** **

**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.

 

 

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**EXPLANATORYNOTE**

 

We are filing this Annual Report on Form 10-KSB/Afor the fiscal year ended April 30, 2005, to reflect a correction in the classificationof certain items in our statement of operations for the fiscal year ended April 30,2005, and to report a material weakness in our internal control over financialreporting.

 

We have restated our financial statements forthe fiscal year ended April 30, 2005, to correct the classification ofcertain sales and marketing expenses and certain general and administrativeexpenses from continuing operations to discontinued operations.  See Note 16 of the Notes to FinancialStatements.  The costs for which theclassification has been corrected are related directly to our discontinuedheart valve business.  The correction inclassifications had no effect on our net loss or net loss per share, nor anyeffect on our balance sheet, statement of changes in shareholders’ equity(deficit) or statement of cash flows. This Form 10-KSB/A amends only Items 6, 7 and 8A.  The remaining items are unaffected by the correctionin classification, have not been updated and are not reproduced in this Form 10-KSB/A.  In addition, this Form 10-KSB/A containscurrently-dated certifications from our Chief Executive Officer and ChiefFinancial Officer, as required by Sections 302 and 906 of the Sarbanes-OxleyAct of 2002.  The certifications of ourChief Executive Officer and Chief Financial Officer are attached to this Form 10-KSB/Aas Exhibits 31.1, 31.2, 32.1 and 32.2.

 

**TABLEOF CONTENTS**

 
| PART  II          |   |                                                           |   |
|-------------------|--------|----------------------------------------------------------------|--------|
|              |   |                                                           |   |
| ITEM 6            |   | MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION |   |
| ITEM 7            |   | FINANCIAL STATEMENTS                                           |   |
| ITEM 8A           |   | CONTROLS  AND PROCEDURES                                       |   |
|              |   |                                                           |   |
| SIGNATURES        |   |                                                           |   |
| INDEX TO EXHIBITS |   |

 

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**PART II**

 

**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.*

 

**Restatement**

 

As discussedin Note 16 to our financial statements, we restated our financialstatements for the fiscal year ended April 30, 2005, to correct theclassification of certain sales and marketing expenses and certain general andadministrative expenses from continuing operations to discontinued operations.  The costs for which the classification hasbeen corrected are related directly to our discontinued heart valvebusiness.  The correction inclassifications had no effect on our net loss or net loss per share, nor any effecton our balance sheet, statement of changes in shareholders’ equity (deficit) orstatement of cash flows.  The “Results ofOperations for the Fiscal Years Ended April 30, 2005 and 2004” section of thisManagement’s Discussion and Analysis or Plan of Operation has been corrected toreflect this restatement.

 

**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 valvebusiness.  On April 8, 2005, we announcedthat our efforts to find a buyer for the heart valve business were unsuccessfuland that we 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 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.

 

**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 

 

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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.

 

In June 2005, the Financial AccountingStandards Board (FASB) issued DIG Issue B 38.  This implementation issue requirescompanies to assess whether puts and calls embedded in financial contracts,require that the host contract and embedded derivative be bifurcated and valuedseparately.  DIG Issue B 38 specifically addresses debt host contracts.

 

At the time we sold our preferred stockinstrument we concluded that it was an equity host contract.  Because DIGIssue B 38 does not apply to puts embedded in equity contracts, we alsoconcluded that DIG Issue B 38, which is effective for fiscal periods beginningafter December 15, 2005, did not apply to the put obligation embedded inour preferred stock.

 

**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 $317,386, 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,Continuing Operations. *For fiscal year 2005, general andadministrative expenses totaled $4,012,506 compared to $2,395,062 in fiscalyear 2004.  The major contributors to theincrease in general and administrative expenses were expenses related to debtand convertible preferred stock fundraising activities and severance costsincurred in fiscal year 2005.  Increasesin costs related to fundraising activities included an increase in legal feesof $324,558, an increase in other professional fees of $815,664 and an increasein travel costs of $164,502.  Severance andexpenses related to changes in personnel totaled $267,533.

