchase         |       |             |       |        |       | 18,373          |       |             |       |         |       | 18,373      |       |
| Stock compensation expense                                      |       |             |       |        |       | 247,796         |       |             |       |         |       | 247,796     |       |
| Warrants issued in connection with short  term financing        |       |             |       |        |       | 711,337         |       |             |       |         |       | 711,337     |       |
| Warrants issued in connection with  convertible debt            |       |             |       |        |       | 58,253          |       |             |       |         |       | 58,253      |       |
| Beneficial conversion feature associated  with convertible debt |       |             |       |        |       | 68,000          |       |             |       |         |       | 68,000      |       |
| Common stock issued for services                                |       | 112,500          |       | 1,125       |       | 126,950         |       |             |       |         |       | 128,075     |       |
|                                                            |       |             |       |        |       |            |       |             |       |         |       |        |       |
| Total, April 30, 2005                                           |       | 10,849,583       |       | $           | 108,496    |            | $          | 23,386,478       |       | $            | —     |        | $          | (42,406,957 | ) | $ | (18,911,983 | ) |
|                                                                 |            |                  |            |             |            |                 |            |                  |            |              |            |             |            |  |  |  |  |  |  |

 

45

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**MedicalCV, Inc.**

**Notes to Financial Statements**

 

1.             Business Description and Going Concern

 

MedicalCV, Inc.(the “Company”) is a corporation engaged in the manufacture and marketing ofcardiovascular surgery devices.  InApril 2005, the Company elected to discontinue the sale of mechanicalheart valves which had been the Company’s primary business and its sole sourceof revenues (see Note 4).  TheCompany’s operations are now primarily focused on the development of atechnology platform for the treatment of atrial fibrillation using a laserdevice.

 

The Company’sfinancial statements for the year ended April 30, 2005, have been preparedon a going concern basis, which contemplates the realization of assets andsettlement of liabilities and commitments in the normal course ofbusiness.  The Company has sustainedlosses and negative cash flows from operations in recent years and expectsthese conditions to continue for the foreseeable future.  At April 30, 2005, the Company had anaccumulated deficit of $42,406,957. Although the Company recently raised funds through the sale ofconvertible preferred stock (see Note 9), the level of cash required foroperations during fiscal year 2006 is difficult to predict, and managementanticipates that development of its new products will require additionalcapital.  These matters raise substantialdoubt about the Company’s ability to continue as a going concern.  Management intends to seek additional debt orequity financing as it continues development of new products.  However, the Company may not be able toobtain such financing on acceptable terms or at all.  If the Company is unable to obtain suchadditional financing, it will be required to significantly revise its businessplans and drastically reduce operating expenditures such that it may not beable to develop or enhance its products, gain market share in the United Statesof America or respond to competitive pressures or unanticipated requirements,which could seriously harm its business, financial position and results ofoperations.

 

The Company issubject to risks and uncertainties common to medical technology-basedcompanies, including rapid technological change, new product development andacceptance, actions of competitors and regulators, dependence on key personneland market penetration.

 

2.             Summary of Significant AccountingPolicies

 

**Use of Estimates**

** **

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

 

**Fair Value of Financial Instruments**

** **

The Company’sfinancial instruments consist primarily of cash and cash equivalents, tradeaccounts receivable, short and long term debt (including lease obligations),accounts payable and puttable warrants for which the carrying amountsapproximate fair value.  The interestrates currently available to the Company approximate current rates for debtagreements with similar terms and average maturities.

 

46

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**Cash and Cash Equivalents**

** **

Cash and cashequivalents consist of checking accounts and a money market account, all ofwhich are held in three depository institutions.  The Company considers all highly-liquidinvestments with original maturities of three months or less to be cashequivalents.  The carrying value of cashequivalents approximates fair value because of the short maturity of theseinstruments.  Deposits in theseinstitutions may exceed the amount of federal insurance provided on suchdeposits.

 

**Inventories**

** **

Inventoriesconsist of various mechanical heart valves that are stated at the lower of costor market, with cost determined utilizing standard costs, which approximate thefirst-in, first-out method of inventory valuation.  All inventories are reported as currentassets of discontinued operations.

 

**Property, Plant and Equipment**

** **

Property,plant and equipment is stated at cost. Depreciation and amortization is computed using the straight-line methodover the estimated useful lives of the related assets.  The building is depreciated over a 30-yearlife.  Machinery and equipment, furnitureand fixtures, tooling and software are depreciated over their 18 months tofive-year lives.  Equipment held for saleis carried at the lower of its cost or estimated market value.  The Company ceases depreciation of equipmentheld for sale upon determination that such equipment will no longer be used inoperations.  Maintenance and repairs arecharged to current operations when incurred. The cost and related accumulated depreciation or amortization of assetsdisposed of are removed from the related accounts and any resulting gains orlosses are included in the statement of operations.

 

**Long-Lived Assets**

** **

The Companyperiodically evaluates the carrying value of long-lived assets to be held andused, including but not limited to, capital assets, when events andcircumstances warrant such a review.  Thecarrying value of a long-lived asset is considered impaired when theanticipated undiscounted cash flow from such asset is separately identifiableand is less than its carrying value.  Inthat event, a loss is recognized based on the amount by which the carryingvalue exceeds the fair value of the long-lived asset.  No losses from impairment have been recognizedin the financial statements.

** **

**Revenue Recognition**

** **

The Companyrecognizes revenue using guidance from SEC Staff Accounting BulletinNo. 104 “Revenue Recognition in Financial Statements.”  Revenue from the sale of its products isrecognized provided that the Company has received a written order, the price isfixed, title has transferred, collection of the resulting receivable isprobable and there are no remaining obligations.  Transfer of title occurs for substantiallyall international sales upon shipment. The Company’s products are not subject to any customer acceptance process.  There are no rights of return unless theproduct does not perform according to specifications.  In periods prior to fiscal year 2005,marketing support was paid to distributors in some markets.  Such payments are reported as a reduction inrevenues in accordance with EITF 01-9. All revenues and related customer accounts receivable are reported aspart of discontinued operations.

 

**Research and Development**

** **

Research anddevelopment costs are expensed as incurred.

 

47

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**Stock-Based Compensation**

** **

The Companyaccounts for stock-based employee compensation arrangements in accordance withthe provisions of Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and its interpretations and complies with thedisclosure provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation” and SFAS No. 148 “Accounting for Stock-BasedCompensation-Transition and Disclosure, an amendment of FASB StatementNo. 123.”

 

The Companyhas adopted the disclosure provisions of SFAS No. 123 for employeestock-based compensation.  For purposesof the pro forma disclosures below, the estimated fair value of the options isamortized to expense over the options’ vesting period.  Had compensation cost for the Company’s stockoptions been recognized based on the fair value at the grant date consistentwith the provisions of SFAS No. 123, the Company’s net loss would havebeen adjusted to the pro forma amounts indicated in the following table:

 

 
| ** **                                                    | ** ** | **For the Years Ended April 30,** | ** **  |
|---------------------------------------------------------------|------------|----------------------------------------|-------------|
| ** **                                                    | ** ** | **2005**                               | ** **  | **2004** | ** ** |
| Net loss reported                                             |       | $                                      | (19,094,872 | ) | $ | (6,238,990 | ) |
| Less:  Pro forma stock based employee  compensation cost |       | (554,463                               | )           | (364,946 | ) |
|                                                          |       |                                   |        |   |   |
| Net loss - pro forma                                          |       | (19,649,335                            | )           | (6,603,936 | ) |
|                                                          |       |                                   |        |   |   |
| Net loss per common share – basic and  diluted           |       |                                   |        |   |   |
| As reported                                                   |       | (1.79                                  | )           | (.78 | ) |
| Pro forma                                                     |       | $                                      | (1.84       | ) | $ | (.83 | ) |

 

**Income Taxes**

** **

Deferredincome taxes are recorded to reflect the tax consequences in future years ofdifferences between the tax bases of assets and liabilities and their financialreporting amounts at each year-end, based on enacted tax laws and statutory taxrates applicable to the periods in which the differences are expected to affecttaxable income.  Deferred tax assets arereduced by a valuation allowance when, in the opinion of management, it is morelikely than not that some portion or all of the deferred tax asset will not berealized.  Income tax expense or benefitis the tax payable or refundable for the year and the change during the year indeferred tax assets and liabilities.

 

**Comprehensive Income (Loss)**

** **

Comprehensiveincome (loss) includes net income (loss) and items defined as othercomprehensive income (loss).  Itemsdefined as other comprehensive income (loss) include items such as foreign currencytranslation adjustments and unrealized gains and losses on certain marketablesecurities.  For the years endedApril 30, 2005 and 2004, there were no adjustments to net loss to arriveat comprehensive loss.

 

**Concentration of Credit Risk**

** **

AtApril 30, 2005 and 2004, approximately 35.7 percent and 37.9 percent,respectively, of the Company’s accounts receivable were due from onedistributor at each respective fiscal year end. Once the decision was made to cease shipping heart valves (see Note 4),the Company required its customers to either prepay or obtain an irrevocableletter of credit equal to the value of their order.  The Company maintains an allowance fordoubtful accounts based upon its historical experience and the expectedcollectibility of all accounts receivable.

 

48

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**Net Income(Loss) Per Share**

 

Basic netincome (loss) per common share is computed using net income (loss) and theweighted-average number of shares of common stock outstanding.  Diluted earnings per share reflect thepotential dilution of securities that could share in the earnings of anentity.  Diluted net loss per commonshare does not differ from basic net loss per common share in the years endedApril 30, 2005 and 2004 since 7,492,905 and 4,300,940, respectively, ofpotential dilutive shares of common stock from the exercise of stock optionsand warrants, were excluded from the computation because the effect ofincluding them in the loss per share computation would have been anti-dilutive.

