**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-KSB**

 
| **ý** | **ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934****FOR THE  FISCAL YEAR ENDED APRIL 30, 2003** |
|------------|----------------------------------------------------------------------------------------------------------------------------------|

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

 

**Commission File Number 000-33295**

 
| **MedicalCV, Inc.**                                                                                                                                                                                                                              |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (Name of Small Business Issuer 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, including Zip Code)                                                                                                                                                                                     |
|                                                                                                                                                                                                                                             |   |   |
| **(651) 452-3000**                                                                                                                                                                                                                               |
| (Issuer’s Telephone Number, including Area Code)                                                                                                                                                                                            |
|                                                                                                                                                                                                                                             |   |   |
| Securities registered pursuant to Section 12(b) of the Exchange Act:                                                                                                                                                                             |
| **None**                                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                                             |
| Securities registered pursuant to Section 12(g) of the Exchange Act:                                                                                                                                                                             |
| **Units  (each consisting of one share of Common Stock, $0.01 par value, and one  redeemable Class A Warrant  to purchase one share of Common Stock), Common Stock ($0.01 par value) and  redeemable Class A Warrants to purchase Common Stock** |
| (Title of Class)                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                  |  |  |  |  |

 

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

 

Theissuer’s revenues for its most recent fiscal year were $3,135,041.

 

Theaggregate market value of the common equity held by non-affiliates of theissuer as of July 15,2003, was approximately $8,132,706,based upon the sale price of one unit on such date.

 

Asof July 15, 2003 the issuer had outstanding 7,843,834 shares of commonstock.  This number includes 1,500,000units, each consisting of one share of common stock and one redeemable Class AWarrant sold in the issuer’s initial public offering.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Information required byPart III of this document is incorporated by reference to specified portions ofthe registrant’s definitive proxy statement for the 2003 Annual Meeting ofShareholders.

 

 

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**TABLEOF CONTENTS**

 
| PART I            |    |
|-------------------|---------|
|              |    |   |
|              | ITEM 1  | Description  of Business |
|              |    |   |
|              | ITEM 2  | Description  of Property |
|              |    |   |
|              | ITEM 3  | Legal  Proceedings |
|              |    |   |
|              | ITEM  4 | Submission  of Matters to a Vote of Security Holders |
|              |    |   |
| PART II           |    |
|              |    |   |
|              | ITEM  5 | Market  for Common Equity and Related Shareholder Matters |
|              |    |   |
|              | ITEM  6 | Management’s  Discussion and Analysis or Plan of Operation |
|              |    |   |
|              | ITEM 7  | Financial  Statements |
|              |    |   |
|              | ITEM 8  | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure |
|              |    |   |
| PART III          |    |
|              |    |   |
|              | ITEM 9  | Directors and Executive Officers of the  Registrant |
|              |    |   |
|              | ITEM 10 | Executive Compensation |
|              |    |   |
|              | ITEM 11 | Security Ownership of Certain Beneficial Owners  and Management and Related Shareholder Matters |
|              |    |   |
|              | ITEM 12 | Certain Relationships and Related Transactions |
|              |    |   |
|              | ITEM 13 | Exhibits, List and Reports on Form 8-K |
|              |    |   |
|              | ITEM 14 | Controls and Procedures |
|              |    |   |
| SIGNATURES        |
|              |    |   |
| INDEX TO EXHIBITS |
|                   |         |  |  |

 

*All references in this report to our experience in thedevelopment, manufacture and marketing of mechanical heart valves, as well asthe number of worldwide implants of heart valves, include the prior operationsof Medical Incorporated, incorporated in 1971, and its successor organization,Omnicor, Inc., incorporated in 1989, the assets of which we acquired in 1992.*

 

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

 

*Our actual results, performance orachievements could differ materially from those expressed in, or implied by,forward-looking statements. Accordingly, we cannot be certain that any of the events anticipated byforward-looking statements will occur or, if any of them do occur, what impactthey will have on us.  We caution you tokeep in mind the cautions and risks described in our Cautionary Statement andto refrain from attributing undue certainty to any forward-looking statements,which speak only as of the date of the document in which they appear.*

 

**PART I**

 

**ITEM1****                                        DESCRIPTION OF BUSINESS**

 

**Overview**

 

We are a cardiothoracicsurgery device company.  Our primarybusiness is the manufacture and marketing of mechanical heart valves known asthe Omnicarbon® Series 3000 and Series 4000. Our Omnicarbon heart valves are used to treat heart valve failure causedby heart disease, natural aging, prosthetic heart valve failure and congenitaldefects.

 

We have beenmanufacturing and marketing Omnicarbon heart valves since 1984.  Approximately 35,000 Omnicarbon heart valveshave been implanted worldwide.  Oursales of heart valves have been primarily to customers in Europe, South Asia,the Middle East and the Far East. Although we derived 62 percent of our net salesin fiscal year 2003 from Europe, we have established a U.S. sales organization,consisting primarily of independent sales representatives who are experiencedin marketing products to cardiothoracic surgeons, and we commenced marketingthe Omnicarbon 3000 heart valve in the U.S. in late January 2002.

 

In order to reduce our dependenceon sales of heart valves, we have developed a strategy to broaden our productofferings to the cardiothoracic surgeon by developing, acquiring and licensingadditional technologies.  Over the lastfiscal year, we acquired a new annuloplasty technology for the repair of themitral valve and we licensed an internal mammary artery (“IMA”) retractor toprovide better exposure of such artery with reduced trauma to the ribs.  We introduced the IMA AccessTMRetractor in December 2002 and expect to introduce the annuloplasty system,following receipt of necessary regulatory approvals, in fiscal year 2004.

 

Our efforts to penetratethe U.S. heart valve market, build our U.S. sales organization and improve ourEuropean distribution capabilities have required a significant investment andconsumed most of the net proceeds from our initial public offering.  To improve our capital structure and provideworking capital for operations, we recently completed several transactions withPKM Properties, LLC (“PKM”), an entity controlled by Paul K. Miller, one of ourdirectors and our largest beneficial owner of securities, and Peter L. Hauser,who following the transaction in which he participated became the beneficial ownerof approximately 10.3% of our securities . In January 2003, we established a discretionary line of credit withPKM.  As of April 30, 2003, we hadborrowed $943,333 under this line of credit. This line of credit, which currently requires the payment of interest ata rate of 7 percent per year, matures on September 17, 2003, and is secured bysubstantially all of our assets.  InApril 2003, we also completed a refinancing transaction in which our corporateheadquarters, manufacturing facility and surrounding land were sold to PKM in asale-leaseback transaction. Simultaneous with the sale, we entered into a lease with PKM to leaseback the facility and a portion of the land. In July 2003, we established a one-year $1.0 million discretionary lineof credit with PKM.  This line ofcredit, which currently requires the payment of interest at a rate of 10percent per year, matures on May 27, 2004, and is secured by substantially allof our assets.  In a simultaneoustransaction, we entered into a loan agreement and borrowed $1.0 millionfrom Peter L. Hauser pursuant to a one-year subordinated note with aninterest rate of 10 percent per year. Pursuant to an intercreditor agreement with PKM, the loan is secured by substantiallyall of our assets.  For more informationon these transactions, please review “Management’s Discussion and Analysis orPlan of Operation – Liquidity and Capital Resources.”

 

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Criticalto our success will be:

 

•                                          obtainingsufficient capital to fund operations and working capital requirements;

 

•                                          gainingphysician acceptance of our core products and new products;

 

•                                          developingand managing our U.S. and global distribution capability;

 

•                                          developingrelationships with cardiothoracic surgeons to create awareness of and demandfor our products on a worldwide basis;

 

•                                          capitalizingon the low rate of design-related complications of the Omnicarbon heart valve;

 

•                                          capitalizingon our experience of 33 years and our heart valve quality record, with nodesign failures or product recalls; and

 

•                                          developing,acquiring and licensing new technologies for products targeted to thecardiothoracic surgeon.

 

For more informationregarding the risks to which we are subject, please review "Management'sDiscussion and Analysis or Plan of Operation – Cautionary Statement."

 

Between 1978 and 2000, wemanufactured and marketed the Omniscience heart valve, predecessor to theOmnicarbon heart valve.  Approximately50,000 Omniscience heart valves have been implanted since the late 1970s.  Beginning in the early 1970s through 1987,we manufactured and sold the Lillehei-Kaster heart valve, one of the firstheart valves sold, which we licensed from the University of Minnesota.  There have been approximately 55,000 implantationsof the Lillehei-Kaster heart valve worldwide. In total, we have 33 years of experience in developing, manufacturingand marketing heart valves, and we have sold more than 140,000 heart valvesworldwide.

 

Ourcompany was incorporated in Minnesota on March 30, 1992, under the name CV Dynamics, Inc.  In April 1992, we acquired all of thetangible and intangible assets of Omnicor, Inc.  Omnicor resulted from the corporate and financial restructuring ofa predecessor company called Medical Incorporated, which was organized in 1971 to develop andmarket the Lillehei-Kaster heart valve,licensed from the University of Minnesota.  Our company changed its name to MedicalCV,Inc. in February 2000.

 

**IndustryBackground**

 

There are two types ofprosthetic heart valves:  mechanical andbiological tissue.  The primaryadvantage of mechanical heart valves is durability because such devices aremade from low-wear metal and carbon materials. They generally outlast the patient’s lifetime.  However, in order to prevent the formation of blood clots,mechanical heart valves require the continuous use of blood thinners.  Biological tissue heart valves are valvesmade from animal or cadaver tissue or, in some cases, the patient’s own tissue.  Tissue heart valves generally have lowerdurability but also a lower risk of blood clotting compared to mechanical heartvalves.  If a tissue heart valve failsdue to deterioration or calcification, for example, a new heart valve must beimplanted, requiring additional open heart surgery.  Tissue heart valves are generally prescribed for patients who areless tolerant to blood thinners, such as patients with gastrointestinal ulcersor liver dysfunction, elderly patients, women in child-bearing years and veryactive people.

 

Cardiovascular surgeonsgenerally choose a particular type of mechanical heart valve based upon anumber of factors.  A principal factoris the potential formation of blood clots resulting from the poor flow of bloodon certain areas of the heart valve.  Aclot forming on the heart valve, known as valve thrombosis, can impair theperformance of the heart valve.  If aclot detaches itself and moves through the bloodstream, it can result inarterial blockage, known as thromboembolism, or stroke.  To minimize thromboembolism, a mechanicalheart valve implant patient is given doses of blood thinners, which mayincrease the risk of bleeding and other complications.  In addition, mechanical heart valves maycause varying degrees of red blood cell destruction, known as hemolysis, whichis tolerable by a majority of patients. Another factor is the performance and efficiency of the heart valve interms of loss of cardiac energy or “cardiac work” required to move bloodthrough the heart valve orifice.  Lowercomplication rates translate into better quality of life for the patient andreduced medical treatment costs.

 

Hospitals and clinicadministrators have been increasingly influential in medical device purchasingdecisions due to the increasing emphasis on medical cost containment.  The price of a mechanical heart valve andthe costs resulting from the treatment of complications affect costeffectiveness.