 

*Engineering and Regulatory,Continuing Operations.*  Engineering and regulatory expenses increasedto $1,581,016 for fiscal year 2005, compared to $910,646 for fiscal year2004.  The increase in these costsreflected increased development efforts related to the atrial fibrillationtechnology purchased 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 $17,221,491. 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 $1,873,381, 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 taxprovision in fiscal years 2005 or 2004 due to net operating losses generatedfor income tax 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 areduction in accounts receivable of $717,829, offset by decreases in accountspayable of $906,964 and increases in prepaid expenses of $271,928, were theother main contributors 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.  Weexpect our 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 on term debt of$1,000,000 and payments made under related-party lease agreements of$319,288.  Net cash provided by financingactivities was $4,273,655 in fiscal year 2004, and consisted of long-termborrowings of $3,150,000 and net proceeds from equity sales in February 2004and April 2004 of $1,618,424, partially offset by $291,084 of payments onrelated-party lease obligations and principal payments of $150,000 on 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, we conducteda private placement to accredited investors of units, with each unit consistingof one share of common stock and one common stock purchase warrant.  In this placement, we sold 2,730,763 unitsfor aggregate gross proceeds of $4,014,222. During fiscal year 2004 we received gross proceeds from this privateplacement of $1,749,099.  The five-yearwarrants sold with the common stock are exercisable to purchase an aggregate of2,730,763 shares of common stock at an exercise price of $1.60 per share.  In connection with the placement, we issuedour placement agent a five-year warrant to purchase 123,272 units at anexercise price of $1.8375 per unit, paid our placement agent cash commissionsof $181,210 and paid our placement agent a non-accountable expense allowance of$67,954.  In addition, we issued a findera five-year warrant to purchase 95,189 units at an exercise price of $1.8375per unit, paid a finder’s fee of $140,928 and reimbursed a finder for expensesof $4,163.  The warrants underlying theunit warrants issued to the placement agent and the finder are exercisable fora period of five-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 with PKM,pursuant to which we granted PKM a security interest in all of our intellectualproperty, and a security agreement which we entered into with PKM in May2003.  We also acknowledged and accepteda 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 to Tower-introducedinvestors in this financing at an exercise price of $0.625 per share.

 

These bridge notes were converted into preferredstock and warrants in April 2005 at 100 percent of the issuance price of suchsecurities, as described below.  Because theconvertible bridge notes provided a contingent conversion option to the noteholders 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 to accreditedinvestors, warrants for the purchase of 27,052,500 shares of common stock tosuch investors, and warrants for the purchase in the aggregate of 1,635,960shares 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 numberof shares 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:

 

8

----

 

•              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.

 

9

----

 

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                   |       | $         | 182,000     |   |
| Cash usage                              |       | —    |        |
| **Balance as of July 31, 2004**    | ** ** | **$**     | **182,000** | ** ** |
| Adjustments to provision                |       | 46,000    |        |
| Cash usage                              |       | 93,239    |        |
| **Balance as of October 31, 2004** | ** ** | **$**     | **134,761** | ** ** |
| Adjustments to provision                |       | 48,000    |        |
| Cash usage                              |       | 116,808   |        |
| **Balance as of January 31, 2005** | ** ** | **$**     | **65,953**  | ** ** |
| Adjustments to provision                |       | 32,000    |        |
| Cash usage                              |       | 73,119    |        |
| **Balance as of April 30, 2005**   | ** ** | **$**     | **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.

 

10

----

 

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 |   |

 

----

(1)           Future payments includeinterest due.

** **

**Qualitative and Quantitative Disclosures about MarketRisk**

** **

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 in foreignmarkets.  We do not currently participatein 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.

 

11

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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.

 

12

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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                                |       |

 

13

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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.

 

As discussed in Note 16, the Company has restated its financial statementsfor the year ended April 30, 2005. 

 

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 notinclude any adjustments that might result from the outcome of this uncertainty.

 
| /s/ PricewaterhouseCoopers LLP                                                           |   |
|------------------------------------------------------------------------------------------|--------|
|                                                                                     |
| PricewaterhouseCoopers LLP                                                               |
| Minneapolis, Minnesota                                                                   |
| July 8, 2005, except as to Notes 4, 13 and 16 for which the date  is March 10, 2006 |

 

14

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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 redeemable 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.