 

**Recent AccountingDevelopments:**

** **

In December 2004,the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” whichrevises SFAS No. 123 and supersedes APB Opinion No. 25.  Among other items, SFAS No. 123Reliminates the use of the intrinsic value method of accounting, and requirescompanies to recognize compensation cost for share-based payment awards withemployees, based on the grant date fair value of those awards, in the financialstatements.  The Company is required toadopt the provisions of this standard effective May 1, 2006.  The Company has not yet determined which ofthe adoption methods prescribed by SFAS No. 123R it will elect, nor has itdetermined the impact of adopting this statement.  In March 2005, the SEC issued SAB No. 107,“TOPIC 14: Share-Based Payment,” which addresses the interaction between SFAS No. 123Rand certain SEC rules and regulations and provides views regarding thevaluation of share-based payment arrangements for public companies.  This bulletin is effective immediately.

 

In November 2004,the FASB issued SFAS No. 151, “Inventory Costs – an amendment of ARB No. 43,Chapter 4.”  This statement clarifiesthat abnormal amounts of idle facility expense, freight, handling costs, andwasted materials (spoilage) should be recognized as current-period charges andrequires the allocation of fixed production overheads to inventory be based onnormal capacity of the production facilities. The Company is required to adopt the provisions of this standardeffective May 1, 2006.  The Company has  not yet determined the impact of adopting thisstatement.

 

3.             Property,Plant and Equipment, Net

 

Property,plant and equipment, excluding property and equipment of discontinuedoperations, were as follows at April 30:

 
| **Property, Plant and Equipment, Net**    | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|
|                                      |       |       |       |       |       |
| Land                                      |       | $          | 182,000    |       | $          | 182,000 |   |
| Building                                  |       | 1,251,601  |       | 1,251,601  |       |
| Machinery and equipment                   |       | 1,579,829  |       | 1,378,959  |       |
| Furniture and fixtures                    |       | 245,955    |       | 229,814    |       |
| Tooling                                   |       | 116,363    |       | 116,363    |       |
| Software                                  |       | 151,892    |       | 147,332    |       |
|                                      |       |       |       |       |       |
|                                      |       | 3,527,640  |       | 3,306,069  |       |
|                                      |       |       |       |       |       |
| Accumulated depreciation and amortization |       | (2,699,849 | )          | (2,384,624 | )          |
|                                      |       |       |       |       |       |
|                                      |       | $          | 827,791    |       | $          | 921,445 |   |

 

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4.             DiscontinuedOperations

 

On November 17, 2004, the Company’sboard of directors voted to authorize management to cease production of heartvalves but to continue marketing the valves while exploring the merits ofpossible strategic alternatives for the heart valve business, including, butnot limited to, a joint venture with another party or the sale of the business.  Following exploration of a number ofalternatives, management concluded during April 2005 that an orderlywinding up of the valve business was the Company’s best alternative.  On April 6, 2005, the Company’s boardauthorized management to discontinue sales of heart valves effective April 30,2005, and to seek a buyer for the related production equipment.

 

As a result of the Company’s discontinuanceof the heart valve business, the Company made a determination during the fourthquarter of fiscal year 2005 that the remaining assets of the heart valveoperations should be considered “held for sale” pursuant to SFAS No. 144, “Accountingfor Impairment or Disposal of Long-Lived Assets.”  (SFAS No. 144)  Pursuant to SFAS No. 144, the Companyceased depreciation of property and equipment held for sale and evaluatedwhether any of the long-lived assets of the discontinued heart valve businesswere impaired.  Based upon the estimatedselling prices of these assets, management concluded that the carrying value ofthese assets is not impaired.  As of April 30,2005 and 2004, the carrying value of the remaining net assets of the heartvalve business is reported as assets of discontinued operations on the Company’sbalance sheet.  In connection with thisdecision to discontinue the sale of heart valves, the Company reduced thecarrying value of certain excess inventories, resulting in a provision recordedduring the fourth quarter of fiscal year 2005 of $1,306,215.  This provision was included in the 2005 lossfrom discontinued operations.

 

Valve business revenue and loss before incometaxes included in discontinued operations are as follows:

 
| ** **                        | ** ** | **For the Years Ended April 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Revenues                          |       | $                                      | 2,304,897  |   | $ | 3,410,975 |   |
|                              |       |                                   |       |   |   |
| Income (Loss) Before Income Taxes |       | $                                      | (1,023,349 | ) | $ | (790,424 | ) |

 

The carrying amounts and major classes of theassets and liabilities, which are presented as assets and liabilities ofdiscontinued operations on the accompanying balance sheet as of April 30,2005, are as follows:

 
| ** **                                                                                     | ** ** | **April 30** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                     | ** ** | **2005**          | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                     |       |              |       |   |   |
| Accounts receivable, net of allowance of  $196,521 and $102,869 in 2005 and 2004, respectively |       | $                 | 557,291    |   | $ | 1,495,401 |   |
| Inventories                                                                                    |       | 228,665           |       | 2,518,698 |   |
| Prepaid expenses                                                                               |       | 89,692            |       | 50,156 |   |
| Other assets                                                                                   |       | —            |       | 1,140 |   |
| Total current assets of discontinued  operations                                               |       | $                 | 875,648    |   | $ | 4,065,395 |   |
|                                                                                           |       |              |       |   |   |
| Property, plant and equipment, net                                                             |       | $                 | 188,145    |   | $ | 214,173 |   |
| Other long-term assets                                                                         |       | 179,654           |       | — |   |
| Total non-current assets of discontinued  operations                                           |       | $                 | 367,799    |   | $ | 214,173 |   |
|                                                                                           |       |              |       |   |   |
| **LIABILITIES**                                                                                |       |              |       |   |   |
| Accounts payable                                                                               |       | $                 | 192,295    |   | $ | 1,323,015 |   |
| Accrued expenses                                                                               |       | 10,300            |       | 40,257 |   |
| Total current liabilities of discontinued  operations                                          |       | $                 | 202,595    |   | $ | 1,363,272 |   |
|                                                                                           |       |              |       |   |   |
| Net assets of discontinued operations                                                          |       | $                 | 1,040,852  |   | $ | 2,916,296 |   |

 

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5.             Debtwith Related Parties, Note Payable and Convertible Bridge Notes

 

**Debt with RelatedParties:**

** **

In January 2003,the Company established a discretionary line of credit with PKM Properties, LLC(PKM), an entity controlled by Paul K. Miller. Mr. Miller serves on the Company’s Board of Directors and is itslargest shareholder.  This line of creditwas initially scheduled to mature on April 17, 2003.  On April 15, 2003, the maturity date wasextended to September 17, 2003.  Asof April 30, 2004, the Company had borrowed $943,333 under the line ofcredit.  In addition, the Companyincurred direct financing costs of $67,828, which were amortized to interestexpense over the original three-month term of the line of credit.  The Company issued PKM a second mortgage onthe Company’s real estate and a security interest in all remaining assets ofthe Company.  In October 2003, theCompany amended the discretionary line of credit with PKM originallyestablished in January 2003 to extend the maturity date to May 27,2004, and to increase the interest rate to a fixed rate of 10 percent.  Additionally, on February 3, 2004, thematurity date of the line of credit was extended to June 30, 2005.  In connection with the original line ofcredit, the Company issued a warrant to PKM with a five-year term to purchase350,000 shares of the Company’s common stock at an exercise price of $0.596 pershare.  The fair value of the warrants of$128,995 was amortized to interest expense over the original three-month termof the line of credit.  As a result ofanti-dilution adjustments through April 30, 2005, this warrant isexercisable for 409,020 shares at $0.51 per share.  This debt was converted to preferred stock onApril 1, 2005 (see Note 9).

 

On July 8,2003, the Company entered into a $1.0 million term debt agreement withPKM.  Pursuant to the agreement, theCompany borrowed $764,728 during the first quarter of fiscal year 2003 andborrowed the final draw of $235,272 on August 20, 2003.  The debt, which was collateralized bysubstantially all of the Company’s assets, bore interest at a rate of 10percent per year, with an original maturity date of May 27, 2004.  In connection with the first quarter borrowings,the Company issued a warrant to PKM with a ten-year term for the purchase of320,178 shares of the Company’s common stock at an exercise price of $0.70 pershare.  The Company also issued a warrantto purchase an additional 60,179 shares of the Company’s common stock on thesame terms in conjunction with the final draw on August 20, 2003.  As a result of anti-dilution adjustmentsthrough April 30, 2005, these warrants are exercisable for an aggregate of502,358 shares at $0.53 per share.  Inconnection with this financing, on July 8, 2003, the Company agreed toextend the term of 700,000 previously issued warrants from five years to tenyears.  The allocated fair value of thewarrants issued prior to July 31, 2003, and the incremental value of the existingwarrants was $383,361, which was reported as a discount of the term debt.  This discount, which was presented as areduction of the carrying value of the debt on the consolidated balance sheet,was being amortized as interest expense over the eleven-month term of thedebt.  In addition, the Company incurreddirect and incremental costs of $65,000 in completing the debt 

 

51

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arrangement, which wereincluded in deferred financing costs and were being amortized as interestexpense over the original eleven-month term of the debt.  On February 3, 2004, the maturity dateof the term debt was extended to June 30, 2005.  In connection with the extension, the Companyissued a warrant to PKM with a ten-year term for the purchase of 330,933 sharesof the Company’s common stock at an exercise price of $2.00 per share. The fairvalue of the warrants issued was $598,179. As a result of anti-dilution adjustments through April 30, 2005,this warrant is exercisable for 987,860 shares at $0.67 per share.  This debt was converted to preferred stock onApril 1, 2005 (see Note 9).