 

Our Omnicarbon heartvalves are designed to replace heart valves that have been made defective bydisease or congenital origin. Cardiovascular disease is one of the most prevalent diseases in theworld and is a leading cause of death in humans.  The aging population in most developed countries will fuel themarket for cardiovascular implants. Developing countries and eastern European countries are expected toincrease spending on health care and may increase their consumption ofmechanical heart valves due to the prevalence of rheumatic fever and otherdiseases.  These global markets for cardiovasculardevices are characterized by large multinational manufacturers and industryconsolidation.  Among the major

 

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product segments are pace makers, heart valves, angioplasty productsand coronary stents.  A number of themajor manufacturers, such as Medtronic and St. Jude, have medical device lineswhich include all or most of these products.

 

The bileaflet mechanicalheart valve, a valve with two moving leaflets which allow the blood to flow inone direction, is the world’s most frequently implanted prosthetic heart valveand accounts for most heart valve sales in the worldwide heart valvereplacement market.  The bileafletmechanical heart valve manufactured by St. Jude has been implanted in over onemillion patients to date, according to the manufacturer.  Despite a clear market preference forbileaflet mechanical heart valves, we believe that we will be able to increaseour market position with our Omnicarbon heart valves.  Omnicarbon heart valves are the only all-carbon monoleaflet mechanicalheart valves.  A monoleaflet valve hasone moving leaflet which allows the blood to flow in one direction.  In clinical studies conducted in Europe,Canada and Japan, the Omnicarbon design has consistently demonstrated lowerrates of thromboembolism, valve thrombosis, blood thinner-related bleeding andhemolysis than the two market leaders.

 

Potential complicationsor side effects with all mechanical heart valve implants include, but are notlimited to:

 

•                                          thromboembolismand valve thrombosis, resulting in minor stroke;

 

•                                          hemorrhage;

 

•                                          deteriorationof suture attachments of heart valve to surrounding tissue;

 

•                                          tissueinterference with heart valve function; and

 

•                                          mechanicalfailure of the heart valve.

 

**OurMarket Opportunity**

 

We believe that the significantlylow complication rates of our Omnicarbon heart valves and our experience in theheart valve field will enable us to build market share in the U.S., to increasemarket share internationally and to introduce additional products targeted tothe cardiothoracic surgery market.  Ourstrategy is to create awareness of our products and their advantages amongcardiovascular surgeons, organizations that make purchasing decisions formedical devices and third party payers who pay for such treatment.  To communicate with these groups, we areusing our own corporate marketing personnel, sales managers, independent salesrepresentatives and clinical advisory board members.  In addition, we support clinical studies, utilizestate-of-the-art marketing materials, exhibit our products at majorcardiovascular meetings, strategically advertise in the major cardiovascularjournals, host a dual physician and patient enhanced website and encourageinterested surgeons to visit our facility and attend in-house presentations.

 

**ProductDescription**

 

Our Omnicarbon all-carbonmonoleaflet mechanical heart valves consist of a rotatable housing ring withina compliant suture ring, which adapts to the native annulus or natural valverim, and a curved, freely rotating disc, which is retained by two shieldsextending from the ring.  The disc pivotaxis forms two orifices, one larger than the other, with a maximum openingangle of 80 degrees.  The example shownbelow is larger than actual size.

 

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The housing and disc ofthe Omnicarbon 3000 and 4000 heart valves are made of pyrolytic carbon, whichoffers blood compatibility and durability. Pyrolytic carbon components represent the largest portion of our productioncosts.  In 1999, we began manufacturingOmnicarbon heart valves utilizing our own proprietary pyrolytic carbon coatingprocess.  These heart valves, known asOmnicarbon 4000 heart valves, represent the heart valves we currently sell inmarkets other than the U.S. and Japan.

 

At this time, we do nothave clearance from the FDA to manufacture Omnicarbon 4000 heart valves forsale in the U.S.; therefore, we use pyrolytic carbon components purchased fromSnia S.p.A. Carbomedics.  These heartvalves, known as Omnicarbon 3000 heart valves, represent the heart valves wesell in the U.S. and Japan.

 

We are conducting testingand preparing a premarket approval submission for FDA clearance of ourpyrolytic carbon process in order to manufacture carbon components for the saleof Omnicarbon 4000 heart valves in the U.S. We believe that we can obtain that approval from the FDA for ourpyrolytic carbon process by late calendar year 2004.  We further believe that approval of our pyrolytic carbon coatingprocess will enable us to substantially decrease the manufacturing cost ofOmnicarbon heart valves sold in the U.S., thereby improving our grossmargins.  If we receive such clearance,we plan to discontinue our Omnicarbon 3000 heart valves and begin sellingOmnicarbon 4000 heart valves in the U.S. We cannot assure you, however, as to when or whether we will receive FDAclearance.

 

**Marketingand Sales**

 

Oursales and marketing plan focuses on:

 

•                                          creatingwidespread awareness of and demand for our Omnicarbon heart valves amongcardiovascular surgeons, cardiologists and medical treatment organizations thatmake medical device purchasing decisions;

 

•                                          capitalizingon our quality record, with over 140,000 of our heart valves having beenimplanted over the last 33 years without design failure or product recall;

 

•                                          creatingawareness of the superior clinical performance of our Omnicarbon heart valves,including lower complication rates of thromboembolism, bleeding and hemolysiscompared to other mechanical heart valves, including those of the two marketleaders;

 

•                                          offeringquality service, rapid product delivery and competitive pricing;

 

•                                          capitalizingon trends that influence the worldwide cardiovascular market, such as theincreased number of cardiovascular surgical procedures due to the aging populationand increases in health care spending in developing countries and easternEurope; and

 

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•                                          expanding ourproduct offering for the cardiothoracic surgeon, including new products as wellas product improvements to our current heart valve line.

 

Our goal is to reachcardiothoracic surgeons, organizations that make purchasing decisions withregard to medical devices and third party payers who pay for such treatment tomake them aware of the advantages of our product.  To reach these groups, we are using our corporate marketing andtechnical personnel, sales managers, sales representatives and clinicaladvisory board members.  In addition,we:

 

•                                          supportvarious clinical studies;

 

•                                          utilizestate-of-the-art marketing materials;

 

•                                          exhibit ourproducts at major cardiovascular meetings;

 

•                                          strategicallyadvertise in the major cardiovascular journals;

 

•                                          host awebsite targeting both physicians and patients; and

 

•                                          encouragefacility visits by surgeons using or interested in our products.

 

*UnitedStates.*  As of April30, 2003, our U.S. sales team consisted of our senior vice president — salesand marketing, a director of sales,a field sales manager, a direct sales representative and over 20independent sales representatives located throughout the U.S., who areexperienced in marketing medical devices to cardiothoracic surgeons.  We provide to our sales representativestraining programs, marketing aides, educational materials for the medicalcommunity and sales literature.  We arecommitting substantial resources to train, support and motivate our U.S. salesteam to introduce the Omnicarbon heart valve and advance sales of Omnicarbon3000 heart valves in the U.S.

 

*International*.  We market and sell our products primarily inEurope, South Asia, the Middle East and the Far East.  As of April 30, 2003, we had a network of over 35 independent distributors sellingOmnicarbon Series 3000 and Series4000 heart valves in these geographic areas. At April 30, 2003, approximately 38 percent of our accounts receivable were duefrom one international distributor, Mercé V. Electromedicina, S.L., anaffiliate of our company.  We generallyrequire no collateral from our customers with respect to trade accountsreceivable.  We maintain an allowancefor doubtful accounts based upon our historical experience and the expectedcollectibility of all accounts receivable. For more information on these matters, please review Note 13 to ourConsolidated Financial Statements.

 

Our customary businesspractice is to enter into three-year exclusive distributor contracts with newdistributors, which are linked to annual minimum sales goals.  In addition, our distributors are requiredto attend annual training meetings to ensure competency in heart valve surgery,to promote the Omnicarbon heart valve at local medical meetings and to call onprospective customers on a regular basis.

 

**Manufacturingand Supply**

 

We manufacture andassemble Omnicarbon heart valves and other products at our facility in InverGrove Heights, Minnesota.  Wemanufacture our Omnicarbon 4000 heart valve in its entirety, utilizing ourproprietary pyrolytic carbon process. We assemble our Omnicarbon 3000 heart valve using our own proprietarysuture ring and pyrolytic carbon components purchased from Snia S.p.A.Carbomedics.

 

Pyrolytic carbon has beenused in mechanical heart valves for approximately 30 years.  Pyrolytic carbon coating on such componentsas heart valve housings and heart valve leaflets is formed by the pyrolysis ofcarbon.  We began to develop our ownpyrolytic carbon coating process in 1995. Our process involves heating propane to a high temperature, which breaksit down into hydrogen and carbon.  Thehydrogen is then vented and the carbon atoms are deposited on the surface ofgraphite substrate shaped as a disc or housing ring.  Pyrolytic carbon coating has greater blood compatibility comparedto other materials historically used in heart valves, resulting in a lower incidenceof thromboembolism and other potential complications.  Pyrolytic carbon components have been tested to last longer thanany patient’s lifetime.  We alsomanufacture knitted, seamless Teflon tubings which are used in constructingsuture rings to correspond with various heart valve sizes.  We have developed and instituted a complete,vertically integrated manufacturing and quality control system for ourOmnicarbon 4000 heart valves.  Thepyrolytic carbon components we purchase from Snia S.p.A. Carbomedics for ourOmnicarbon 3000 heart valves are tested under the same rigorous requirements asour Omnicarbon 4000 heart valves.

 

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We ship all of ourproducts from our facility in Inver Grove Heights, Minnesota, either todistributors or directly to hospitals. We generally do not have a significant backlog of orders and maintain asufficient inventory of products which enables us to ship within 24 to 48 hoursof receipt of orders.

 

We assemble ourOmnicarbon 3000 and 4000 heart valves in a controlled clean room environment inour facility, where we fabricate the sewing cuff, conduct final cleaning andinspection and package the finished heart valves.  The packaged heart valves are then sterilized and quarantined.  They must pass sterility tests before beingreleased for shipping.** **We believe that our manufacturingfacilities meet applicable standards for “good manufacturing practices”established by the FDA and other applicable government standards.  In the normal course, our facility is frequentlysubject to inspections by the FDA and foreign regulatory agencies in connectionwith their reviews of our products.

 

We believe that the rawmaterials and components used in manufacturing our Omnicarbon 4000 heart valvesare readily available.  However, we purchasethe pyrolytic carbon parts for our Omnicarbon 3000 heart valves only from SniaS.p.A. Carbomedics, a supplier whose materials and manufacturing meet FDAregulations for inclusion in our medical devices.  We purchase these components under an original equipmentmanufacturing supply contract which expires in December 2003.  Under this contract, we are obligated topurchase minimum quantities of our carbon-coated components exclusively fromSnia S.p.A. Carbomedics during the term of the agreement.  These components are manufactured pursuantto our specifications.  Snia S.p.A.Carbomedics has agreed to supply our requirements and, to date, we have notexperienced shortages or significant delays in their supply of components.  Snia S.p.A. Carbomedics may terminate thiscontract if we fail to make any payment promptly when due, or if we infringeany patent of Snia S.p.A. Carbomedics by making or having made any product orusing any method covered by such patent in or in preparation for commercialsale of cardiac valve prostheses, or if we are in default of any of ourmaterial obligations under this contract. We currently depend upon Snia S.p.A. Carbomedics for these criticalcomponents and have no other supplier of pyrolytic carbon parts for ourOmnicarbon 3000 heart valves.  Althoughwe cannot be assured of continued supplies on reasonable terms, we are in theprocess of renegotiating the terms of our supply agreement with Snia S.p.A.Carbomedics.