 

15

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**MEDICALCV, INC.**

**Statementsof Operations**

 
| ** **                                                                      | ** ** | **Year Ended April 30,** | ** **  |
|---------------------------------------------------------------------------------|------------|--------------------------|-------------|
| ** **                                                                      | ** ** | **2005**                 | ** **  | **2004** | ** ** |
| ** **                                                                      | ** ** | **(Restated)**           | ** **  | ** ** | ** ** |
| Operating expenses, continuing operations:                                      |       |                     |        |   |   |
| Sales and marketing                                                             |       | $                        | 317,386     |   | $ | — |   |
| General and administrative                                                      |       | 4,012,506                |        | 2,395,062 |   |
| Engineering and regulatory                                                      |       | 1,581,016                |        | 910,646 |   |
| Total operating expenses                                                        |       | $                        | 5,910,908   |   | $ | 3,305,708 |   |
| Loss from operations                                                            |       | $                        | (5,910,908  | ) | $ | (3,305,708 | ) |
| Other (expense) income:                                                         |       |                     |        |   |   |
| Interest expense                                                                |       | (1,352,183               | )           | (918,027 | ) |
| Interest income                                                                 |       | 22,994                   |        | 4,993 |   |
| Other (expense) income                                                          |       | (9,981,394               | )           | (1,229,824 | ) |
| Total other expense                                                             |       | $                        | (11,310,583 | ) | $ | (2,142,858 | ) |
|                                                                            |       |                     |        |   |   |
| Loss from continuing operations                                                 |       | $                        | (17,221,491 | ) | $ | (5,448,566 | ) |
| Loss from discontinued operations                                               |       | (1,873,381               | )           | (790,424 | ) |
| Net Loss                                                                        |       | $                        | (19,094,872 | ) | $ | (6,238,990 | ) |
|                                                                            |       |                     |        |   |   |
| Basic and diluted loss per share-Continuing  Operations                         |       | $                        | (1.62       | ) | $ | (0.68 | ) |
| Basic and diluted loss per  share-Discontinued Operations                       |       | (0.17                    | )           | (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 |   |

 

16

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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:                      |       |                          |        |   |   |
| 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 |       | 851,882                       |        | 1,726,268 |   |
| Increase in fair value of puttable warrants                                                       |       | 9,987,609                     |        | — |   |
| 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.

 

17

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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 | ) |
|                                                                 |            |                  |            |             |            |                 |            |                  |            |              |            |             |            |  |  |  |  |  |  |

 

18

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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 cardiac tissue ablation and the potential treatment ofatrial fibrillation using a laser device.

 

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.

 

19

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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 beenrecognized in 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 acceptanceprocess.  There are no rights of returnunless the product 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.

 

20

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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-Based Compensation-Transitionand Disclosure, an amendment of FASB Statement No. 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 foreigncurrency translation adjustments and unrealized gains and losses on certainmarketable securities.  For the yearsended April 30, 2005 and 2004, there were no adjustments to net loss toarrive at 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.

 

21

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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 |   |

 

22

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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** | ** ** |
| ** **                        | ** ** | **(Restated)**                         | ** ** | ** ** | ** ** |
| Revenues                          |       | $                                      | 2,304,897  |   | $ | 3,410,975 |   |
|                              |       |                                   |       |   |   |
| Income (Loss) Before Income Taxes |       | $                                      | (1,873,381 | ) | $ | (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 |   |

 

23

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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 and borrowedthe 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 quarterborrowings, the Company issued a warrant to PKM with a ten-year term for thepurchase of 320,178 shares of the Company’s common stock at an exercise priceof $0.70 per share.  The Company alsoissued a warrant to purchase an additional 60,179 shares of the Company’scommon stock on the same terms in conjunction with the final draw on August 20,2003.  As a result of anti-dilutionadjustments through April 30, 2005, these warrants are exercisable for anaggregate of 502,358 shares at $0.53 per share. In connection with this financing, on July 8, 2003, the Companyagreed to extend the term of 700,000 previously issued warrants from five yearsto ten years.  The allocated fair valueof the warrants issued prior to July 31, 2003, and the incremental valueof the existing warrants was $383,361, which was reported as a discount of theterm debt.  This discount, which waspresented as a reduction of the carrying value of the debt on the consolidatedbalance sheet, was being amortized as interest expense over the eleven-monthterm of the debt.  In addition, theCompany incurred direct and incremental costs of $65,000 in completing the debt