 

In November 2003,the Company amended the one-year $1.0 million term debt agreement with PKM,initiated on July 8, 2003, to provide for an additional $500,000 ofborrowings with the same terms as the July 8, 2003 financing and extendedthe term of the loan to June 30, 2005. The Company issued, as additional consideration, a ten-year warrant topurchase up to 77,381 shares of common stock at an exercise price of $1.68 pershare with terms and conditions that include weighted-average anti-dilutionrights.  As a result of anti-dilutionadjustments through April 30, 2005, this warrant is exercisable for203,125 shares at $0.64 per share.  Theallocated fair value of the newly-issued warrant was $63,365 and was accountedfor as a discount on the borrowings under the term debt.  This discount was amortized as interestexpense over the remaining term of the debt. As of April 30, 2004, the discount was fully amortized.  This debt was converted to preferred stock onApril 1, 2005 (see Note 9).

 

On July 8,2003, the Company also entered into a $1.0 million term debt agreement withPeter L. Hauser (“Hauser”), a principal shareholder.  The Company borrowed $1.0 million under thisbridge financing during the quarter ended July 31, 2003.  The debt, which was collateralized bysubstantially all of the Company’s assets pursuant to an intercreditoragreement with PKM, bore interest at a rate of 10 percent per year and had amaturity date of June 30, 2004.  Inconnection with the term debt, the Company also issued a warrant with aten-year term to purchase up to 380,357 shares of the Company’s common stock atan exercise price of $0.70 per share.  Asa result of anti-dilution adjustments through April 30, 2005, this warrantis exercisable for 502,358 shares at $0.53 per share.  The allocated fair value of the warrant was$281,706 and was accounted for as a discount on the borrowings under the termdebt.  This discount, which was presentedas a reduction of the carrying value of the debt on the balance sheet was beingamortized as interest expense over the original twelve-month term of thedebt.  In addition, the Company incurred directand incremental costs of $71,772 in completing the debt arrangement, which wereincluded in deferred financing costs and were being amortized as interestexpenses over the original twelve-month term of the debt. On February 3,2004, the maturity date of the term debt was extended to June 30,2005.  In connection with the extension,the Company issued a warrant to Hauser with a ten-year term for the purchase of136,000 shares of the Company’s common stock at an exercise price of $2.00 pershare.  The fair value of the warrantsissued was $245,845.  As a result ofanti-dilution adjustments through April 30, 2005, this warrant isexercisable for 405,970 shares at $0.67 per share.  This debt was converted to preferred stock onApril 1, 2005 (see Note 9).

 

The extensionsof the maturity dates of the term debt issued to PKM and Hauser as describedabove were accounted for as an extinguishment of debt in accordance with EITF 96-19“Debtor’s Accounting for a Modification or Exchange of Debt Instruments.”  Accordingly, unamortized discounts aggregating$391,789 and the fair value of the warrants issued in connection with thematurity date extensions, amounting to $844,024, were included in the Company’sdetermination of the debt extinguishment loss recorded in the fourth quarter offiscal year 2004.  The $1,235,813aggregate loss from these transactions, accounted for as an extinguishment ofdebt, is included in other expenses, net in the statement of operations for theyear ended April 30, 2004.

 

On November 17,2004, the Company entered into a discretionary credit agreement (the “October 2004Discretionary Credit Agreement”) with PKM, covering advances by PKM of up to$500,000.  The October 2004 Discretionary Credit Agreement had amaturity date of February 28, 2005, 

 

52

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that was subsequently extendedto June 30, 2005.  It required the payment of interest at a rate of10 percent per year, and it also contained various representations and loancovenants as are customary in banking and finance transactions.  TheCompany issued a credit note to PKM to evidence such indebtedness.

 

In connectionwith the October 2004 Discretionary Credit Agreement, the Company enteredinto an intellectual property security agreement with PKM pursuant to which PKMwas granted a security interest in all of the Company’s intellectualproperty.  The Company and its creditors agreed to an amendment to thefirst amended and restated subordination and inter-creditor agreement by andbetween PKM and Hauser.  Pursuant to this agreement, proceeds borrowedunder the October 2004 Discretionary Credit Agreement were deemed “seniordebt.”  Further, PKM, pursuant to a waiver agreement, waived past defaultsunder the January 2003 Discretionary Credit Agreement and the November 2003Credit Agreement.  These defaults involved the late payments of interestand failure to send periodic financial statements.  As additional consideration for the October 2004Discretionary Credit Agreement, the Company issued to PKM a warrant with aten-year term to purchase 34,014 shares of the Company common stock at a pershare exercise price of $1.47.  Thewarrant contains anti-dilution provisions.  The allocated fair value ofthe newly issued warrant was $42,986 and was accounted for as a discount on theborrowings.  This discount, which waspresented as a reduction of the carrying value of the debt on the balance sheetwas amortized as interest expense over the original four-month term of thedebt.

 

On March 3,2005, the Company entered into a February 2005 Credit Agreement (the “Agreement”)with PKM.  The Agreement provided for a$500,000 discretionary credit facility under which PKM made available to theCompany up to $500,000 in the form of loans bearing interest at 10% peryear.  Principal and interest were due onthe amounts borrowed no later than June 16, 2005.  This debt and the other amounts the Companyhad borrowed from PKM were collateralized by substantially all of the Company’sassets.  A February 2005Discretionary Credit Note (“Note”) reflected this indebtedness.  On March 3, 2005, in consideration ofthe foregoing financing, the Company issued to PKM a ten-year warrant for thepurchase of 750,000 shares of the Company’s common stock with an exercise priceof $0.50 per share.  The allocated fairvalue of the warrant was $589,321 and was accounted for as a discount on theborrowings.  This discount, which waspresented as a reduction of the carrying value of the debt on the balancesheet, was fully amortized as interest expense during fiscal year 2005.  The Company repaid this note in April 2005.

 

**Note Payable:**

** **

In November 2003,the Company also entered into a loan agreement and borrowed $500,000 from DraftCo. (“Draft”), pursuant to a note that matured on June 30, 2004, whichbore interest at an annual rate of 10 percent. Pursuant to an amended intercreditor agreement among PKM, Hauser, andDraft, the loan was collateralized by substantially all of the Company’sassets.  The Company issued the lenderwarrants to purchase up to 90,909 shares of common stock at an exercise priceof $1.43 per share with other terms comparable to the warrants issued to PKM asdescribed above.  As a result ofanti-dilution adjustments through April 30, 2005, this warrant isexercisable for 209,677 shares at $0.62 per share.  The allocated fair value of the warrants was$100,056 and was accounted for as a discount on the borrowings under the termdebt.  This discount, which was presentedas a reduction of the carrying value of the debt on the balance sheet, wasamortized as interest expense over the seven-month term of the debt.  In addition, the Company incurred direct andincremental costs of $31,850 in completing the debt arrangement, which areincluded in deferred financing costs and are being amortized as interestexpenses over the term of the debt.  TheCompany repaid this note in June 2004.

 

53

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The Companydetermined the fair value of all warrants described above using the BlackScholes option pricing model and the volatility and dividend yield assumptionsidentified in Note 9 and using a risk-free interest rate commensurate with theterm of the applicable warrant.

 

**Convertible Bridge Notes:**

 

In December 2004and January 2005, the Company issued convertible bridge notes totaling$425,000.  The notes, which were due on May 31,2005, bore interest at the rate of 10 percent per year and were convertibleinto securities to be issued in the Company’s next equity financing, ifany.  Within 10 days of the consummationof the Company’s next equity financing each note holder was required to electone of the following two alternatives: (1) convert the entire unpaidprincipal and all accrued but unpaid interest under the note into equitysecurities sold by the Company in its next equity financing (“Next Shares”) ata price per share equal to 80 percent of the issuance price of the Next Shares,and retain the warrants issued in connection with the convertible bridge notes,or (2) surrender the note and the warrants issued in connection with thebridge notes to the Company in exchange for the issuance of a number of NextShares and any accompanying warrants issuable in connection with the NextShares, equal to the amount of such securities that could be purchased usingthe entire unpaid principal and all accrued but unpaid interest under the note.

 

In April 2005,these notes were converted in connection with the preferred stock financingdescribed in Note 9, at 100 percent of the issuance price of suchsecurities.  In consideration ofconverting at 100 percent rather than 80 percent of the issuance price of thepreferred stock, the note holders were permitted to retain the warrants issuedto them in connection with the convertible bridge financing.  Because the convertible bridge notes provideda contingent conversion option to the note holders which resulted in abeneficial conversion price when converted, the Company recorded an interestcharge of $68,000 upon conversion of these notes in April 2005.

 

In connectionwith issuance of the convertible bridge notes, the Company issued to the noteholders warrants to purchase up to an aggregate of 85,000 shares of commonstock.  The warrants, which have afive-year terms, are exercisable at a price per share equal to the per share orper unit price of equity securities sold in the Company’s next offering.  However, such exercise price could not exceed$1.49 per share.  The warrants containanti-dilution provisions.  The allocatedfair value of the newly issued warrants was $79,030 and was accounted for as adiscount on the borrowings.  Thisdiscount, which was initially presented as a reduction of the carrying value ofthe debt, was amortized as interest expense through the April 2005conversion date of the notes.

 

6.             RelatedParty Lease Obligation

 

On April 4,2003, the Company sold its corporate headquarters and manufacturing facilityand surrounding land in Inver Grove Heights, Minnesota, to PKM (see Note 5regarding the Company’s relationship with PKM).

 

In connectionwith the transaction, the Company received total consideration of $3.84 millionconsisting of (1) $1.0 million in cash, (ii) PKM’s assumption of theCompany’s $2.5 million outstanding indebtedness to Associated Bank, and (iii) PKM’sassumption of the Company’s promissory note with Dakota Electric Associationand land special assessments payable to Dakota County aggregating$336,105.  Also in connection with thetransaction, the Company issued to PKM a five-year warrant for the purchase of350,000 shares of the Company’s common stock at an exercise price of $0.625 pershare.  As a result of anti-dilutionadjustments through April 30, 2005, this warrant is exercisable for420,673

 

54

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shares at $0.52 per share.  These warrants had an allocated fair value of$89,602.  The Company determined the fairvalue of the warrants using the Black Scholes option pricing model.