 

**ProductDevelopment and Research**

 

We are expanding our lineof cardiothoracic surgery products by developing, acquiring and licensing newproducts that can be marketed to cardiothoracic surgeons.

 

*Annuloplasty System.*  In August 2002, we acquired from Segmed,Inc., a new annuloplasty technology known as the Northrup Universal Heart ValveRepair SystemTM for the repair of the mitral valve.  The product is scheduled for introduction during fiscal year2004, enabling us to enter the heart valve repair market.  Introduction of this product will requireapproval of the FDA and certain foreign regulatory authorities.

 

*IMA Access Retractor.*  In September 2002, we licensed the IMAAccessTM Retractor.  This product isdesigned to provide better exposure of the internal mammary artery during takedown for coronary artery bypass, with reduced trauma to the ribs.  We introduced this product in our markets,following the completion of product development, in December 2002.

 

*Novadynebileaflet heart valve development project*.  Althoughwe believe, and the scientific literature supports, that themarket preference for bileaflet designs is not scientifically justified, weundertook certain product development efforts towards developing a bileafletheart valve.  Due to increased marketacceptance of the Omnicarbon valve and the high costs of research and development,we have suspended development of this product.

 

*Bloodfilters*.  We have thetechnology base and manufacturing capability to produce a broad line oftransfusion and extra-corporeal blood filters, but current sales of thisproduct are immaterial,and are not considered part of our core strategy.

 

Ourresearch and development expenses principally consist of engineering costs.  Our research and development expenses were$558,141 in fiscal year 2003, compared to $491,278 in fiscal year 2002.  Research and development costs relateprimarily to product and process development initiatives.  We anticipate that research anddevelopment and clinical and regulatory expenses will continue to rise infuture periods.

 

**Patentsand Proprietary Rights**

 

We believe strongly inprotecting our intellectual property and will seek patent protection for newproducts and processes under development whenever we believe it isadvisable.  As of April 30, 2003, we hadthree U.S. patents, all relating to our bileaflet heart valve underdevelopment.** **We also have twopending foreign patent applications.  Wehave filed U.S. and foreign patent applications for the process and processingequipment used in our pyrolytic carbon coating process and are

 

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awaiting further patent prosecution in relation to these applications. ** **Ourcurrent patents will begin to expire in 2015. We cannot assure you that any patents held by us will be valid,enforceable or otherwise of value to us in relation to our competitors or themarket in general, or that any patent for which we have applied or may applywill be granted.

 

We have no patentscovering the design of our Omnicarbon heart valves and we do not intend to seeksuch patents.  Because heart valves of thisdesign have been sold in the marketplace for many years, the product is nolonger patentable.  We do not believethat protecting the design of a heart valve is critical for the success of aheart valve manufacturer.  We believethat the key to success lies in a vertically integrated infrastructure, thesoundness of design, clinical safety and efficacy of performance of the heartvalve and the manufacturer’s ability to successfully build product awareness.

 

We also rely upon tradesecrets and proprietary know-how.  Werequire our technical employees and consultants to agree in writing to keep ourproprietary information confidential and, with certain limitations, to assignall inventions relating to our business to us.

 

We have used, andtherefore claim common law rights in, the following trademarks: * GlideThru,UltraPure,* and *UPP Carbon*.  We also have a federal registration for themarks: *MedicalCV and Omnicarbon*.

 

**GovernmentRegulation**

 

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

 

Afterpremarket approval is received, the FDA may require testing and surveillanceprograms to monitor the effectiveness of approved products which have beencommercialized.  It has the power toprevent or limit further marketing of a product based on the results of suchpost-marketing programs.  In addition,the FDA may, at any time after the approval of a premarket approvalapplication, conduct periodic inspections to determine compliance with goodmanufacturing practice regulations and current medical device reportingregulations.  If the FDA concludes thatwe are not in compliance with applicable laws or regulations, it can instituteproceedings to:

 

•                                          seize ourproduct;

 

•                                          issue aproduct recall;

 

•                                          imposeoperating restrictions; and/or

 

•                                          assess civilpenalties or recommend criminal prosecution.

 

The FDA also regulates recordkeepingfor medical devices and reviews hospital and manufacturers’ required reports ofadverse experiences to identify potential problems with FDA-authorized devices.

 

Someof the products that we intend to develop and market can be cleared under Section510(k) of the Federal Food, Drug and Cosmetic Act.  The process of obtaining Section 510(k) clearance typicallyrequires less time and expense than the premarket approval process.  Section 510(k) clearance normally takes fromsix months to one year, but can take years, and generally requires thesubmission of supporting data, which in some cases can be extensive.  In addition, the FDA may require review byan advisory panel as a condition for Section 510(k) clearance.  We intend to continue to rely on the Section510(k) process with regard to certain products, such as the annuloplastysystem.  However, we may develop andproduce enhancements to our heart valves and annuloplasty product that willrequire clearance under the FDA’s lengthier and expensive premarket approvalprocess, which can take a number of years and can require extensive supportingdocumentation.  If we encounterdifficulties in the premarket approval process, the commercial marketing of afuture product could be substantially delayed or prevented.

 

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Internationalsales of our products are also subject to extensive regulation.  Foreign regulatory bodies haveestablished varying regulations governing product standards, packagingrequirements, labeling requirements, import restrictions, tariff regulations,duties and tax requirements.  Generally, the extent and complexity of theregulation of medical devices is increasing worldwide, with regulations in somecountries already nearly as extensive as those in the U.S.  This trend may continue, and the cost andtime required to obtain marketing approval in any given country thus mayincrease.  We cannot assure you that anyforeign approvals will be allowed on a timely basis, or at all.

 

Tomarket our products in countries of the European Union, we are required toobtain CE mark certification.  CE markcertification is the international symbol of adherence to certain qualityassurance standards and compliance with European medical device directives.  In June 1995, we received ISO 9001 and EN46001 qualification of our quality system for our manufacturing processes inour facility in Inver Grove Heights, Minnesota.  We obtained the CE mark for our Omnicarbon 3000 heart valve onJune 27, 1995, for our Omniscience heart valve on July 15, 1998, and for ourOmnicarbon 4000 heart valve on April 8, 1999.

 

We derive the greatmajority of our revenues from sales of Omnicarbon heart valves outside theU.S.  Our inability, or the failure ofour foreign distributors, to comply with varying foreign regulations or theimposition of new regulations could restrict the sale of our productsinternationally and thereby materially adversely affect our business, financialcondition, operating results and cash flows.

 

**Competition**

 

The mechanical heartvalve market is highly competitive, with St. Jude supplying the majority ofmechanical heart valves sold worldwide. Other competitors in the mechanical heart valve field include SniaS.p.A. Carbomedics, Edwards Life Sciences, Medtronic, Sorin Biomedica spa inItaly, ATS Medical, Inc. and MCRI, Inc. Many of these competitors have:

 

•                                          greater nameand product recognition;

 

•                                          greater financial, manufacturing andmarketing resources;

 

•                                          greaterregulatory compliance capabilities;

 

•                                          strongerphysician relationships; and

 

•                                          broader andmore established product lines than we have.

 

Most of these competitorsmarket bileaflet heart valves, for which there is currently a dominant marketpreference.  Some of these competitorsalso market tissue heart valves and are currently pursuing new mechanical heartvalve designs, biocompatible coatings for mechanical heart valves, longerlasting tissue heart valves and surgical alternatives to implanting prostheticheart valves.  It is possible thatdevelopments by our competitors could render our current or proposed heartvalves obsolete.  We cannot assure youthat we will be able to compete against such competitors.

 

**ProductLiability and Insurance**

 

The development and saleof medical devices entails significant risk of product liability claims and,sometimes, product failure claims. Although approximately 35,000 of our Omnicarbon heart valves have beenimplanted with no design failures, and although there is significant clinicaldata to reasonably convince us that these products are safe and effective, weface an inherent business risk of financial exposure to product liabilityclaims if the use of our products results in personal injury or death.  We also face the possibility that defects inthe design or the manufacturing of our products could necessitate a productrecall.  We have not, to date,experienced significant product liability claims, and we have never had aproduct recall.  We cannot assure you,however, that we will not experience losses in the future due to productliability claims or recalls.

 

We currently maintainproduct liability insurance with coverage limits of $5,000,000 in the aggregateannually.  We cannot assure you thatsuch coverage limits will be adequate. In addition, trends regarding claims and damages in the medical deviceindustry could increase the cost of insurance, which is already expensive, andmay make insurance coverage difficult for us to obtain in the future onacceptable terms, or at all.  Any claimsagainst us, regardless of their merit or eventual outcome, could involve asignificant financial outlay in connection with the investigation of claims orpayment of deductible amounts to insurance companies.  A significant claim could involve payment of an amount whichcould have a material adverse effect upon our business, financial condition,operating results and cash flows.  Inaddition, adverse publicity resulting from product liability litigation maymaterially and adversely affect us, regardless of whether the claims are validor whether we are liable.

 

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**Employees**

 

As of April 30, 2003, wehad 41full-time employees,including 24 who werein manufacturing and research and development, and the remainder of whom were in administration andsales and marketing. ** **We are not a party to anycollective bargaining agreement and believe that our relations with employeesare good.

 

**ITEM 2****                                                        DESCRIPTION OF PROPERTY**

 

We lease a 55,000 squarefoot production and administrative facility located on 19 acres of land inInver Grove Heights, a suburb of Saint Paul, Minnesota.  Our facility has approximately 8,000 squarefeet of general office space and over 32,000 square feet of manufacturingspace.  Our facility also includes over9,500 square feet of controlled environment rooms and necessary support areasfor producing and assembling our products. Our facility is subject to inspection by the FDA and foreign regulatoryagencies as part of their product marketing clearance and surveillanceprograms.  In April 2003, this facilitywas sold in a sale-leaseback transaction to PKM Properties, LLC, an entitycontrolled by Paul K. Miller, one of our directors and our largest beneficialowner of securities.  We signed a leasewith an initial 10-year lease term, with options to renew or repurchase thefacility.

 

**ITEM 3****                                                        LEGAL PROCEEDINGS**

 

As of April 30, 2003, wewere not a party to any material litigation.

 

**ITEM 4****                                                        SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

Not applicable.

 

**ExecutiveOfficers of the Registrant**

 

The following tableprovides information with respect to our executive officers as of April 30,2003.  Each executive officer has beenappointed to serve until his successor is duly appointed by the board or hisearlier removal or resignation from office.

 
| **Name**        |   | **Age** |   | **Position  with MedicalCV**                     |   |
|-----------------|--------|---------|--------|--------------------------------------------------|--------|
| Blair P. Mowery |   | 57      |   | President, Chief  Executive Officer and Director |   |
| Jules L. Fisher |   | 49      |   | Chief Financial Officer                          |   |
| Allan R. Seck   |   | 57      |   | Senior Vice President -  Sales and Marketing     |   |

 

*BlairP. Mowery*became our President and Chief Executive Officer inJune 2001, and was appointed to our board of directors in July 2001.  After serving our company as an independentadvisor through his wholly-owned company, Bioscrene Ltd., from February 1996 toAugust 1996, he joined us in August 1996 as Vice President - BusinessDevelopment and was promoted to Chief Operating Officer in 1999.  From April 1991 through December 1993, Mr.Mowery was President and Chief Operating Officer of GalaGen, Inc., a biopharmaceuticalcompany.  From March 1987 to March 1991,he was President of Procor Technologies, a joint venture with Abbott RossLaboratories and the predecessor company to GalaGen.