 

24

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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 the debt.  In addition, the Company incurred direct andincremental 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 discountsaggregating $391,789 and the fair value of the warrants issued in connectionwith the maturity date extensions, amounting to $844,024, were included in theCompany’s determination of the debt extinguishment loss recorded in the fourthquarter of fiscal year 2004.  The$1,235,813 aggregate loss from these transactions, accounted for as anextinguishment of debt, is included in other expenses, net in the statement ofoperations for the year 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, 

 

25

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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 a ten-yearterm to purchase 34,014 shares of the Company common stock at a per shareexercise price of $1.47.  The warrantcontains anti-dilution provisions.  The allocated fair value of the newlyissued 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, was amortizedas 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.

 

26

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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

 

27

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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 the DakotaElectric 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   |       |
|                                                    |            |           |            |          |            |  |

 

28

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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, representfederal and state amounts of $466,533, with expiration dates in fiscal years2016 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 publicoffering, the Company issued 1,500,000 units at a price of $4.50 per unit forgross proceeds of $6,750,000.  Afteroffering costs, 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 218,461 units at $1.8375per unit.  As a result of anti-dilutionadjustments through April 30, 2005, these warrants are exercisable for 599,137units at $0.67 per unit.

 

29

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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 $1,000 statedvalue 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 of certaindefaults, the preferred shareholders have the right to require the Company toredeem the preferred shares at 110% their stated value, including any accruedbut unpaid dividends.  As a result ofthese redemption provisions, the carrying value of these preferred shares isconsidered to be redeemable and is reported as a “mezzanine” instrument on theCompany’s balance sheet beginning on April 30, 2005.  The aggregate liquidation value of theseredeemable 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 

 

30

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(including the converted debt) hasbeen recognized as other expense of approximately $4,266,047 upon closing.  In prior periods, this charge was reported asinterest expense, but has been reclassified to other expense in these financialstatements, consistent with guidance regarding the presentation of derivatives,as set forth in the December 1, 2005, Current Accounting and DisclosureIssues in the Division of Corporation Finance of the Securities and ExchangeCommission.  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 aggregatepurchase of 3,004,474 shares of common stock under various plans coveringcertain employees, 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 keyemployees.  The foregoing options wereissued outside the Company’s stock option plans.  Such options vest to the extent of 25 percentper year, commencing on the first anniversary of the date of grant.  They are exercisable at $0.89 per share,which was the closing price of the Company’s common stock on the OTC BulletinBoard on April 1, 2005.  Theseoptions expire on April 1, 2012.

 

31

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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 areexercisable at $1.00 per share, which was the closing price of the Company’scommon stock on 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 the yearsended 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.

 

32

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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 to investorsand issued warrants to purchase 190,378 units to an agent and finder involvedin 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, warrants topurchase 2,409,914 common shares during the year ended April 30, 2005 andwarrants 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 cardiac tissue ablation and the potentialtreatment of atrial fibrillation.  TheCompany paid LightWave an initial standstill payment consisting of 15,000shares of the Company’s common stock, $10,000 upon closing and an additional$30,000 to LightWave in installments in 2004 and 2005.  The Company will be obligated to pay $125,000to LightWave within 45 days after the first commercial sale of the Company’sproduct in the United States or Europe to two or more parties and $385,000within 45 days following the Company’s achievement of $1,500,000 of cumulativegross sales of disposable products.  Inaddition, during fiscal year 2004, the Company issued to LightWave a warrantfor the purchase of 25,000 shares of common stock at closing and, during fiscalyear 2005, a warrant for the purchase of 25,000 shares of common stock uponreceiving FDA 510(k) clearance.  Inaddition, the Company is obligated to issue a warrant for the purchase of 25,000shares of common stock upon a receipt of a U.S. utility patent covering theproduct and a warrant for the purchase of 25,000 shares of common stock uponthe first commercial sale of the 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    |   |