 

Simultaneouswith the sale of the facility, the Company entered into a lease with PKM tolease back the facility and a portion of the land.  The lease has a ten-year initial term withoptions for the Company to extend the lease up to ten additional years.  Under certain conditions, the Company alsohas an option to purchase the building at the end of the initial ten-year termat the fair value at that time.

 

Due to theCompany’s continued involvement with the property including the ability to buyback the property at a future date, the transaction is accounted for as afinancing of the property sold and leased back. Accordingly, the net book value of the facility and land sold to PKMwith a net book value of $707,015 (gross value of $1,433,601 net of accumulateddepreciation of $726,586) continues to be presented as part of the Company’sproperty, plant and equipment balance (see Note 3).  The related party lease obligation of$3,455,420 represents the minimum amounts due PKM for the initial ten year termdiscounted at 4.4 percent and additional payments to be paid to PKM for theDakota Electric Association and Dakota County obligations assumed by PKM.

 

Scheduledmaturities of the related party lease obligation are as follows:

 
| **Year Ending April 30,** | ** ** | **Amount** | ** ** |
|--------------------------------|------------|------------|------------|
|                           |       |       |       |
| 2006                           |       | 311,155    |       |
| 2007                           |       | 324,183    |       |
| 2008                           |       | 334,784    |       |
| 2009                           |       | 366,198    |       |
| 2010                           |       | 350,783    |       |
| Thereafter                     |       | 1,449,029  |       |
|                           |       | $          | 3,136,132  |   |
|                                |            |            |            |  |

 

7.             Leases

 

**Operating Leases**

** **

The Companyleased certain manufacturing equipment under various operating leaseagreements, which expired at various dates in fiscal year 2004.  At the end of the lease terms, the Companyexercised its option to return the equipment.

 

Rental expenseunder operating leases was $0 and $6,502 in fiscal years 2005 and 2004,respectively.

 

8.             IncomeTaxes

 

The componentsof deferred income taxes at April 30, 2005 and 2004, are as follows:

 
| ** **                                         | ** ** | **2005**  | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|-----------|------------|----------|------------|
|                                               |       |      |       |     |       |
| Federal net operating loss carryforwards           |       | 9,955,309 |       | $        | 7,022,085  |   |
| Research and experimentation credit  carryforwards |       | 466,533   |       | 466,533  |       |
| State net operating loss carryforwards             |       | 498,170   |       | 300,032  |       |
| Other carryforwards                                |       | 11,937    |       | 12,696   |       |
|                                                    |            |           |            |          |            |  |

 

55

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| ** **                           | ** ** | **2005**    | ** ** | **2004**   | ** ** |
|--------------------------------------|------------|-------------|------------|------------|------------|
|                                 |       |        |       |       |       |
| Inventories                          |       | 47,418      |       | 96,045     |       |
| Allowance for uncollectible accounts |       | 70,748      |       | 37,033     |       |
| Property, plant and equipment        |       | (263,771    | )          | (289,293   | )          |
| Accrued expenses and other           |       | (7,409      | )          | 14,609     |       |
|                                 |       |        |       |       |       |
| Net deferred tax assets              |       | 10,778,935  |       | 7,659,740  |       |
|                                 |       |        |       |       |       |
| Valuation allowance                  |       | (10,778,935 | )          | (7,659,740 | )          |
|                                 |       |        |       |       |       |
| Net deferred tax asset               |       | $           | —     |       | $          | — |   |
|                                      |            |             |            |            |            |  |  |

 

The Companyhas established valuation allowances to fully offset tax assets due touncertainty about the Company’s ability to generate the future taxable incomenecessary to realize these deferred tax assets, particularly in light of theCompany’s history of significant operating losses.  In addition, future utilization of availablenet operating loss carryforwards may be limited under Internal Revenue Code Section 382as a result of changes in ownership that have or may result from the issuanceof common stock, convertible preferred stock or common stock options andwarrants.

 

The Company’sfederal net operating loss carryforwards of approximately $27,653,656 and statenet operating loss carryforwards of $7,699,685 expire in various fiscal yearsfrom 2020 through 2025.  Availableresearch and experimentation credit carryforwards at April 30, 2005,represent federal and state amounts of $466,533, with expiration dates infiscal years 2016 through 2021.

 

9.             Shareholders’Equity (Deficit)

 

**Common Stock**

** **

On November 27,2001, the Company closed on its initial public offering.  In connection with the initial public offering,the Company issued 1,500,000 units at a price of $4.50 per unit for grossproceeds of $6,750,000.  After offeringcosts, the Company received net proceeds of $5,396,485.  Each unit consisted of one share of commonstock and one redeemable Class A Warrant. Each Class A Warrant became exercisable and separable from thecommon stock on May 20, 2003.  Theholder of each Class A Warrant was entitled to purchase, at any time untilNovember 20, 2004, one share of common stock at an exercise price of $6.50per share, subject to customary anti-dilution adjustments.  The Company could redeem the Class AWarrants for $0.01 per warrant at any time, upon ten business days’ writtennotice, if the closing price of the Company’s common stock or units exceeded$8.50, subject to customary anti-dilution adjustments, for any ten consecutivetrading days before such notice.  TheCompany did not redeem any of these warrants prior to their expiration in November 2004.

 

During thefourth quarter of fiscal year 2004 and the first quarter of fiscal year 2005,the Company closed on the private sale of 2,730,763 units for $1.47 perunit.  Each unit consisted of one shareof common stock and one five-year warrant to purchase a common share for $1.60per share.  Proceeds from the offering,net of offering costs of $455,190, were $3,559,032.  In addition to cash commissions included inthe offering costs, the Company issued to the private placement agent andfinder five-year warrants to purchase an aggregate of 313,650 units at $1.8375per unit.  As a result of anti-dilutionadjustments through April 30, 2005, these warrants are exercisable for 937,215units at $0.67 per unit.

 

56

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During thefiscal year ended April 30, 2005, the Company issued 112,500 shares ofcommon stock to consultants for services. The fair value of these shares was expensed and is included in operatingexpenses for the fiscal year ended April 30, 2005.

 

During theyear ended April 30, 2004, the Company issued 55,522 shares of commonstock to various consultants in exchange for services.  The fair value of these shares was expensedand is included in operating expenses for the year ended April 30, 2004.

 

**Preferred Stock**

 

On April 1,2005, under the terms of a Securities Purchase Agreement with accreditedinvestors, the Company issued 18,035 shares of 5% Series A ConvertiblePreferred Stock to such investors, warrants for the purchase of 27,052,500shares of common stock to such investors, and warrants for the purchase in theaggregate of 1,635,960 shares of common stock to the placement agent andfinder.  Each share of preferred stock isconvertible into the number of shares of common stock equal to the $1,000stated value divided by $0.50, subject to anti-dilution adjustments.  As a result, the 18,035 preferred shares soldmay be converted into 36,070,000 shares of common stock, subject toanti-dilution adjustments.

 

The preferred stock,which is non-voting, has a stated value of $1,000 and accrues cumulativedividends at a rate of 5% of this stated value annually.  Dividends are payable quarterly but may, atthe option of the Company be added to the stated value rather than paid incash, if certain conditions are met.  Thepreferred stock, including any accrued dividends, are convertible, at theoption of the holders, into shares of common stock at a conversion price of$0.50 per share.  In certaincircumstances, the Company may have the option to require the preferredstockholders to convert their shares into common stock.  In the event of a fundamental transaction, asdefined, the preferred shareholders have the right to require the Company toredeem the preferred shares at their stated value, including any accrued butunpaid dividends.  In the event ofcertain defaults, the preferred shareholders have the right to require theCompany to redeem the preferred shares at 110% their stated value, includingany accrued but unpaid dividends.  As aresult of these redemption provisions, the carrying value of these preferredshares is considered to be redeemable and is reported as a “mezzanine”instrument on the Company’s balance sheet beginning on April 30,2005.  The aggregate liquidation value ofthese redeemable preferred shares at April 30, 2005 is $18,109,116.  However, the carrying value of thisredeemable preferred stock at April 30, 2005 is zero, net of a discountassociated with the warrants issued to the shareholders, the placement agentand the finder, as described below.

 

In connectionwith the preferred stock sale, the Company issued the preferred stockpurchasers warrants for the purchase of 27,052,500 shares of common stock at$0.50 per share, and the Company also issued warrants for the purchase of1,635,960 common shares at $0.50 per share to the preferred stock placementagent and finder.  These warrants have aterm of five years.  The Company isrequired to register the common shares underlying the preferred stockconversion option and the purchaser warrants. If the Company does not meet certain registration deadlines, thepreferred stockholders will be entitled to liquidated damages, as defined.  In the event of a fundamental transaction, asdefined, the warrants issued to the preferred shareholders, the placement agentand the finder, all provide the warrant holders with the right to put thewarrants to the Company for cash in an amount equal to the fair value of thewarrants, as determined using the Black Scholes option pricing model.  As a result of this put right, the warrantsare reported at their fair value as a liability on the Company’s balance sheetbeginning on April 30, 2005 and future changes in the fair value of thewarrant will result in charges or benefits to the Company’s results ofoperations. The fair value of these warrants upon closing of the preferredstock sale was $22,271,047.  Because thefair value of these warrants at April 30, 2005 exceeded the proceedsreceived in the preferred stock and warrant issuances, the excess of the fairvalue of the warrants over the proceeds received 

 

57

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(including the converted debt)was recognized as an interest charge of approximately $4,266,047 uponclosing.  During the period betweenclosing and April 30, 2005, the fair value of these warrants increased toapproximately $27,992,609.  The Companyhas reported this $5,721,562 increase in fair value as other expense in thefourth quarter of fiscal year 2005.