 

*Jules L. Fisher*became our Chief Financial Officer inJanuary 2002.  From October 1996 toDecember 2001, Mr. Fisher served as Vice President and Chief Financial Officerof Minntech Corporation, a manufacturer of medical supplies and devices,sterilants, and filtration and separation products primarily for kidneydialysis, open-heart surgery and endoscopy. From August 1991 to October 1996, he held the position of Director,Operations Accounting for U.S. Surgical Corp. Mr. Fisher also served as Director, Financial Reporting and Analysis inthe Pharmaceutical Group of Bristol-Myers Squibb Company from May 1987 toFebruary 1991.

 

*AllanR. Seck*joined our company in May 1999 as Vice President -Sales and Marketing.  In March 2001, hewas promoted to Senior Vice President - Sales and Marketing.  From May 1996 until May 1999, Mr. Seck servedas Vice President - Sales and Marketing for AVECOR Cardiovascular, Inc., wherehe was responsible for sales, marketing, customer service, technical support,customer education and shipping.  He hasalso held senior management positions with Biomedicus, Inc., thecardiopulmonary division of Medtronic, and Johnson & JohnsonCardiovascular.

 

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**PARTII**

 

**ITEM 5****                                                        MARKET FOR COMMON EQUITY AND RELATEDSHAREHOLDER MATTERS**

 

Our units were listed onThe Nasdaq SmallCap Market under the symbol “MDCVU” from the completion of ourinitial public offering in November 21, 2001, until March 19, 2003.  Our units are now traded under the samesymbol on the OTC Bulletin Board (“OTCBB”). The following table sets forth the approximate high and low closingprices as reported by The Nasdaq SmallCap Market and the approximate high andlow bid prices as reported by the OTCBB for our units for the periodsindicated.  Such quotations reflectinter-dealer prices, without retail mark-up, mark-down or commission, and maynot represent actual transactions.

 
| **Period**                                    |   | **High** | ** ** | **Low** | ** ** |
|-----------------------------------------------|--------|----------|------------|---------|------------|
| Fiscal  Year 2002                             |   |     |       |    |       |
| Third  Quarter (commencing November 21, 2001) |   | $        | 4.50       |    | $          | 3.00 |   |
| Fourth  Quarter                               |   | $        | 3.70       |    | $          | 2.35 |   |
|                                          |   |     |       |    |       |
| Fiscal  Year 2003                             |   |     |       |    |       |
| First  Quarter                                |   | $        | 2.45       |    | $          | 0.55 |   |
| Second  Quarter                               |   | $        | 1.44       |    | $          | 0.60 |   |
| Third  Quarter                                |   | $        | 1.15       |    | $          | 0.55 |   |
| Fourth  Quarter                               |   | $        | 1.01       |    | $          | 0.25 |   |

 

As of April 30, 2003, wehad 95 shareholders of record and approximately 387 beneficial owners.

 

We have never declared orpaid cash dividends.  We currentlyintend to retain future earnings, if any, to operate and expand our business,and we do not anticipate paying cash dividends on our common stock in theforeseeable future.  Any payment of cashdividends in the future will be at the discretion of our board of directors andwill depend upon our results of operations, earnings, capital requirements,contractual restrictions and other factors deemed relevant by our board.

 

**Sales ofUnregistered Securities during the Fourth Quarter of Fiscal Year 2003**

 

On April 4, 2003, wecompleted a refinancing transaction in which our headquarters and manufacturingfacility was sold in a sale-leaseback transaction to PKM Properties, LLC(“PKM”), an entity controlled by Paul K. Miller.  Mr. Miller is a member of our board of directors and is ourlargest beneficial owner of securities. As part of the consideration for this transaction, we issued to PKM afive-year warrant to purchase 350,000 shares of our common stock at $0.625 pershare.

 

The foregoing issuancewas made in reliance upon the exemption provided in Section 4(2) of theSecurities Act.  Such securities are restricted as to sale or transfer,unless registered under the Securities Act, and the certificate representingsuch securities contains a restrictive legend preventing sale, transfer orother disposition, unless registered under the Securities Act.  Inaddition, the recipient of such securities received material informationconcerning our company, including, but not limited to, our reports on Form10-KSB and Form 10-QSB, as filed with the Securities and ExchangeCommission.  No underwriting commissions or discounts were paid withrespect to the issuance of such securities.

 

**ITEM 6****                                                        MANAGEMENT’S DISCUSSION AND ANALYSISOR PLAN OF OPERATION**

 

*The following discussion contains variousforward-looking statements within the meaning of Section 21E of the ExchangeAct.  Although we believe that, inmaking 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 relateto us or our management, are intended to identify such forward-lookingstatements.  These forward-lookingstatements are subject to numerous risks and uncertainties that could causeactual results to differ materially from those anticipated.  Factors that could cause actual results todiffer materially from those anticipated, certain of which are beyond ourcontrol, include those discussed in our Cautionary Statement as well as thosediscussed elsewhere in this Form 10-KSB.*

 

*Our actual results, performance or achievementscould differ materially from those expressed in, or implied by, forward-lookingstatements.  Accordingly, we cannot becertain that any of the events anticipated by forward-looking statements willoccur or, if any of them do occur, what impact they will have on us.  We caution you to keep in mind th**e*

 

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*cautions and risks described ourCautionary Statement as well as those discussed elsewhere in this Form 10-KSBand to refrain from attributing undue certainty to any forward-lookingstatements, which speak only as of the date of the document in which theyappear.*

 

**Overview**

 

We area cardiothoracic surgery device company. Our primary products are mechanicalheart valves known as the Omnicarbon® Series 3000 and Series 4000, which wemanufacture and market.  Our heart valves are used to treat heartfailure caused by the aging process, heart diseases, prosthetic heart valvefailure and congenital defects.  To date,we have distributed the Omnicarbon 3000 and 4000 heart valves primarily inEurope, South Asia, the Middle East and the Far East.  In fiscal year 2003, we derived 62 percent of our net sales from Europe.  As an innovator of heart valve technology,we have more than 33years of experience in developing, manufacturing and marketing five generationsof heart valves, and we have sold approximately 140,000 heart valves worldwide.

 

On July 26, 2001, the FDA gave us notice of premarketapproval to sell our Omnicarbon 3000 heart valve in the U.S., the largestgeographic market for mechanical heart valves. In anticipation of FDA premarket approval, we invested in our sales andmarketing infrastructure, including adding sales management to our staff andrecruiting field sales representatives to call on domestic surgery centers inthe U.S.  Based upon our Omnicarbonheart valve’s 18 years of implants in patients in Europe, we believe thatwe can establish a competitive position in the mechanical heart valve industryin the U.S. and leverage this position into other critical areas ofcardiothoracic surgery.  We also expectthat our ability to market the Omnicarbon 3000 heart valve in the U.S. willfavorably affect our international sales, as many cardiovascular surgeons andothers who make purchasing decisions are aware of the FDA’s rigorous premarket approval process andconsider it to be a validation of the safety and efficacy of medicaldevices.  Our company had its firstimplant of the Omnicarbon 3000 heart valve in the U.S. in December 2001.

 

The worldwide heart valve market is dynamic and highlycompetitive.  In addition, technologyand competitive offerings, such as new tissue heart valves, place increasedpressure on us as we seek to increase our market share and revenue.  For more information regarding these risks,you should review our Cautionary Statement.

 

**Critical Accounting Policies**

 

*The preparation of our financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the amounts reported in theconsolidated 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, deferred income tax assets, account**s receivableallowance,  and inventory obsolescence.  Actual amounts could differ significantlyfrom management’sestimates.*

 

***RevenueRecognition*****. **We recognizerevenue using guidance from SEC Staff Accounting Bulletin No. 101 “RevenueRecognition in Financial Statements.”  Revenue from thesale of our mechanical heart valves is recognized provided that we havereceived a purchase order, the price is fixed, title has transferred,collection of the resulting receivable is probable and there are no remainingobligations.  Transfer of title occursfor substantially all sales upon shipment. Our products are not subject to any customer acceptance process.  There are no rights of return unless theproduct does not perform according to specifications.

 

***DeferredIncome Tax Assets*****. **In assessingthe realizability of our deferred tax assets, management considers whether itis more likely than not that our deferred income tax assets will berealized.  The ultimate realization ofdeferred income tax assets is dependent on the generation of future taxableincome, which must occur prior to the expiration of our net operating loss andcredit carryforwards, which comprise the majority of the deferred taxassets.  As of April 30, 2003, we have established a valuation allowance of $6,618,352 to fully offset our deferred tax assetsdue to uncertainty about predicting the sufficiency of future taxable income necessary torealize these deferred tax assets, particularly in light of our recent historyof significant operating losses.  In addition,future utilization of available net operating loss carryforwards may be limitedunder Internal Revenue Code 382 as a result of future changes in ownership.

 

***Accounts Receivable Allowance*. **Indetermining the adequacy of our allowance for doubtful accounts, managementconsiders a number of factors, including the aging of our receivable portfolio,customer payment trends, the financial condition of our customers and economic conditions in our customers’ countries.  Our analysis in determining the allowance for doubtful accountsis performed by management on a customer-by-customer basis.  Although our recorded allowance includes ourbest

 

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estimates, we cannot predict theresolution of these matters with certainty.  As of April 30, 2003, our allowance fordoubtful accounts was $113,295.

 

***Inventory Obsolescence*. **Indetermining the appropriate carrying value of our inventories, managementconsiders a number of factors, including the aging of our inventory, recentsales trends, industry market conditions and economic conditions.  Our analysis requires us to estimaterevenues by type of mechanical heart valve. For example, we have expected a decline in Omniscience heart valves,which has been a consideration in the valuation of these items in ourinventory.  Although adjustments to thecarrying value of our inventories reflect our best estimates, the estimatesrequire a large degree of judgment.  During the fiscal year ended April 30, 2003, we recorded a provisionfor inventory obsolescence of $105,422.