 

33

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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 minimum paymentsdue 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 $182,000, 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 additional severance costs of approximately $46,000,of which $20,000 is included in general and administrative expenses and $26,000(restated) is included in discontinued operations.  In the quarter ended January 31, 2005,the Company terminated an additional eleven employees resulting inapproximately $48,000 of severance costs, of which $16,000 is included ingeneral and administrative expenses and $32,000 (restated) is included indiscontinued operations.  During thequarter ended April 30, 2005, the Company terminated two additional employeesresulting in approximately $32,000 of severance costs charged to general andadministrative expenses.  The Company paidall these severance amounts due to these former employees by September 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     |   |

 

34

----

 

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.

 

16.           Restatement ofFinancial Statements

 

The Company has restated its financialstatements for the fiscal year ended April 30, 2005, to correct theclassification of certain sales and marketing expenses and certain general andadministrative expenses from continuing operations to discontinued operations.  The costs for which the classification hasbeen corrected are related directly to the Company’s discontinued heart valvebusiness (see Note 4).  The Company hasmade the appropriate modifications to the statement of operations to giveeffect to the correction in classification of $729,415 of sales and marketingexpenses and $57,617 of general and administrative expenses to discontinuedoperations.

 

The changes in classifications described above had no effect on theCompany’s net loss or net loss per share, nor any effect on the Company’sbalance sheet, statement of changes in shareholders’ equity (deficit) orstatement of cash flows.  The table belowpresents the effect of these changes in classifications.

 
| ** **                                                           | ** ** | **As Previously  Reported** | ** **  | **As Restated** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------|-------------|----------------------|------------|
| Operating expenses, continuing operations:                           |       |                             |        |                 |       |
| Sales and marketing                                                  |       | $                                | 1,109,801   |                 | $          | 317,386 |   |
| General and administrative                                           |       | 4,070,123                        |        | 4,012,506            |       |
| Engineering and regulatory                                           |       | 1,581,016                        |        | 1,581,016            |       |
| Total operating expenses                                             |       | 6,760,940                        |        | 5,910,908            |       |
| Loss from operations                                                 |       | (6,760,940                       | )           | (5,910,908           | )          |
| Other (expense) income:                                              |       |                             |        |                 |       |
| Interest expense                                                     |       | (1,352,183                       | )           | (1,352,183           | )          |
| Interest income                                                      |       | 22,994                           |        | 22,994               |       |
| Other (expense) income                                               |       | (9,981,394                       | )           | (9,981,394           | )          |
| Total other expense                                                  |       | (11,310,583                      | )           | (11,310,583          | )          |
|                                                                 |       |                             |        |                 |       |
| Loss from continuing operations                                      |       | (18,071,523                      | )           | (17,221,491          | )          |
| Loss from discontinued operations                                    |       | (1,023,349                       | )           | (1,873,381           | )          |
| Net loss                                                             |       | $                                | (19,094,872 | )                    | $          | (19,094,872 | ) |
|                                                                 |       |                             |        |                 |       |
| Basic and diluted net loss per share –  Continuing Operations   |       | $                                | (1.70       | )                    | $          | (1.62 | ) |
| Basic and diluted net loss per share –  Discontinued Operations |       | (.09                             | )           | (.17                 | )          |
| Basic and diluted net loss per share                                 |       | $                                | (1.79       | )                    | $          | (1.79 | ) |

 

35

----

 

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

 

**Restatementof Previously Issued Financial Statements**

 

As describedin Note 16 to the financial statements, we identified errors in thepresentation of our previously issued statements of operations.  As a result of these errors, we have restatedour financial statements for the the quarter ended October 31, 2004 and theyear ended April 30, 2005.  

 

**Evaluationof Disclosure Controls and Procedures**

 

We maintaindisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934, as amended (the "ExchangeAct")) that are designed to ensure that information required to bedisclosed by us in the reports we file or submit under the Exchange Act isrecorded, processed, summarized, and reported, within the time periods specifiedin the Securities and Exchange Commission’s rules and forms and that suchinformation is accumulated and communicated to our management, including ourprincipal executive officer and principal financial officer, to allow timelydecisions regarding required disclosure. 