 

The Companyobtained gross cash proceeds of $13,603,000 at the closing (net of $30,000 inlegal fees which were withheld by the lead investor).  The Company also converted $4,402,000 ofindebtedness into the above-referenced securities.  The Company incurred cash offering costs of $817,980,including agent commissions, a finder’s fee and out-of-pocket expensereimbursements to certain third parties. The Company also paid legal and administrative expenses of $18,086incurred by PKM in this transaction.

 

**Stock Options**

** **

The Company’sshareholders have authorized the issuance of stock options for the aggregate purchaseof 3,004,474 shares of common stock under various plans covering certainemployees, members of the Board of Directors and certain independentcontractors approved by the Board of Directors. Options are typically granted at prices not less than fair market valueat the date of grant.  Options generallybecome exercisable between one to three years after grant date and have amaximum term of three to ten years depending on the plan.

 

The followingis a summary of stock option activity with respect to the Company’s variousplans as well as option grants made outside the Company’s plans (describedbelow), and includes option activity for employees, directors andnon-employees:

 
| ** **                       | ** ** | **Options** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** |
|----------------------------------|------------|-------------|------------|--------------------------------------------------|------------|
|                             |       |        |       |                                             |       |
| Outstanding, April 30, 2003 |       | 1,085,940   |       | $                                                | 3.46       |   |
|                             |       |        |       |                                             |       |
| Granted                          |       | 260,127     |       | 1.28                                             |       |
| Expired                          |       | (94,340     | )          | 5.00                                             |       |
|                             |       |        |       |                                             |       |
| Outstanding, April 30, 2004 |       | 1,251,727   |       | $                                                | 2.65       |   |
|                             |       |        |       |                                             |       |
| Granted                          |       | 7,688,091   |       | 0.96                                             |       |
| Exercised                        |       | 6,250       |       | 0.44                                             |       |
| Expired                          |       | 684,400     |       | 3.61                                             |       |
|                             |       |        |       |                                             |       |
| Outstanding, April 30, 2005 |       | 8,249,168   |       | 1.00                                             |       |

 

On April 1,2005, the Company awarded (1) a non-qualified stock option for thepurchase of 3,440,348 shares of common stock to the Company’s President andChief Executive Officer, (2) a non-qualified stock option for the purchaseof 1,290,131 shares of common stock to the Company’s Vice President, Financeand Chief Financial Officer, and (3) non-qualified stock options for thepurchase of an aggregate of 1,935,196 shares of common stock to other key employees.  The foregoing options were issued outside theCompany’s stock option plans.  Suchoptions vest to the extent of 25 percent per year, commencing on the firstanniversary of the date of grant.  Theyare exercisable at $0.89 per share, which was the closing price of the Company’scommon stock on the OTC Bulletin Board on April 1, 2005.  These options expire on April 1, 2012.

 

58

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On March 21,2005, the Company granted a stock option for the purchase of 100,000 shares ofcommon stock to two of the Company’s directors for their services as directors.  The foregoing options were issued outside theCompany’s stock option plans.  Theoptions were 100 percent vested at the date of the grant, and they are exercisableat $1.00 per share, which was the closing price of the Company’s common stockon the OTC Bulletin Board on March 21, 2005.  These options expire on March 21, 2015.

 

At April 30,2005 and 2004, 970,931 and 944,768 options, respectively, were available forgrant under the Company’s stock option plans. On August 9, 2001, the Company’s shareholders approved the 2001Equity Incentive Plan (2001 Plan) and reserved 500,000 shares of common stockfor issuance upon exercise of stock options to be granted under the 2001 Planto employees, officers, consultants, advisors, employee and non-employeedirectors and employees of certain related entities.  The number of shares reserved for issuanceunder the 2001 Plan increases on January 1 of each year by the greater of50,000 shares or 3.5 percent of the outstanding shares of the Company’s commonstock on such date, unless the Board of Directors sets the increase at a lowernumber of shares.  On January 1,2005 and 2004, the number of shares available under the 2001 Plan increased by375,579 shares and 279,827 shares, respectively, pursuant to the foregoingprovision.

 

The followingtable summarizes information about stock options outstanding and exercisable atApril 30, 2005:

 
| ** **                    | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                     | ** ** |
|-------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted   Average  Exercise  Price** | ** ** |
|                          |       |                    |       |                                                        |       |   |   |   |   |   |   |
| $0.30 –  $1.76           |       | 7,700,684               |       | 9.20                                                        |       | $ | 0.93 |   | 460,243 |   | $ | 1.22 |   |
| $2.16 –  $5.00           |       | 548,484                 |       | 4.34                                                        |       | $ | 2.16 |   | 496,956 |   | $ | 1.43 |   |
|                          |       | 8,249,168               |       |                                                        |       |   |   | 957,199 |   |   |   |

 

During theyears ended April 30, 2005 and 2004, the Company issued four and ten-yearoptions to purchase an aggregate of 161,950 and 167,643 shares of the Company’scommon stock at exercise prices ranging from $1.67 to $2.00 and $0.30 to $1.68per share, respectively, to certain non-employees who provided technicaladvisory services to the Company.  Theaggregate fair value of the options using the Black-Scholes valuation model was$247,796 and $189,312 and was expensed in fiscal years 2005 and 2004.  The following assumptions were used to valuethe options for the years ended April 30, 2005 and 2004:

 
| ** **              | ** ** | **2005**             | ** ** | **2004**             | ** ** |
|-------------------------|------------|----------------------|------------|----------------------|------------|
| Dividend yield rate     |       | 0 percent            |       | 0 percent            |       |
| Risk free interest rate |       | 3.32 to 4.27 percent |       | 3.80 to 4.01 percent |       |
| Expected life           |       | 4 to 10 years        |       | 4 to 10 years        |       |
| Volatility              |       | 125 percent          |       | 118 percent          |       |

 

**Stock Warrants**

** **

At April 30,2005 and 2004, the Company had outstanding and exercisable warrants to purchase38,282,185 and 6,241,178 shares, respectively, of the Company’s common stock atprices ranging from $0.50 to $6.75 per share. The warrants expire at various dates through March 3, 2015.  At April 30, 2005 and 2004, the weightedaverage remaining contractual life of the warrants was 9.02 and 4.77 years andthe weighted average exercise price of the warrants was $0.71 and $3.27,respectively.

 

59

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As discussedabove under “Common Stock” during the fourth quarter of fiscal year 2004, theCompany issued warrants to purchase 1,189,863 shares of common stock toinvestors and issued warrants to purchase 190,378 units to an agent and finderinvolved in the Company’s private placement.

 

As discussedabove under “Preferred Stock” during the fourth quarter of fiscal year 2005,the Company issued warrants to purchase 27,052,500 shares of common stock toinvestors and issued warrants to purchase 1,635,960 shares to an agent andfinder involved in the Company’s private placement.

 

As discussedin Notes 5 and 6, the Company issued to certain lenders and a lessor, warrantsto purchase 2,409,914 common shares during the year ended April 30, 2005and warrants to purchase 700,000 common shares during the year ended April 30,2004.  In addition, warrants to purchase314,544 common shares were issued to agents or finders in fiscal year 2005.

 

As discussedin Note 10, during the year ended April 30, 2004, the Company issued aseven-year warrant to purchase 25,000 shares of common stock in connection witha technology purchase agreement and during the year ended April 30, 2005,the Company issued a seven-year warrant to purchase 25,000 shares of commonstock for the achievement of a milestone under such purchase agreement.

 

As discussedin Note 5, several warrants issued contain anti-dilution features.  Due to these features, holders of theoutstanding warrants became eligible to purchase an additional 2,353,089 commonshares during fiscal year 2005.

 

10.           AtrialFibrillation Technology Purchase Agreement

 

In August 2003,the Company entered into a technology purchase agreement with LightWave and itsprincipals relating to the acquisition of LightWave’s interests in technologyconsisting of a catheter/probe containing elements of optical fiber, coolantpassages and other features for the purpose of delivering laser energy to theepicardial surface of the heart for treatment of atrial fibrillation.  The Company paid LightWave an initialstandstill payment consisting of 15,000 shares of the Company’s common stock,$10,000 upon closing and an additional $30,000 to LightWave in installments in2004 and 2005.  The Company will beobligated to pay $125,000 to LightWave within 45 days after the firstcommercial sale of the Company’s product in the United States or Europe to twoor more parties and $385,000 within 45 days following the Company’s achievementof $1,500,000 of cumulative gross sales of disposable products.  In addition, during fiscal year 2004, theCompany issued to LightWave a warrant for the purchase of 25,000 shares ofcommon stock at closing and, during fiscal year 2005, a warrant for thepurchase of 25,000 shares of common stock upon receiving FDA 510(k)clearance.  In addition, the Company isobligated to issue a warrant for the purchase of 25,000 shares of common stockupon a receipt of a U.S. utility patent covering the product and a warrant forthe purchase of 25,000 shares of common stock upon the first commercial sale ofthe product.

 

Following thefirst commercial sale, the Company has agreed to pay LightWave payments equalto 6 percent of net sales of the LightWave product in countries in which theCompany obtains patent protection and 4 percent of net sales of the LightWaveproduct in territories in which there is no patent protection.  Commencing with the second year following theCompany’s first commercial sale, the Company has agreed to make minimum annualpayments as follows:

 
| **Year Following**    | ** ** | ** **                 | ** ** |
|-----------------------|------------|----------------------------|------------|
| **Commercialization** | ** ** | **Minimum Annual Payment** | ** ** |
| 2                     |       | $                          | 50,000     |   |
| 3                     |       | $                          | 75,000     |   |
| 4                     |       | $                          | 100,000    |   |
| 5                     |       | $                          | 200,000    |   |
| 6                     |       | $                          | 300,000    |   |
| 7                     |       | $                          | 350,000    |   |
| 8                     |       | $                          | 350,000    |   |
| 9                     |       | $                          | 400,000    |   |
| 10                    |       | $                          | 500,000    |   |

 

60

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The Company isobligated to make such payments for a period of ten years following the firstcommercial sale.  The Company’stechnology purchase agreement with LightWave contains other customaryconditions, including mutual indemnification obligations.  LightWave and two of its principals haveagreed to certain noncompetition obligations, nondisclosure obligations,certain obligations to assign new developments or inventions relating to theacquired technology to the Company.  TheCompany has agreed to use its reasonable commercial efforts to commercializethe technology within three years following the acquisition of the technologyfrom LightWave.  If the Company fails inany year to pay minimum annual payments, the Company may be obligated to grantLightWave a nonexclusive right to use the technology acquired from LightWave,or pay LightWave the difference between payments actually made and minimumpayments due for a given year.