 

**Selected Financial Data**

 
|                                                                     |   | **Years ended April 30,** | ** ** |
|--------------------------------------------------------------------------|--------|---------------------------|------------|
|                                                                     |   | **200****3**              |       | **200****2** | ** ** |
| **Statement of Operations Data:**                                        |   |                      |       |   |   |
| Net sales                                                                |   | $                         | 3,135,041  |   | $ | 2,982,198 |   |
| Cost of goods sold                                                       |   | 1,715,402                 |       | 2,109,453 |   |
| Gross profit                                                             |   | 1,419,639                 |       | 872,745 |   |
| Total operating expenses                                                 |   | 5,667,851                 |       | 4,463,110 |   |
| Net loss                                                                 |   | (4,667,709                | )          | (4,297,665 | ) |
| Basic and diluted net loss per share                                     |   | (.60                      | )          | (.62 | ) |
| Weighted average number of shares outstanding                            |   | 7,843,834                 |       | 6,980,820 |   |
|                                                                     |   |                      |       |   |   |
| **Balance Sheet Data:**                                                  |   |                      |       |   |   |
| Total current assets                                                     |   | $                         | 4,623,691  |   | $ | 6,441,819 |   |
| Total current liabilities                                                |   | 2,968,189                 |       | 3,683,594 |   |
| Working capital                                                          |   | 1,655,502                 |       | 2,758,225 |   |
| Total assets                                                             |   | 6,054,920                 |       | 8,091,226 |   |
| Long-term debt and capital lease obligations, including current  portion |   | 3,788,573                 |       | 2,983,906 |   |
| Total shareholders’ equity (deficit)                                |   | (385,930                  | )          | 4,026,040 |   |
|                                                                     |   |                      |       |   |   |
| **Statement of Cash Flows Data:**                                        |   |                      |       |   |   |
| Net cash used in operating activities                                    |   | $                         | (4,309,507 | ) | $ | (3,186,805 | ) |
| Cash and cash equivalents at end of year                                 |   | 184,227                   |       | 2,781,675 |   |
|                                                                     |   |                      |       |   |   |
| **General Data and Ratio:**                                              |   |                      |       |   |   |
| Current ratio                                                            |   | 1.6                       |       | 1.7 |   |
| Gross profit margin on net sales                                         |   | 45.3                      | %          | 29.3 | % |

 

**Results ofOperations for the Fiscal Years Ended April 30, 200****3 and 2002**

 

*Net Sales*.  Net sales in the year ended April 30, 2003,increased 5.2 percentto $3,135,041 from$2,982,198 in the prioryear.  The increase was attributable tohigher Omnicarbon unit sales in the U.S. and Middle East marketsdue to the increased sales focus and successful expansion of clinical sites inthose markets.

 

In fiscal years 2003 and 2002, the vast majority of our sales weredenominated in U.S. dollars. Fluctuations in foreign currency exchange rates have not resulted insignificant losses or gains on outstanding trade accounts receivable.  All of our distributors are required to payfor products in U.S. dollars, other than our Japanese distributor, which paysin Japanese yen,and two European customers, which pay in euros.   We recognize thata strong U.S. dollar can adversely affect unit sales payable in currenciesother than U.S. dollars for our foreign distributors.

 

*Gross Profit.*  Gross profit as a percentage of net sales increased to 45.3 percent in the year ended April 30, 2003, from 29.3 percent in the prior year.  The improvement in fiscal year 2003 grossprofit margins was attributable primarily to reductions in Omnicarbon 4000product costs combined with favorable mix due to unit sales growth in the U.S.market. Wehave expended considerable resources in developing our new carbon manufacturingprocess technologies utilized in manufacturing the Omnicarbon 4000 heart valve,which is currently sold outside theU.S. market.  Gross profit margins inthe prior year wereunfavorably impacted by non-recurring costs associated with these developmentactivities.  Our strategy is to obtainFDA approval of our proprietary pyrolytic carbon manufacturing process in order to market theOmnicarbon 4000 in the U.S.  Due to itslower manufacturing cost, we believe the Omnicarbon 4000 will generatesignificantly higher gross profit margins when sold in the U.S. than theOmnicarbon 3000 heart valve.

 

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*Sales and Marketing*.  Sales and marketing expenses in the yearended April 30, 2003, were $2,864,747 or 91.4 percent of net sales compared to $2,089,104 or 70.1 percent of net sales in the prior year.  The increase in spending in fiscal year 2003 related to expanded Omnicarbon marketingefforts in the U.S.,and to a lesser extent, international markets. Our overallstrategy is to promote the clinical results of the Omnicarbon heart valve andthe technical strengths of our company in designing and manufacturingmechanical heart valves.

 

*General and Administrative*.  General and administrative expenses for theyear ended April 30, 2003, were $1,926,418 or 61.4 percent of net sales compared to $1,594,968 or 53.5 percent of net sales in the prior year.  The increase was primarily attributable toincreased expensesassociated with operating as a public company and salary and related expenses associatedwith strengthening the executive management staff.

 

*Engineering and Regulatory*.  Engineering and regulatory expenses for theyear ended April 30, 2003, were $876,686 or 28.0 percent of net sales compared to $779,038 or 26.1 percent of net sales in the prior year.  The increase in fiscal year 2003 spending was primarily attributable to expenses associated with thepurchase and development of the Northrup Universal Heart Valve Repair SystemTMand the IMA AccessTM Retractor device combined with costs related to the pursuitof FDA approval for our proprietary pyrolytic carbon manufacturing process inorder to market the Omnicarbon 4000 heart valve in the U.S.

 

*Other (Expense) Income*.  Interest expense totaled $467,315 in the year ended April 30, 2003, compared to $463,388 in the prior year.  Interest expense reflectedamortization of deferred financing costs for both years.  Lossfrom the early extinguishment of convertible subordinated bridge notes of$335,410 was reflected in fiscal year 2002.

 

*Income Tax Provision*.  In light of our recent history of operatinglosses, we recorded a valuation allowance to fully offset our deferred taxassets in fiscal year 2000.  We havecontinued to provide a full valuation allowance through fiscal year 2003due to the inherent uncertainty about the sufficiency of future taxable income necessary torealize our deferred tax assets.

 

*Loss from Operations*.  As of April 30, 2003,we had an accumulated deficit of  $17,073,095.  We have incurred losses in each of the last seven fiscal years.  Since 1994, we have invested in developing a bileaflet heartvalve, a proprietary pyrolytic carbon coating process and obtaining premarketapproval from the FDA to market our Omnicarbon 3000 heart valve in theU.S.  Our strategy has been to invest intechnology to better position ourselves competitively once FDA premarketapproval was obtained.  We expectcumulative net losses to continue at least through fiscal year 2004 because of anticipated spendingnecessary to market the Omnicarbon 3000 heart valve in the U.S. and toestablish and maintain a strong marketing organization for domestic and foreignmarkets.

 

**Liquidity and Capital Resources**

 

Cashand cash equivalents decreasedto $184,227 at April30, 2003, from $2,781,675 at April 30, 2002. The decreasein cash and cash equivalents of $2,597,448 from the prior yearwas due to the following:

 
| Net cash used in operating activities      |   | $         | (4,309,507 | ) |
|--------------------------------------------|--------|-----------|------------|---|
| Net  cash used in investing activities     |   | (128,960  | )          |
| Net cash  provided by financing activities |   | 1,841,019 |       |
| Net  decrease                              |   | $         | (2,597,448 | ) |

 

Netcash used in operating activities increased $1,122,702 from $3,186,805 in the prior year to $4,309,507 in the fiscal year ended April 30, 2003.  The increase was due principally to funding higher operating losses in fiscal year 2003 as we increased ourmarketing efforts in the U.S.  Inaddition, increases in accounts receivable, inventories and prepaid assets werepartially offset by increases in accounts payable and accrued expenses.  Inventories increased $368,078 in fiscal year 2003 and $188,084 in fiscal year 2002.  The increases in inventories in fiscal years 2003 and 2002 were related to carrying additional inventory tosupport the launch of the Omnicarbon3000 heart valve inthe U.S. market and anticipatedgrowth ininternational sales.

 

Netcash used in investing activities was $128,960 and $465,024 for the fiscal years ended April 30, 2003 and 2002, respectively.  Weinvested $128,960 inproperty, plant, and equipment in the year ended April 30, 2003, compared to $384,024 in the prior year.  Our investment in property, plant, and equipment in fiscalyear 2002 related primarily to thedevelopment of our proprietary pyrolytic carbon manufacturing process.  As described in Commitments and ContingentLiabilities, we loaned $81,000 to UROPACE during fiscal year 2002.

 

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Netcash provided by financing activities was $1,841,019 in the fiscal year ended April 30, 2003,and consisted primarily of borrowings from related parties of $1,303,333combined with net proceeds from the related party sale-leaseback transaction of$1,000,000; partially offset by principal payments of $462,314. We completed our initial public offering early in the third quarter of fiscal year 2002,which generated net proceeds of $5,396,485.  Other sources of cash from financingactivities in fiscal year 2002 were our increased borrowings of $1,570,000 on our line ofcredit and the net proceeds of $438,885 from the sale of $500,000principal amount of convertible subordinatedbridge notes.  We used $975,000 of funds generated through our offering to repay the bridge notes in the fourthquarter of fiscal year 2002 and to make principal payments on our bank line ofcredit.

 

Throughout fiscal year2003 and subsequent to April 30, 2003, we entered into a number of financingtransactions to provide funds necessary to meet our working capital and capitalexpenditure needs and to meet other obligations.  These financing activities consisted of the following:

 

•                                          In December2002, we received a $60,000 unsecured advance from an executive officer.  Principal and interest on this advance wasrepaid in April 2003.

 

•                                          In January2003, we established a line of credit with PKM Properties, LLC (“PKM”), anentity controlled by Paul K. Miller. Mr. Miller is a member of our board of directors and is our largestbeneficial owner of securities.  The lineof credit bears interest at the higher of 7 percent or 1 percent above a bankreference rate (7 percent is the rate in effect as of April 30, 2003).  The line of credit is currentlycollateralized by a security interest in substantially all of our assets.  This line of credit matures on September 17,2003.  In connection with the line ofcredit, we also issued a warrant to PKM with a five-year term to purchase350,000 shares of our common stock at an exercise price of $0.596 pershare.  The allocated fair value of thewarrants was $128,995.  This discountwas completely amortized to interest expense as of April 30, 2003.  The amount outstanding under this short-termdebt with related party at April 30, 2003 was $943,333.

 

•                                          On April 4,2003, we sold our corporate headquarters, manufacturing facility andsurrounding land in Inver Grove Heights, Minnesota to PKM.  In connection with the transaction, wereceived total consideration of $3.84 million consisting of (1) $1.0 million incash, (ii) PKM’s assumption of our $2.5 million outstanding indebtedness toAssociated Bank which eliminated our indebtedness to Associated Bank, and (iii)PKM’s assumption of our promissory note with Dakota Electric Association andland special assessments payable to Dakota County aggregating $336,105.  We relied on a fair market value appraisalof the property in determining the amount of such consideration.   Also in connection with the transaction, weissued to PKM a five-year warrant for the purchase of 350,000 shares of ourcommon stock at an exercise price of $0.625 per share.   These warrants had an allocated fair valueof $89,602.

 

Of the net cash proceeds,$300,000 plus interest was applied to our indebtedness to PKM pursuant to theline of credit agreement described above.

 

Simultaneous with thesale of the facility, we entered into a lease with PKM to lease back thefacility and a portion of the land.  Thelease has a ten-year initial term with options for us to extend the lease up toten additional years.  Under certain conditions,we also have an option to purchase the building at the end of the initialten-year term at the fair value at that time.

 

Due to our continuedinvolvement with the property, including the ability to buy back the propertyat a future date, the transaction is accounted for as a financing of theproperty sold and leased back.  Accordingly, the net book value of the facility and land sold toPKM with a net book value of $759,146 continues to be presented as part of ourproperty, plant and equipment balance. The related party lease obligation of $3,779,100 at April 30, 2003, representsthe minimum amounts due PKM for the initial ten-year term discounted at 4.4percent and additional payments to be paid to PKM for the Dakota ElectricAssociation and Dakota County obligations assumed by PKM.

 

•                                          On July 8,2003, we completed a $2.0 million bridge financing transaction, resulting innet proceeds of approximately $1.87 million.