 

Ourmanagement, with the participation of our Chief Executive Officer and ChiefFinancial Officer, evaluated the effectiveness of our company's disclosurecontrols and procedures as of the end of the period covered in this AnnualReport on Form 10-KSB/A. Based on this evaluation and because of the materialweakness described below, our Chief Executive Officer and Chief FinancialOfficer have concluded that our disclosure controls and procedures were noteffective as of the end of the period covered in this Annual Report on Form10-KSB/A.  To address the materialweakness described below, we have expanded our disclosure controls andprocedures to include additional analysis and other procedures over the preparationof the financial statements included in this report.  Accordingly, our management has concludedthat the financial statements included in this report fairly present in allmaterial respects our financial position, results of operations and cash flowsfor the periods presented in conformity with generally accepted accountingprinciples. 

 

**MaterialWeakness in Internal Control Over Financial Reporting**

 

A materialweakness is a control deficiency or a combination of control deficiencies thatresult in more than a remote likelihood that a material misstatement of theannual or interim financial statements will not be prevented or detected.  Our management has concluded that, as ofApril 30, 2005, we did not maintain effective controls over the preparation,review, presentation and disclosure of our statement of operations.  Specifically, our controls did not prevent ordetect the incorrect presentation of certain expenses as part of continuingoperations rather than as part of discontinued operations, in accordance withgenerally accepted accounting principles. This control deficiency resulted in the restatement of our financialstatements for the quarter ended October 31, 2004 and the year ended April 30,2005.  Additionally, this controldeficiency could result in a misstatement of the presentation and disclosure ofour statement of operations that would result in a material misstatement in ourannual or interim financial statements that would not be prevented ordetected.  Accordingly, managementdetermined that this control deficiency constitutes a material weakness in ourinternal control over financial reporting as of April 30, 2005.

 

**Changes inInternal Control Over Financial Reporting**

 

There was nochange in our internal control over financial reporting that occurred duringour quarter ended April 30, 2005 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

**Plan forRemediation of Material Weakness**

 

We havedeveloped a plan to address this material weakness that includes addingadditional professional accounting personnel. On an interim basis, we engaged a senior financial consultant inFebruary 2006 to provide an immediate expansion in our technical finance andaccounting resources.  This individualwill be retained until additional accounting personnel have been employed.  We will continue to assess the adequacy andappropriateness of our financial staff and adjust accordingly as changes in ourbusiness warrant.  Management believesthat our plan to address this material weakness, when fully implemented, willremediate this material weakness. Although we are not certain when the material weakness will beremediated, we will need a period of time over which to demonstrate that thesecontrols are functioning appropriately to conclude that we have adequatelyremediated the material weakness.

 

36

----

 

**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 March 17,2006.

 
|   | 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)   |       | March 17, 2006 |
| Marc P. Flores         |       |                                     |       |           |
|                   |       |                                     |       |           |
|                   |       | Vice President, Finance and Chief        |       |           |
| /s/ John H. Jungbauer  |       | Financial Officer (Principal Accounting  |       |           |
| John H. Jungbauer      |       | Officer and Principal Financial Officer) |       | March 17, 2006 |
|                   |       |                                     |       |           |
|                   |       |                                     |       |           |
|                   |       | 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 |   |   |   | March 17, 2006 |
|--------|--------|-----------------------|--------|--------|--------|----------------|
|   |   | John H. Jungbauer     |   |   |   |           |
|   |   | Attorney-in-fact      |   |   |   |           |

 

37

----

 

**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,                                                                                   |

 

38

----

 
|   |   | 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)).                                                                          |

 

39

----

 
| 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                                                                                                                                                                                                                                                                                                              |

 

40

----

 
|     |   | 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 Exchange Act Rule 13a-14(a).                                                                                                                                                                                                     |
| 31.2     |   | Chief Financial Officer Certification  pursuant to Exchange Act Rule 13a-14(a).                                                                                                                                                                                                     |
| 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.                                                                                                                                                                                                          |

 

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