 

11.           Researchand Development Costs

 

Research andDevelopment costs principally consist of engineering costs, included as part ofengineering and regulatory in the statement of operations, totaled $1,278,709and $762,525 for the fiscal years ended April 30, 2005 and 2004,respectively.  Research and Developmentcosts relate primarily to product and process development initiatives.

 

12.           Savingsand Retirement Plan

 

The Companysponsors a 401(k) savings and retirement plan (the Plan) which is available toall eligible employees.  Under the Plan,the Company may make a discretionary contribution to the Plan upon approval bythe Company’s Board of Directors. Employees are fully vested in their own contributions and earningsthereon and become fully vested in the Company’s contributions and earningsthereon after three years of service. The Company made contributions to the Plan of $18,943 and $19,662 infiscal years 2005 and 2004, respectively.

 

13.           RestructuringCharge

 

In the quarterended July 31, 2004 (the first quarter of fiscal year 2005), the Companyrestructured its executive management team, resulting in the termination of twoemployees, which resulted in a charge of approximately $214,000, to general andadministrative expenses.  This chargerepresented the amount of future severance payments due to these formeremployees.  During the quarter ended October 31,2004, the Company terminated an additional five employees in an effort toreduce operating costs.  Thisrestructuring resulted in approximately $46,000 of additional severance costs,which were charged to general and administrative expense.  In the quarter ended January 31, 2005,the Company terminated an additional eleven employees resulting inapproximately $48,000 of severance costs charged to general and administrativeexpense.  The Company expects to pay allamounts due to these former employees by August 2005.  As of April 30, 2005, $24,834 remainedaccrued but not paid.

 
| ** **                        | ** ** | **Total** | ** ** |
|-----------------------------------|------------|-----------|------------|
|                              |       |      |       |
| Restructuring charges             |       | $         | 308,000    |   |
| Cash usage                        |       | 283,166   |       |
| Balance as of April 30, 2005 |       | $         | 24,834     |   |

 

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14.           ProductLiability Contingency

 

In March 2005,the Company became aware that a patient who was utilizing the Company’s heartvalve had died.  The Company has notreceived any claims related to this matter but believes that any such claimwould be covered by its existing liability insurance.  Based upon the expectation that insurancewill cover the cost of any claims after the Company’s payment of thedeductible, the Company does not expect the ultimate resolution of this matterto have a material effect on the Company’s financial position, results ofoperations or cash flows.

 

15.           SegmentInformation

 

The Companyviews its operations and manages its business as one segment, the manufacturingand marketing of cardiothoracic surgery devices.  Factors used to identify the Company’s singleoperating segment include the organizational structure of the Company and thefinancial information available for evaluation by the chief operating decisionmaker.  The following table summarizesnet sales by geographic area (all of which are reported as part of the lossfrom discontinued operations):

 
| ** **    | ** ** | **For the Years Ended** | ** ** |
|---------------|------------|-------------------------|------------|
| ** **    | ** ** | **April 30,**      | ** ** |
| ** **    | ** ** | **2005**                | ** ** | **2004** | ** ** |
|          |       |                    |       |   |   |
| Europe        |       | $                       | 1,190,967  |   | $ | 1,462,385 |   |
| South Asia    |       | 51,800                  |       | 479,035 |   |
| Middle East   |       | 379,280                 |       | 463,382 |   |
| Far East      |       | 70,511                  |       | 48,854 |   |
| Other         |       | 221,297                 |       | 316,341 |   |
| United States |       | 391,042                 |       | 640,978 |   |
| Total         |       | $                       | 2,304,897  |   | $ | 3,410,975 |   |

 

At April 30, 2005 and 2004,substantially all of the Company’s operations and assets were based in theUnited States.

 

62

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| **ITEM 8** | ** ** | **CHANGES IN AND DISAGREEMENTS  WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE** |
|------------|------------|--------------------------------------------------------------------------------------------|

** **

As previouslyreported, on June 9, 2005, PricewaterhouseCoopers LLP (“PwC”) informed theaudit committee of our board of directors that it will decline to stand forre-election as our independent registered public accounting firm and will ceaseto serve as our independent registered public accounting firm upon completionof PwC procedures regarding the following: (1) our financial statements as of and for the year ended April 30,2005 and (2) the Form 10-KSB in which such financial statements willbe included.  As a result, our AuditCommittee will select another independent registered public accounting firm toperform our audit for the fiscal year ending April 30, 2006.

 

The reports of PwC on our financialstatements as of and for the years ended April 30, 2003 and 2004 containedan explanatory paragraph expressing significant doubt about our ability tocontinue as a going concern, but did not contain an adverse opinion or disclaimerof opinion, and were not further qualified or modified as to uncertainty, auditscope or accounting principle.

 

During the years ended April 30, 2003and 2004 and through June 9, 2005, there have been no disagreements withPwC on any matter of accounting principles or practices, financial statementdisclosure, or auditing scope or procedure, which disagreements, if notresolved to the satisfaction of PwC, would have caused PwC to make referencethereto in its reports on our financial statements for such years.

 

During the years ended April 30, 2003and 2004 and through June 9, 2005, there has been one reportable event ofthe type described in Item 304(a)(1)(iv)(B) of Regulation S-B.  The reportable event occurred in March 2004when PwC informed our audit committee that there was a material weakness ininternal controls over financial reporting.  Specifically, PwC identifieda material weakness in the design and operation of internal controls relatingto documenting and reporting international distribution marketing expendituresand related reimbursement.  Followingthis communication from PwC, we implemented procedures and reporting todocument and support customer marketing expenses which remedied this materialweakness.

 

**ITEM 8A****                CONTROLS ANDPROCEDURES**

** **

We maintain asystem of disclosure controls and procedures that is designed to providereasonable assurance that information, which is required to be disclosed, isaccumulated and communicated to management timely.  At the end of the period covered by thisreport, we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures pursuant to Exchange Act Rule 13a-15.  Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in timely alerting them to materialinformation required to be included in our periodic filings with the SEC.

 

During ourmost recent fiscal quarter, there has been no change in our internal controlover financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) underthe Exchange Act) that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**ITEM 8B**                OTHERINFORMATION

** **

**Not applicable.**

 

63

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**PART III**

 

**ITEM 9**                  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS ANDCONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

** **

We incorporateby reference the information contained under the captions “Proposal No. 1Election of Directors,” “Our Board of Directors and Committees,” and “Section 16(a) BeneficialOwnership Reporting Compliance” in our definitive proxy statement for theannual meeting of shareholders to be held September 22, 2005.

 

Our executiveofficers serve at the discretion of our board of directors.  Our directors hold office until our nextannual meeting of shareholders and until their successors have been elected andqualified.  There are no familyrelationships among our directors and executive officers.  Information regarding our executive officersis provided in Part I of this Form 10-KSB under separate caption.

 

We haveadopted a Code of Business Conduct and Ethics that is applicable to all of ouremployees, officers (including our principal executive officer, principalfinancial officer, principal accounting officer or controller, and personsperforming similar functions) and directors. Our Code of Business Conduct and Ethics satisfies the requirements ofItem 406(b) of Regulation S-B.  OurCode of Business Conduct and Ethics is posted on our internet website atwww.medcvinc.com and is available free of charge, upon written request to ourChief Financial Officer at MedicalCV, Inc., 9725 South Robert Trail, InverGrove Heights, MN 55077.  We intend todisclose any amendments to or waivers from a provision of our Code of BusinessConduct and Ethics that requires disclosure on our website at www.medcvinc.com.

 

**ITEM 10**                EXECUTIVECOMPENSATION

** **

We incorporateby reference the information contained under the captions “ExecutiveCompensation” and “Non-Employee Director Compensation” in our definitive proxystatement for the annual meeting of shareholders to be held September 22,2005.

 

**ITEM 11**                SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED SHAREHOLDER MATTERS

** **

We incorporateby reference the information contained under the captions “Security Ownershipof Certain Beneficial Owners and Management” and “Equity Compensation PlanInformation” in our definitive proxy statement for the annual meeting ofshareholders to be held September 22, 2005.

 

**ITEM 12**                CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

** **

*We incorporate by reference theinformation contained under the caption “Certain Relationships and RelatedTransactions” in our definitive proxy statement for the annual meeting ofshareholders to be held September 22, 2005.*

* *

**ITEM 13**                EXHIBITS

** **

See “Index toExhibits.”