 

Under the terms of thefinancing, we established a one-year $1.0 million discretionary line of creditwith PKM.  The line, which requires thepayment of interest at a rate of 10 percent per year, matures on May 27, 2004,and is secured by substantially all of our assets.   As additional consideration for the financing, we agreed toissue PKM ten-year warrants for the purchase of up to 380,357 shares of ourcommon stock at an

 

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exercise price of $0.70per share with terms and conditions that include weighted-average anti-dilutionrights.  We also agreed to modifycertain terms of the warrants issued to PKM in connection with a creditfacility extended by PKM in January 2003, to conform to the terms of thewarrants issued as part of this bridge debt financing.

 

In a simultaneoustransaction, we entered into a loan agreement and borrowed $1.0 millionfrom Peter L. Hauser pursuant to a one-year subordinated note with aninterest rate of 10 percent per year. Pursuant to an intercreditor agreementwith PKM, the loan is secured by substantially all of our assets.  The lender was issued ten-year warrants forthe purchase of 380,357 shares of our common stock on terms comparable to thePKM warrants described above.  Followingthe transaction, Mr. Hauser became the beneficial owner of approximately 10.3percent of our securities.

 

We expectthat our operating losses and negative operating cash flow will continueat leastthroughfiscal year 2004 as we expand our manufacturingcapabilities, continue increasing our corporate staff to support the U.S.roll-out of our Omnicarbon 3000 heart valve, and add marketing programs domestically andinternationally to build awareness of and create demand for our Omnicarbonheart valves.   We anticipate that our sales and marketingand general and administrative expenses will continue to constitute a materialuse of our cash resources.  The actualamounts and timing of our capital expenditures will varysignificantly depending upon thespeed at which we are able to expand our distribution capability in domesticand international markets and the availability of financing.

 

Our capital requirements may vary depending upon the timingand the success of the implementation of our business plan, regulatory,technological and competitive developments, or if:

 

•                                          increasedsales levels of our core products and new products are not achieved;

 

•                                          operatinglosses exceed our projections;

 

•                                          our manufacturing and development costsor estimates prove tobe inaccurate;

 

•                                          we determine to aquire, license or develop additionaltechnologies;

 

•                                          we experience substantialdifficulty in gaining U.S. market acceptance or delays in obtaining FDA clearance of our proprietarycarbon coating process for heart valves sold in the U.S. market; or

 

•                                          we make acquisitions.

 

Our ability to continueas a going concern depends upon our ability to obtain additional debt and/orequity financing in the second quarter of fiscal year 2004.  We are currently seeking additionalfinancing to fund our operations and working capital requirements.  We cannot provide any assurance, however,that such additional financing will be available on terms acceptable to us orat all.  We will need to obtainadditional capital prior to the maturity date of our revolving line of creditwith PKM on September 17, 2003, or otherwise extend or restructure this debt tocontinue operations.

 

Weanticipatethat we will need to raise between $4,000,000 and $6,000,000 of additional equity or debt financing to fundoperations and working capital requirements beginning inSeptember 2003.  We previouslyanticipated that these funds would need to be raised by mid to late calendaryear 2004. Weexpect to face substantial difficulty in raising funds in the current marketenvironment and we have no commitments at this time to provide the requiredfinancing.  If weobtain the foregoingfinancing, we believe we willhavesufficient capital resources tooperate and fund the growth of ourbusiness for the remainder of fiscal year 2004 and into fiscalyear 2005.

 

Wecannot assure you that we will be able to raise sufficient additionalcapital on terms that we consideracceptable, or at all.  Theterms of any equity financing are expected to be highly dilutive to ourexisting security holders.  Thedelisting of our securities from the Nasdaq SmallCap Market that occurred inMarch 2003 will negatively affect our ability to raise capital.  Ifwe are unable to obtain adequate financing on acceptable terms, we will be unable tocontinue operations.

 

Until such time as thelevel of U.S. market acceptance of our heart valves increases and the FDAapproves our pyrolytic carbon process, we anticipate that we will continue todepend upon cash provided by financing activities to address our workingcapital requirements.  By broadening ourportfolio of cardiothoracic surgery products, we hope to reduce our dependenceon sales of heart valves and reduce our reliance upon financing transactions,which may not be available to us.  Wecannot, however, assure you that our efforts to diversify our product offeringswill:

 

•                                          beattainable;

 

15

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•                                          be profitable;

 

•                                          reduce ourreliance upon financing transactions; or

 

•                                          enable us tocontinue operations.

 

**Commitments and Contingent Liabilities**

 

*Snia S.p.A. Carbomedics (formerlySulzer Carbomedics).* In July 1998, we entered into a three-year supply agreement with SniaS.p.A. Carbomedics, the source ofcertain raw material components used in the manufacture of our Omnicarbon 3000heart valves.  The supply agreement wasextended for an additional two years in March 2001.  The agreement provides that we purchase a minimum number of rawmaterial units each calendar year through December 2003. Under the terms of the agreement, we are required to compensate SniaS.p.A. Carbomedics for any purchaseshortfalls up to a maximum of $200,000 per year.  We have not met the minimum purchase requirements for the pastthree calendar years.  In addition, wedo not believe we will meet the minimum purchase requirement for calendar year2003.  As a result, we expensed $138,738in fiscalyear 2003, and $148,991 in fiscal year 2002 related to these purchase shortfalls.  Thesecharges were reflected in cost of goods sold. Future purchase shortfalls could adversely affect our ongoingrelationship with Snia S.p.A. Carbomedics.

 

*UROPACE*.  In July 1995, we established a wholly owned subsidiary, UROPACE, Inc., tocommercialize technology for treating female urinary incontinence.  On November 1, 2000, we completed thespin-off of UROPACE to our existing shareholders.  The separation was effected by transferring from our company toUROPACE all assets, tangible and intangible, relating to the development offemale urinary incontinence technology. Our shareholders of record on September 15, 2000 received one share ofcommon stock of UROPACE for each 6.882 shares of our common stock they held onthat date.  The assets transferred toUROPACE had no book value at November 1, 2000, and the operations of UROPACEbefore the spin-off had no revenues and minimal expenses during fiscal year2000 and fiscal year 2001.  As a part ofthis spin-off, we agreed to loan UROPACE up to $356,250 at a variable interestrate.  Principal and interest on thenote will be payable in installments equal to 5 percent of UROPACE’s future annual net sales until the noteand interest is paid in full.  At April30, 2003, we had loaned UROPACE $235,000,none of which had been repaid.  Due to the development stage of UROPACE andthe uncertainty associated with the collection of these borrowings, we haverecorded an allowance for the entire balance of the loan, with the correspondingexpense included in other (expense) income in the Consolidated Statement ofOperations.

 

*Related Party Lease Obligation. *On April 4, 2003, we soldour corporate headquarters, manufacturing facility and surrounding land inInver Grove Heights, Minnesota to PKM. In connection with the transaction, we received total consideration of$3.84 million consisting of (1) $1.0 million in cash, (ii) PKM’s assumption ofour $2.5 million outstanding indebtedness to Associated Bank which eliminatedour indebtedness to Associated Bank, and (iii) PKM’s assumption of ourpromissory note with Dakota Electric Association and land special assessmentspayable to Dakota County aggregating $336,105.

 

We simultaneously leasedback our facility pursuant to a ten-year lease, with options to renew and anoption to repurchase the facility.  Wewill continue to utilize the facility as we did prior to the sale-leasebacktransaction, with no change in operations.

 

*Capital Leases*.  We lease certainmanufacturing equipment under various capital leases.  Thecapital lease terms extendinto fiscal year 2004 with implicit interest rates rangingfrom 6.9 to 16.2 percent.  The capitalleases are collaterized by the underlying equipment with a total original costof $322,733.

 

*Clinical Studies. *We entered into an agreement with severallarge non-U.S. hospitals to conduct clinical studies regarding certain aspectsof our Omnicarbon heart valve’s clinical performance. The agreement runs through fiscal year 2006.  In general, recipients of clinical study payments are required topurchase our productsin order to complete their studies.

 

*Consulting*.  In November 2001, we entered into a separation agreementand release with Adel A. Mikhail, Ph.D., who was our founder and served as ourPresident and Chief Executive Officer from March 1992 until June 15, 2001, whenhe retired.  Dr. Mikhail continues toserve as Chairman of our Board of Directors. As part of the agreement, we agreed to retain Dr. Mikhail as anindependent consultant for a period of two years.  Dr. Mikhail receives a $6,000 per month retainer.  The agreement expires in June 2003.  We also entered into an employmentseparation agreement with an officer in late 2002, which provides forconsulting services through calendar 2003.

 

*Short-Term Debt with Related Party.*  We established a line of credit in January2003 with PKM. As noted above, PKM is an entity controlled by a principalshareholder, who also serves on our board of directors.  This line matures on September 17, 2003.

 

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|                                   |   | **Payments Due By Period** |      |
|----------------------------------------|--------|----------------------------|-----------|
| **Summary of Contractual Obligations** |   | **TOTAL**                  |      | **Less than One****Year** | ** ** | **Two to Three****Years** | ** ** | **Four or More****Years** | ** ** |
| Snia  S.p.A. Carbomedics               |   | $                          | 200,000   |   | $ | 200,000 |   | $ |   |   | $ |   |   |
| UROPACE Loan                           |   | 121,250                    |      | 121,250 |   |   |   |   |   |
| Related  Party Lease Obligation(1)     |   | 4,214,006                  |      | 454,944 |   | 835,528 |   | 2,903,634 |   |
| Capital Leases(1)                      |   | 42,069                     |      | 42,069 |   |   |   |   |   |
| Clinical Studies                       |   | 410,380                    |      | 137,762 |   | 192,247 |   | 80,371 |   |
| Consulting                             |   | 98,872                     |      | 98,872 |   |   |   |   |   |
| Short-Term  Debt with Related Party    |   | 943,333                    |      | 943,333 |   |   |   |   |   |
| TOTAL CONTRACTUAL OBLIGATIONS          |   | $                          | 6,030,010 |   | $ | 1,998,230 |   | $ | 1,047,775 |   | $ | 2,984,005 |   |
|                                        |        |                            |           |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                                  Future payments include interest due.

 

**Recent AccountingPronouncements**

 

In June 2002, the FASB issuedSFAS No. 146, “Accounting for Exit or Disposal Activities.”  The new statement addresses the accountingfor costs associated with exit or disposal activities.  The provisions of the statement wereeffective for disposal activities initiated after December 31, 2002.  The adoption of SFAS No. 146 did not have animpact on our financial position or results of operations.  The new standard principally affects thetiming of when charges are recorded as opposed to the amount of the ultimatecharge.  There have been no exit ordisposal activities subsequent to December 31, 2002.

 

We adopted theprovisions of FASB Interpretation No. 45, “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others” in the third quarter of fiscal year 2003.  The disclosure provisions of theinterpretation are effective for our financial statements for the third quarterof fiscal year 2003.  The provisions forinitial recognition and measurement are effective on a prospective basis forguarantees that are issued or modified after December 31, 2002.  The implementation of this accountingpronouncement did not have a material effect on our results of operations,financial position or cash flows.