 

64

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**ITEM 14**                PRINCIPALACCOUNTANT FEES AND SERVICES

** **

**We incorporate by reference the informationcontained under the caption “Independent Registered Public Accounting Firm” inour definitive proxy statement for the annual meeting of shareholders to be heldSeptember 22, 2005.**

 

65

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**SIGNATURES**

 

In accordancewith Section 13 or 15(d) of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized, in the City of Inver Grove Heights, State of Minnesota, on December7, 2005.

 
|   | MedicalCV, Inc.                                                                            |
|--------|-------------------------------------------------------------------------------------------------|
|   |                                                                                            |
|   | By                                                                                              | /s/ Marc P.  Flores |   |
|   | Marc P.  Flores, President, Chief Executive Officer  and Director (Principal Executive Officer) |

 

In accordancewith the Exchange Act, this report has been signed below by the followingpersons on behalf of the registrant, and in the capacities and on the dateindicated.

 
| **Signature**          | ** ** | **Title**                                | ** ** | **Date**         |
|------------------------|------------|------------------------------------------|------------|------------------|
|                   |       |                                     |       |             |
|                   |       |                                     |       |             |
|                   |       | President, Chief Executive Officer and   |       |             |
| /s/ Marc P. Flores     |       | Director (Principal Executive Officer)   |       | December 7, 2005 |
| Marc P. Flores         |       |                                     |       |             |
|                   |       |                                     |       |             |
|                   |       | Vice President, Finance and Chief        |       |             |
| /s/ John H. Jungbauer  |       | Financial Officer (Principal Accounting  |       |             |
| John H. Jungbauer      |       | Officer and Principal Financial Officer) |       | December 7, 2005 |
|                   |       |                                     |       |             |
|                   |       |                                     |       |             |
|                   |       | Chairperson of the Board                 |       |             |
| Susan L. Critzer       |       |                                     |       |             |
|                   |       |                                     |       |             |
|                   |       | Director                                 |       |             |
| Larry G. Haimovitch    |       |                                     |       |             |
|                   |       |                                     |       |             |
| *                      |       | Director                                 |       |             |
| Lawrence L. Horsch     |       |                                     |       |             |
|                   |       |                                     |       |             |
| *                      |       | Director                                 |       |             |
| David B. Kaysen        |       |                                     |       |             |
|                   |       |                                     |       |             |
| *                      |       | Director                                 |       |             |
| Paul K. Miller         |       |                                     |       |             |
|                   |       |                                     |       |             |
|                   |       | Director                                 |       |             |
| J. Robert Paulson, Jr. |       |                                     |       |             |

 

----

| *      | By     | /s/ John H. Jungbauer |   |   |   | December 7, 2005 |
|--------|--------|-----------------------|--------|--------|--------|------------------|
|   |   | John H. Jungbauer     |   |   |   |             |
|   |   | Attorney-in-fact      |   |   |   |             |

 

66

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**INDEX TO EXHIBITS**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                                                                     |
|--------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |       |                                                                                                                                                                                                                                                                                |
| 3.1                |       | Restated Articles of Incorporation of the Registrant (incorporated by  reference to Post Effective Amendment No. 2 to our Registration  Statement on Form SB-2 filed April 29, 2005 (File No. 333-116394)).                                                     |
| 3.2                |       | Bylaws of the Registrant (incorporated by reference to our  Registration Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).                                                                                                                    |
| 4.1                |       | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                                                     |
| 4.2                |       | Specimen common stock certificate (incorporated by reference to our  Registration Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).                                                                                                           |
| 10.1               |       | 1992 Stock Option Plan (incorporated by reference to our Registration  Statement on Form SB-2, filed on August 31, 2001 (File No. 333-68884)).                                                                                                                       |
| 10.2               |       | 1993 Director Stock Option Plan (incorporated by reference to our  Registration Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).                                                                                                             |
| 10.3               |       | 1997 Stock Option Plan (incorporated by reference to our Registration  Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).                                                                                                                      |
| 10.4               |       | 2001 Equity Incentive Plan (incorporated by reference to our  Registration Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).                                                                                                                  |
| 10.5               |       | Warrant Agreement by and between the Registrant and Adel A. Mikhail,  dated February 2, 2001 (incorporated by reference to our Registration  Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).                                           |
| 10.6               |       | Common Stock Purchase Warrant issued by the Registrant to PKM  Properties, LLC, dated January 17, 2003 (incorporated by reference to  our Quarterly Report on Form 10-QSB/A, filed on April 4, 2003 (File  No. 000-33295)).                                     |
| 10.7               |       | Warrant Agreement to purchase 380,357 shares of common stock issued  by the Registrant to Peter Ludwig Hauser, dated July 1, 2003  (incorporated by reference to our Current Report on Form 8-K, filed  July 14, 2003 (File No. 000-33295)).               |
| 10.8               |       | Amendment to Warrants by and between the Registrant and PKM  Properties, LLC, dated July 1, 2003 (incorporated by reference to our  Current Report on Form 8-K, filed July 14, 2003 (File  No. 000-33295)).                                                     |
| 10.9               |       | Warrant Agreement to purchase 320,178 shares of common stock issued  by the Registrant to PKM Properties, LLC, dated July 1, 2003  (incorporated by reference to our Current Report on Form 8-K, filed  July 14, 2003 (File No. 000-33295)).                    |
| 10.10              |       | Warrant Agreement to purchase 60,179 shares of common stock issued by  MedicalCV, Inc. to PKM Properties, LLC, dated August 20, 2003  (incorporated by reference to our Quarterly Report on Form 10-QSB filed  on December 15, 2003 (File No. 000-33295)). |
| 10.11              |       | Warrant Agreement to purchase 77,381 shares of common stock issued by  the Registrant to PKM Properties, LLC, dated November 13, 2003  (incorporated by reference to our Quarterly Report on Form 10-QSB filed  on March 22, 2004 (File No. 000-33295)).        |
| 10.12              |       | Warrant Agreement to purchase 136,000 shares of common stock issued  by the Registrant to Peter L. Hauser, dated February 3, 2004  (incorporated by reference to our Annual Report on Form 10-KSB filed on  July 29, 2004 (File No. 000-33295)).           |
| 10.13              |       | Warrant Agreement to purchase 330,933 shares of common stock issued  by the Registrant to PKM Properties, LLC, dated February 3, 2004  (incorporated by reference to our Annual Report on Form 10-KSB filed on  July 29, 2004 (File No. 000-33295)).            |
| 10.14              |       | Letter Agreement between the Registrant and Lawrence L. Horsch, dated  effective August 19, 2003 (incorporated by reference to our Annual  Report on Form 10-KSB filed on July 29,                                                                                   |

 

67

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|   |   | 2004 (File No. 000-33295)).                                                                                                                                                                                                                                                                                                                                        |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15  |   | Non-Qualified Stock Option Agreement issued by the Registrant to  Lawrence L. Horsch in the amount of 100,000 shares, dated August 19,  2003 (incorporated by reference to our Annual Report on Form 10-KSB  filed on July 29, 2004 (File No. 000-33295)).                                                                                          |
| 10.16  |   | Building Lease Agreement between the Registrant and PKM Properties,  LLC, dated April 4, 2003 (incorporated by reference to our Annual Report  on Form 10-KSB filed on July 29, 2004 (File No. 000-33295)).                                                                                                                                         |
| 10.17  |   | Technology Purchase Agreement between the Registrant and LightWave  Ablation Systems, Inc., Gregory Brucker and Robert Svenson M.D., dated  August 27, 2003 (incorporated by reference to our Annual Report on  Form 10-KSB filed on July 29, 2004 (File No. 000-33295)).                                                                      |
| 10.18  |   | Warrant Agreement to purchase 25,000 shares of common stock issued by  the Registrant to LightWave Ablation Systems, Inc., dated  August 27, 2003 (incorporated by reference to our Annual Report on  Form 10-KSB filed on July 29, 2004 (File No. 000-33295)).                                                                                |
| 10.19  |   | Technology Assignment Agreement between the Registrant, LightWave  Ablation Systems, Inc., Robert H. Svenson, M.D. and Gregory  Brucker, dated August 27, 2003 (incorporated by reference to our Annual  Report on Form 10-KSB filed on July 29, 2004 (File  No. 000-33295)).                                                             |
| 10.20  |   | Proprietary Information and Inventions Agreement between the  Registrant, Robert H. Svenson, M.D. and Gregory Brucker, dated  August 10, 2003 (incorporated by reference to our Annual Report on Form 10-KSB  filed on July 29, 2004 (File No. 000-33295)).                                                                                    |
| 10.21  |   | Technical Assistance Agreement between the Registrant and  Robert H. Svenson, M.D., dated August 7, 2003 (incorporated by  reference to our Annual Report on Form 10-KSB filed on July 29,  2004 (File No. 000-33295)).                                                                                                                        |
| 10.22  |   | Technical Assistance Agreement between the Registrant and Gregory  Brucker, dated August 7, 2003 (incorporated by reference to our Annual  Report on Form 10-KSB filed on July 29, 2004 (File  No. 000-33295)).                                                                                                                                     |
| 10.23  |   | Warrant Agreement to purchase up to 100,000 shares of common stock  issued by the Registrant to Segmed, Inc., dated August 7, 2002  (incorporated by reference to our Annual Report on Form 10-KSB filed on  July 29, 2004 (File No. 000-33295)).                                                                                              |
| 10.24  |   | First Amended and Restated Subordination and Intercreditor Agreement  by and between Peter L. Hauser, PKM Properties, LLC and Draft Co., accepted  and acknowledged by the Registrant dated November 24, 2003 (incorporated  by reference to our Annual Report on Form 10-KSB filed on July 29,  2004 (File No. 000-33295)).                        |
| 10.25  |   | Amendment No. 1 to First Amended and Restated Subordination and  Intercreditor Agreement by and between Peter L. Hauser, PKM Properties, LLC  and Draft Co., accepted and acknowledged by the Registrant dated  January 29, 2004 (incorporated by reference to our Annual Report on  Form 10-KSB filed on July 29, 2004 (File No. 000-33295)). |
| 10.26  |   | Amendment No. 2 to First Amended and Restated Subordination and  Intercreditor Agreement by and between Peter L. Hauser and PKM Properties,  LLC, accepted and acknowledged by MedicalCV, Inc. dated April 16,  2004 (incorporated by reference to our Quarterly Report on Form 10-QSB  filed on December 15, 2004 (File No. 000-33295)). |
| 10.27  |   | April 2004 Discretionary Credit Agreement by and between  MedicalCV, Inc. and PKM Properties, LLC dated April 16, 2004  (incorporated by reference to our Quarterly Report on Form 10-QSB filed  on December 15, 2004 (File No. 000-33295)).                                                                                              |
| 10.28  |   | Discretionary Credit Demand Note between MedicalCV, Inc.  (borrower) and PKM Properties, LLC (lender), dated April 16, 2004  (incorporated by reference to our Quarterly Report on Form 10-QSB filed  on December 15, 2004 (File No. 000-33295)).                                                                                              |
| 10.29  |   | Severance and Release Agreement between the Registrant and  Blair P. Mowery, effective August 11, 2004 (incorporated by  reference to Post Effective Amendment No. 1 to our Registration  Statement on Form SB-2 filed September 9, 2004 (File  No. 333-116394)).                                                                         |

 

68

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| 10.30 |   | Severance and Release Agreement between the Registrant and  Allan R. Seck, effective August 6, 2004 (incorporated by reference  to Post Effective Amendment No. 1 to our Registration Statement on  Form SB-2 filed September 9, 2004 (File No. 333-116394)).                                                                                                               |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.31 |   | Letter Agreement between the Registrant and Marc P. Flores,  effective August 30, 2004 (incorporated by reference to our Current  Report on Form 8-K, filed September 2, 2004 (File  No. 000-33295)).                                                                                                                                                                            |
| 10.32 |   | October 2004 Discretionary Credit Agreement by and between  MedicalCV, Inc. and PKM Properties, LLC, dated October 29, 2004,  effective November 17, 2004 (incorporated by reference to our Current  Report on Form 8-K filed on November 23, 2004 (File  No. 000-33295)).                                                                                             |
| 10.33 |   | October 2004 Credit Note issued by  MedicalCV, Inc. (maker) to PKM Properties, LLC (payee), dated  October 29, 2004, effective November 17, 2004 (incorporated  by reference to our Current Report on Form 8-K filed on  November 23, 2004 (File No. 000-33295)).                                                                                                      |
| 10.34 |   | Intellectual Property Security Agreement by  and between PKM Properties, LLC (secured party) and MedicalCV, Inc.  (debtor), dated October 29, 2004, effective November 17, 2004 (incorporated  by reference to our Current Report on Form 8-K filed on  November 23, 2004 (File No. 000-33295)).                                                                            |
| 10.35 |   | Amendment No. 3 to First Amended and  Restated Subordination and Intercreditor Agreement by and between Peter L.  Hauser and PKM Properties, LLC, accepted and acknowledged by  MedicalCV, Inc., dated October 29, 2004, effective  November 17, 2004 (incorporated by reference to our Current  Report on Form 8-K filed on November 23, 2004 (File  No. 000-33295)). |
| 10.36 |   | Waiver Agreement by and between  MedicalCV, Inc. (borrower) and PKM Properties, LLC (lender), dated  October 29, 2004, effective November 17, 2004 (incorporated  by reference to our Current Report on Form 8-K filed on  November 23, 2004 (File No. 000-33295)).                                                                                                         |
| 10.37 |   | Warrant Agreement issued to PKM Properties,  LLC, dated November 17, 2004 (incorporated by reference to our  Current Report on Form 8-K filed on November 23, 2004 (File  No. 000-33295)).                                                                                                                                                                                            |
| 10.38 |   | Warrant Agreement to purchase 25,000 shares  of common stock issued to LightWave Ablation Systems, Inc., dated  December 1, 2004 (incorporated by reference to our Current Report on  Form 8-K/A filed on February 10, 2005 (File No. 000-33295)).                                                                                                                               |
| 10.39 |   | Form of Bridge Note Purchase Agreement  including form of convertible promissory note and form of common stock  purchase warrant), dated December 31, 2004 (incorporated by reference to  our Current Report on Form 8-K filed January 14, 2005 (File  No. 000-33295)).                                                                                                          |
| 10.40 |   | February 2005 Discretionary Credit Agreement by and between  MedicalCV, Inc. and PKM Properties, LLC, dated February 16, 2005,  effective March 3, 2005 (incorporated by reference or our Current Report  on Form 8-K/A filed on March 9, 2005 (File No. 000-33295)).                                                                                                  |
| 10.41 |   | February 2005 Discretionary Credit Note issued by  MedicalCV, Inc. (maker) and PKM Properties, LLC (payee), dated  February 16, 2005, effective March 3, 2005 (incorporated by  reference or our Current Report on Form 8-K/A filed on March 9,  2005 (File No. 000-33295)).                                                                                           |
| 10.42 |   | Warrant Agreement issued to PKM Properties, LLC, dated  February 16, 2005, effective March 3, 2005 (incorporated by  reference or our Current Report on Form 8-K/A filed on March 9,  2005 (File No. 000-33295)).                                                                                                                                                                |
| 10.43 |   | Amendment No. 4 to First Amended and Restated Subordination and  Intercreditor Agreement by and between Peter L. Hauser and PKM Properties,  LLC, accepted and acknowledged by MedicalCV, Inc., dated  February 16, 2005, effective March 3, 2005 (incorporated by  reference or our Current Report on Form 8-K/A filed on March 9,  2005 (File No. 000-33295)).       |
| 10.44 |   | Form of Non-Qualified Stock Option Agreement under the  MedicalCV, Inc. 2001 Equity Incentive Plan (incorporated by reference to  our Quarterly Report on Form 10-QSB filed on March 17, 2005 (File  No. 000-33295)).                                                                                                                                                            |
| 10.45 |   | Form of Non-Qualified Stock Option Agreement under the  MedicalCV, Inc. 1997 Stock                                                                                                                                                                                                                                                                                                              |

 

69

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|     |   | Option Plan (incorporated by reference to our Quarterly Report on  Form 10-QSB filed on March 17, 2005 (File No. 000-33295)).                                                                                                                                             |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.46    |   | Form of Non-Qualified Stock Option Agreement under the  MedicalCV, Inc. 1993 Director Stock Option Plan (incorporated by  reference to our Quarterly Report on Form 10-QSB filed on March 17,  2005 (File No. 000-33295)).                                      |
| 10.47    |   | Non-Qualified Stock Option Agreement issued by the Registrant to  Lawrence L. Horsch in the amount of 149,850 shares, dated November 18,  2004 (incorporated by reference to our Quarterly Report on Form 10-QSB  filed on March 17, 2005 (File No. 000-33295)).     |
| 10.48    |   | Non-Qualified Stock Option Agreement issued by the Registrant to John  H. Jungbauer in the amount of 68,584 shares, dated November 18, 2004  (incorporated by reference to our Quarterly Report on Form 10-QSB filed  on March 17, 2005 (File No. 000-33295)).       |
| 10.49    |   | Non-Qualified Stock Option Agreement issued by the Registrant to John  H. Jungbauer in the amount of 81,416 shares, dated November 18, 2004  (incorporated by reference to our Quarterly Report on Form 10-QSB filed  on March 17, 2005 (File No. 000-33295)).       |
| 10.50    |   | Non-Qualified Stock Option Agreement issued  by the Registrant to Lawrence L. Horsch in the amount of 62,050 shares, dated  January 19, 2005 (incorporated by reference to our Quarterly Report on  Form 10-QSB filed on March 17, 2005 (File No. 000-33295)).       |
| 10.51    |   | Form of Stand-Alone Non-Qualified  Stock Option Agreement issued to Non-Employee Directors (incorporated by  reference to our Current Report on Form 8-K filed on March 25, 2005  (File No. 000-33295)).                                                             |
| 10.52    |   | Securities Purchase Agreement between the  Registrant and the Investors named as signatories thereto, dated  March 31, 2005 (effective April 1, 2005) (incorporated by reference  to our Current Report on Form 8-K filed April 4, 2005 (File  No. 000-33295)). |
| 10.53    |   | Form of 2005 Private Placement Warrant  (incorporated by reference to our Current Report on Form 8-K filed  April 4, 2005 (File No. 000-33295)).                                                                                                                     |
| 10.54    |   | Form of Debt Conversion Agreement  dated March 29, 2005 (effective April 1, 2005) (incorporated by  reference to our Current Report on Form 8-K filed April 4, 2005  (File No. 000-33295)).                                                                |
| 10.55    |   | Registration Rights Agreement between the  Registrant and the Investors named as signatories thereto, dated  March 31, 2005 (effective April 1, 2005) (incorporated by reference  to our Current Report on Form 8-K filed April 4, 2005 (File  No. 000-33295)). |
| 10.56    |   | Engagement Letter between the Registrant  and J Giordano Securities Group, dated December 17, 2004 (incorporated  by reference to our Current Report on Form 8-K filed April 4, 2005  (File No. 000-33295)).                                                         |
| 10.57    |   | Amendment to Engagement Letter between the  Registrant and J Giordano Securities Group, dated March 16, 2005  (incorporated by reference to our Current Report on Form 8-K filed  April 4, 2005 (File No. 000-33295)).                                               |
| 10.58    |   | Letter Agreement between the Registrant and  Tower Finance, Ltd., dated December 8, 2004 (incorporated by reference  to our Current Report on Form 8-K filed April 4, 2005 (File  No. 000-33295)).                                                                   |
| 10.59    |   | Amendment to Letter Agreement between the  Registrant and Tower Finance, Ltd., dated March 16, 2005 (incorporated  by reference to our Current Report on Form 8-K filed April 4, 2005  (File No. 000-33295)).                                                        |
| 23       |   | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                |
| 24  |   | Power of Attorney (included on Signature page).                                                                                                                                                                                                                                          |
| 31.1     |   | Chief Executive Officer Certification  pursuant to Rule 13a-14.                                                                                                                                                                                                                     |
| 31.2     |   | Chief Financial Officer Certification  pursuant to Rule 13a-14.                                                                                                                                                                                                                     |
| 32.1     |   | Chief Executive Officer Certification pursuant  to 18 U.S.C. Section 1350.                                                                                                                                                                                                          |
| 32.2     |   | Chief Financial Officer Certification  pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                          |

 

70

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