 

In December 2002, theFASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transitionand Disclosure — an amendment of FAS 123.” SFAS No. 148 provides alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation and amends certain disclosurerequirements of SFAS No. 123.  Thetransition provisions of this statement are effective for fiscal years endingafter December 15, 2002, and the disclosure requirements of this statement areeffective for interim periods beginning after December 15, 2002.  We currently plan to continue to apply theintrinsic-value based method to account for stock options.  We implemented the year-end disclosureprovisions included in Note 2 as of April 30, 2003 and will implement theinterim period disclosure provisions in the quarter ending July 31, 2003.

 

In January 2003,the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities, aninterpretation of Accounting Research Bulletin No. 51.”  FIN No. 46 requires certain variableinterest entities (“VIEs”), to be consolidated by the primary beneficiary ofthe entity if the equity investors in the entity do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  FIN No. 46 is effective for all VIEs created or acquired afterJanuary 31, 2003.  For VIEs created oracquired prior to February 1, 2003, the provisions of FIN No. 46 must beapplied for the first interim or annual period beginning after June 15,2003.  We currently have no contractualrelationship or other business relationship with a VIE and therefore theadoption of FIN No. 46 did not have a material effect on our consolidatedfinancial position, results of operations or cash flows.  However, should we enter into any sucharrangement with a VIE in the future, our consolidated financial position orresults of operations may be adversely effected.

 

**Qualitative andQuantitative Disclosures about Market Risk**

 

We develop our products in the U.S. and market our productsglobally.  Because we continue to deriveour revenue primarily from sources outside of the U.S., our financial resultscould be affected by many factors, such as changes in currency exchange ratesor weak economic conditions in foreign markets.  Substantially all of our sales are denominated in U.S.dollars.  A strengthening of the U.S.dollar could make our products less competitive in foreign markets.  We do not currently participate in anycurrency hedging activities to mitigate this risk.  We intend to assess the need to use financial instruments tohedge our exchange rate exposure on an ongoing basis.  Our interest income and expenses are sensitiveto changes in the general level of U.S. interest rates, particularly since ourinvestments are in short-term instruments and our short-term debt require interest paymentscalculated at variable rates.  Based onthe current nature and levels of our investments and debt, however, we believethat we currently have no material market risk exposure.

 

17

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Our general investing policy is to limit market and creditrisk and the risk of principal loss. All liquid investments with original maturities of three months or lessare considered to be cash equivalents.

 

**CautionaryStatement**

 

*MedicalCV, Inc., or persons actingon our behalf, or outside reviewers retained by us making statements on ourbehalf, or underwriters of our securities, from time to time, may make, inwriting or orally, “forward-looking statements” as defined under the PrivateSecurities Litigation Reform Act of 1995. This Cautionary Statement, when used in conjunction with an identifiedforward-looking statement, is for the purpose of qualifying for the “safeharbor” provisions of the Litigation Reform Act and is intended to be a readilyavailable written document that contains factors which could cause results todiffer materially from such forward-looking statements.  These factors are in addition to any othercautionary statements, written or oral, which may be made, or referred to, inconnection with any such forward-looking statement.*

 

*The following matters, among others,may have a material adverse effect on our business, financial condition,liquidity, results of operations or prospects, financial or otherwise.  Reference to this Cautionary Statement inthe context of a forward-looking statement or statements shall be deemed to bea statement that any one or more of the following factors may cause actualresults to differ materially from those in such forward-looking statement orstatements.*

 

***Risks related to our business***

 

**If we are unable to fund our significant capital needs, we may berequired to cease operations. **Our ability to continue as a going concern depends upon our ability toobtain additional debt and/or equity financing in the second quarter of fiscalyear 2004.  We are currently seekingadditional financing to fund our operations and working capitalrequirements.  We cannot provide anyassurance, however, that such additional financing will be available on termsacceptable to us or at all.  We will needto obtain additional capital prior to the maturity date of our revolving lineof credit with PKM Properties, LLC ("PKM") on September 17, 2003, orotherwise extend or restructure this debt to continue operations.  

 

Basedon our current rate of expenditures, anticipated net sales and current salesand marketing plans, we estimate thatwe willneed to raise between $4,000,000 and $6,000,000 of additional equity or debtfinancing to fund operations and working capital requirements beginningin September 2003.  We expect to face substantial difficulty inraising funds in the current market environment and we have no commitments atthis time to provide the required financing.  The timing and amount of our future capital requirements willdepend on a number of factors, including:

 

•                                          the extent to which our Omnicarbon 3000heart valve gains market acceptance in the U.S.;

 

•                                          costs of manufacturing and marketing;

 

•                                          potential reductions in heart valvepricing by our competitors;

 

•                                          costs of developing, licensing and acquiring new products andtechnologies;

 

•                                          time and costs involved in obtainingregulatory clearance for our pyrolytic carbon coating process for sales in theU.S. of our Omnicarbon 4000 heart valve and other unanticipated regulatorycosts;

 

•                                          costs involved in filing, prosecuting andenforcing patents or defending against any patent infringementclaims;

 

•                                          competing technological and marketdevelopments; and

 

•                                          progress and cost of clinical trials fornew products.

 

Wewill require additional capital to support our operations, to complete the development of products and tomanufacture and market any products resulting from current developmentprojects.  We cannot assure you thatsuch additional financing will be available on acceptable terms, or atall.  If funds are raised by issuingadditional equity securities, our then existing shareholders will experiencefurther dilution.  If we are unable toobtain additional funds as needed, we may not be able to:

 

•                                          develop or enhance our products;

 

•                                          gain market share in the U.S.;

 

•                                          respond to competitive pressures orunanticipated requirements; or

 

•                                          continueoperations.

 

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**Substantially all of our assets are pledged to lenders andsubject to risk of loss.** In connection with bridge loan transactions in January and July 2003,substantially all of our assets were pledged to secure our indebtedness to PKM,an entity controlled by Paul K. Miller, one of our directors and our largestbeneficial owner of securities, and to Peter L. Hauser, who following thetransaction in which he participated, became the beneficial owner ofapproximately 10.3 percent of our securities. As of July 29, 2003, we were indebted to these lenders in the principalamount of $2,708,070.  We will berequired to obtain substantial additional debt or equity financing beginning inSeptember 2003 to repay this indebtedness at maturity and to fund ongoingoperations.  We cannot assure you thatwe will be able to obtain any additional financing, or that any financingobtained will be on terms favorable to us. If we default under the terms of our agreements with the lenders, or ifwe are unable to repay our indebtedness to them when it becomes due, thelenders may elect to exercise their rights as secured creditors, which mayinclude foreclosing upon and causing the sale of our assets.  If such event should occur, it would likelyresult in the termination of all of our business operations.

 

**We anticipate future losses andnegative cash flows, which may limit or delay our ability to become profitable.**  We have incurred losses in each of the last seven fiscal years.  We had net losses of $4,667,709 for thefiscal year ended April 30, 2003 and $4,297,665 for the fiscal year ended April30, 2002.  As of April 30, 2003, we hadan accumulated deficit of $17,073,095.  If we fail to obtain additional financingwhen required, we may not be able to develop or enhance our products, gainmarket share in the U.S. or respond to competitive pressures or unanticipatedrequirements, which could seriously harm our business, financial position and resultsof operations.  We expect to incuradditional net losses until we are able to generate and sustain substantiallyhigher revenues while maintaining reasonable expense levels, both of whichinvolve uncertainty.  We also mustcontinue to make significant expenditures on sales and marketing in connectionwith our heart valves.  We cannot assureyou that our revenues will grow in future periods or that we will ever becomeprofitable.  If we do achieveprofitability, we cannot assure you that we would be able to sustain orincrease profitability on a quarterly or annual basis in the future. In addition, the reports of our independent accountants for fiscal years 2003 and 2002 include explanatory paragraphs expressing doubt about our ability tocontinue as a going concern.

 

**We rely upon sales of our Omnicarbonheart valves for substantially all of our revenue.**  Our results of operations materially dependon the success of the Omnicarbon 3000 and 4000 heart valves, which accountedfor substantially all of our operating revenue for the fiscal years ended April30, 2003, and April 30, 2002.  Asignificant reduction in sales of Omnicarbon heart valves for any reason,including the introduction of additional competing products, would have amaterial adverse effect on us.  If wedevelop additional products, we would need to obtain regulatory approval beforewe could sell them.  Given thetime-consuming nature of the regulatory clearance process, we do not expect tobe able to sell such additional products in the foreseeable future.  We also anticipate that research anddevelopment and clinical and regulatory expenses will continue to rise infuture periods.

 

**We cannot assure you that our heartvalves will gain physician acceptance.** A limited number of cardiovascular surgeonsand cardiologists can influence medical device selection and purchase decisionsfor a large portion of the target cardiovascular surgery patientpopulation.  We cannot assure you thatour Omnicarbon heart valves, or any of the products that we may develop, willgain any significant degree of physician acceptance, or that users will acceptthese products as preferable to alternative products or methods oftreatment.  Physician acceptance of ourOmnicarbon heart valves will depend upon our ability to demonstrate theclinical advantages of lower complication rates and cost-effectiveness ofOmnicarbon heart valves when compared to other prosthetic heart valves.  Negative publicity involving Omnicarbonheart valves or other prosthetic heart valves could adversely affect theoverall acceptance of Omnicarbon heart valves. Further, because Omnicarbon heart valves are monoleaflet heart valves,we must overcome a market preference for bileaflet heart valves, which aremarketed by most major manufacturers of mechanical heart valves.  Any of the foregoing factors, among others,could limit or detract from physician acceptance of our Omnicarbon heart valvesand have a negative effect on our business, financial condition, operatingresults and cash flows.

 

**We cannot assure you that our efforts to introduce newproducts will be successful.** We are continuously seeking to develop, acquire or license newtechnologies to broaden our product offerings to the cardiothoracic surgerymarket.  We introduced one such productin December 2002 and, subject to necessary regulatory approval, intend tointroduce one or more such products in fiscal year 2004.  We cannot assure you that we will succeed inintroducing such products, that such products will gain market acceptance, orthat such products will significantly contribute to profitability; nor can weassure you that we will be able to recover the cost of investing in thedevelopment and introduction of such products.

 

**Because we do not have FDA clearanceto market our Omnicarbon heart valves manufactured with our proprietarypyrolytic carbon process for sale in the U.S., we depend upon a third partysupplier for critical**

 

19

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**components.**  We market our Omnicarbon 3000 heart valves,which we have now begun to sell in the U.S. and Japan, with pyrolytic carboncomponents produced by Snia S.p.A. Carbomedics, a third party supplier whichsells competing heart valves.  We have asupply contract that requires us to purchase such components for use in theOmnicarbon 3000 heart valve solely from Snia S.p.A. Carbomedics until December2003.  Given the absence of FDA-clearedalternative sources for pyrolytic carbon components for our Omnicarbon 3000heart valves, any disruption or termination of our supply contract, or ourfailure to extend it, if necessary, would have a material adverse effect on ourcontinued ability to sell Omnicarbon 3000 heart valves.  Future purchase shortfalls could adversely affectour ongoing relationship with Snia S.p.A. Carbomedics.  Further, we cannot assure you that we willbe able to obtain FDA clearance to manufacture Omnicarbon heart valves for salein the U.S. using our own pyrolytic carbon process.  Our future success will depend, in part, on obtaining FDA clearanceto manufacture carbon components for heart valves for sale in the U.S.

 

**We may need to fund multiple researchstudies throughout the lifecycle of each of our products, providingstatistically significant scientific data to regulatory agencies and costeffectiveness data to third party payers.**  The FDA, foreign regulatory agencies andthird party health care payers may require scientific clinical outcomes dataand cost effectiveness data.  We willneed to provide this data throughout our products’ lifecycles.  Payers and governmental agencies may changethe frequency and breadth of clinical research required, potentiallysignificantly increasing our costs. Without adequate positive outcomes data that demonstrate advantages fromthe use of our Omnicarbon heart valves, we may not achieve any significantmarket penetration.  We cannot assureyou that our outcomes data will be adequate to meet present or future medicaldevice utility requirements.  If ouroutcomes data does not meet such requirements, we may be unable to sell ourproducts or obtain third party reimbursement for the costs of our products.

 

**Intense competition in the prostheticheart valve industry could prevent us from successfully marketing our productsor render our products obsolete.**  We compete in mature, highly competitive markets in which many ofour competitors have well-known and established products.  To compete successfully in these markets, wemust maintain competitive pricing and demonstrate the advantages of ourOmnicarbon heart valves in terms of post-surgical complications.  Several companies are currently pursuing newmechanical heart valve designs, blood compatible coatings for mechanical heartvalves, longer lasting tissue heart valves and surgical alternatives toimplanting prosthetic heart valves.  Itis possible that technological advances by our competitors, or advances insurgical procedures that delay the need for replacing heart valves, couldrender our Omnicarbon heart valves noncompetitive or obsolete.

 

Our primary competitors,St. Jude Medical, Inc., Medtronic, Inc. and Snia S.p.A. Carbomedics, dominatethe market and control most of the mechanical heart valve marketworldwide.  Our competitors haveextensive clinical data demonstrating the performance of their heart valves andinternal carbon manufacturing capabilities. The companies with which we compete have many additional competitiveadvantages over us, including:

 

•                                          greater namerecognition and product market acceptance;

 

•                                          moreestablished physician relationships;

 

•                                          broaderproduct lines;

 

•                                          greaterdistribution capabilities;

 

•                                          greaterregulatory compliance capabilities;

 

•                                          largermarketing, research and development staffs and facilities; and

 

•                                          greaterfinancial resources.

 

We cannot assure you thatwe will be able to compete against such competitors or their products.

 

**Our future results depend upon thestrength of the mechanical heart valve market.**  Our business could suffer if the use ofmechanical heart valves declines.  Inrecent years, there has been an increase in the number of tissue heart valvesused.  We believe that improvements intissue heart valve longevity and an increase in the average age of heart valvepatients have contributed to the recent increase in the use of tissue heartvalves.  If the use of mechanical heartvalves declines, it could materially adversely affect our business, financialcondition, operating results and cash flows.

 

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**The small number of distributorsoperating in foreign markets that currently generate substantially all of ourrevenues pose a concentration of credit risk and could leave us at any time,impairing our business.** Substantially all of our sales originate from a small number ofdistributors who market our Omnicarbon 4000 heart valves in Europe, South Asia,the Middle East and the Far East. Because we do not control the amount or timing of the resources suchparties allocate to sales of our product, any revenues we derive from suchrelationships depend upon the efforts of such distributors.  If we could not locate a replacement on atimely basis, the loss of an international distributor could adversely affectus.

 

One of our significantinternational distributors, Mercé V. Electromedicina, S.L., is an affiliate ofour company.  During our fiscal yearended April 30, 2003, such affiliate made net purchases of product from ourcompany equal to approximately 30.9percent of our net sales. ** **Sales to this distributor accounted for approximately 38 percent of ouraccounts receivable at April 30, 2003.  Duringour fiscal year ended April 30, 2002, affiliates made net purchases of productfrom our company equal to approximately 48.3 percent of our net sales.  Obligations to us from our distributors areunsecured.  Distributors could fail topay receivables or cease distributing our products at any time, therebymaterially and adversely affecting our business, financial condition, operatingresults and cash flows.

 

**We depend upon sales outside theU.S., which are subject to a number of risks that could harm our ability tosuccessfully commercialize our product and could harm our business.**  We face several risks as a result of doingbusiness in foreign markets, including:

 

•                                          unforeseenchanges in regulatory requirements and government health programs;

 

•                                          potentiallyadverse tax consequences;

 

•                                          political andeconomic instability; and

 

•                                          greaterdifficulty in collecting payments from product sales.

 

In addition, the value ofthe U.S. dollar in relation to other currencies may also harm our sales tocustomers outside the U.S. because we require substantially all of ourcustomers to pay for our products in U.S. currency.

 

**Substantial government regulation inthe U.S. and abroad may restrict our ability to sell our heart valves.**  The FDA and comparable regulatoryauthorities in foreign countries extensively and rigorously regulate ourproducts, product development activities and manufacturing processes.  In the U.S., the FDA regulates the introductionof medical devices as well as the manufacturing, labeling and record-keepingprocedures for such products.  We arerequired to:

 

•                                          obtainclearance before we can market and sell medical devices;

 

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

 

•                                          comply withmanufacturing and reporting requirements; and

 

•                                          undergorigorous inspections.

 

The process of obtainingmarketing clearance for new medical devices from the FDA can be costly and timeconsuming.  For example, the premarketclearance process, which our heart valves and other medical devices mustundergo, can require numerousyears to complete.  Although we haveobtained FDA clearance for our Omnicarbon 3000 heart valve, we cannot assureyou that our future products will obtain FDA clearance on a timely basis, or atall.  Our products must also comply withlaws and regulations of foreign countries in which we market suchproducts.  In general, the extent andcomplexity of medical device regulation is increasing worldwide.  This trend may continue, and the cost andtime required to obtain marketing clearance in any given country may increaseas a result.  We cannot assure you thatour products will obtain any necessary foreign clearances on a timely basis, orat all.

 

**Once medical devices are cleared forsale, regulatory authorities may still limit the use of such products, restrictsales to certain models or sizes, prevent the sale or manufacture of suchproducts or require a recall or withdrawal of such products from themarketplace.**  Followinginitial clearance from regulatory authorities, we continue to be subject toextensive regulatory requirements. Government authorities can withdraw marketing clearance due to ourfailure to comply with regulatory standards or due to the occurrence of unforeseenproblems following initial clearance. Ongoing regulatory requirements are wide-ranging and govern, among otherthings:

 

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

 

•                                          productmanufacturing;

 

•                                          annualinspections to retain ISO certification of our quality system;

 

•                                          suppliersubstitution;

 

•                                          productchanges;

 

•                                          processmodifications;

 

•                                          medicaldevice reporting; and

 

•                                          product salesand distribution.

 

The FDA and variousgovernment agencies inspect our facilities from time to time to determinewhether we are in compliance with applicable laws and regulations.  If we fail to comply or maintain compliancewith medical device laws or regulations, regulatory authorities may fine us andbar us from selling our products.  Ifthe FDA believes we are not in compliance with such laws or regulations, itcan:

 

•                                          seize ourproducts;

 

•                                          require arecall;

 

•                                          withdrawpreviously granted market clearances;

 

•                                          implementprocedures to stop future violations; and/or

 

•                                          seek civiland criminal penalties against us.

 

**The uncertainty of third partyreimbursements and possible health care reforms may adversely affect us. **Our ability to marketproducts successfully in the U.S. will depend in part on the extent to whichreimbursement for the cost of such products and related treatment will beavailable from government health administration authorities, private healthinsurers, health maintenance organizations and other third party payers.  Payers increasingly challenge the need for,and prices of, medical products and services. Payers may deny reimbursement for procedures that they deem experimentalor for devices used in ways other than as cleared by the FDA or stated in theirindications for use.  With respect toour products, some payers could deny coverage until the devices becomegenerally accepted by the medical profession. The inability of hospitals and other providers to obtain reimbursementfrom third party payers for our products would have a material adverse impacton our business, financial condition, operating results and cash flows.

 

Health care reform mayalso impact sales of new products in the U.S. Reforms may include:

 

•                                          mandatedbasic health care benefits;

 

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

 

•                                          fundamentalchanges to the health care delivery system.

 

We anticipate thatCongress and state legislatures will continue to review and assess alternativehealth care delivery systems and payment methodologies, and that public debateof these issues will likely continue in the future.  Due to uncertainties regarding the ultimate features of reforminitiatives and their enactment and implementation, we cannot predict which, ifany, of such reform proposals will be adopted, when they may be adopted or whatimpact they may have on our ability to market our current and futureproducts.  Laws resulting from suchreform initiatives could adversely impact our business, financial condition,operating results and cash flows.

 

22

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**Despite our efforts to protect ourproprietary rights, unauthorized parties may attempt to use information that weregard as proprietary.  We also run therisk of infringing the proprietary rights of third parties.**  We do not have patent protection for thedesign of our Omnicarbon heart valves. We rely upon a combination of trade secrets, know-how and confidentialityagreements to protect the proprietary aspects of our technology, includingaspects of manufacturing.  We havepatent applications filed for the pyrolytic carbon coating process used in ourOmnicarbon 4000 heart valve.  We havepatents for our bileaflet mechanical heart valve development project which iscurrently on hold.  We expect to seekpatent protection for additional products in the future.  Our success will depend, in part, on ourability to protect our products and to manufacture and sell them withoutinfringing the rights of third parties. The validity and breadth of claims covered in medical technology patentsinvolve complex legal and factual questions and, therefore, are highlyuncertain.  In addition, the laws ofmany countries do not protect our proprietary rights to as great an extent asdo the laws of the U.S.  We cannotassure you that:

 

•                                          any pendingpatent applications or any future patent applications will result in theissuance of patents;

 

•                                          the scope ofany patent protection will be effective to exclude competitors or to providecompetitive advantages to us;

 

•                                          we will beable to commercially exploit any issued patents before they expire;

 

•                                          any of ourpatents will be held valid if subsequently challenged;

 

•                                          others willnot claim rights in, or ownership of, the patents and other proprietary rightswe hold;

 

•                                          our productsand processes will not infringe, or be alleged to infringe, the proprietaryrights of others; or

 

•                                          we will beable to protect meaningful rights in proprietary technology over which we donot hold patents.

 

Furthermore, we cannotassure you that others have not developed or will not develop products whichmay duplicate any of our products or manufacturing processes, or that otherswill not design around our patents. Other parties may independently develop or otherwise acquiresubstantially equivalent techniques, gain access to our proprietary technologyor disclose such technology.  In addition,whether or not we obtain additional patents, others may hold or receive patentscovering components of products we independently develop in the future.  We cannot assure you that third parties willnot claim infringement by us, and seek substantial damages, with respect tocurrent or future products.  If we wereto become involved in a dispute regarding intellectual property, whether oursor that of another company, we may be involved in legal proceedings.  Any such claims, with or without merit,could be time-consuming, result in costly litigation, cause product shipmentdelays and require us to:

 

•                                          ceasemanufacturing and selling the product in question, which could seriously harmus;

 

•                                          enter intoroyalty or licensing agreements; or

 

•                                          designcommercially acceptable non-infringing alternative products.

 

We cannot assure you thatwe would be able to obtain royalty or licensing agreements, if required, onterms acceptable to us or at all, or that we would be able to developcommercially acceptable non-infringing alternative products.  Our failure to do so could have a material adverseeffect upon our business, financial condition, operating results and cashflows.

 

**If patients allege that the use ofOmnicarbon heart valves adversely affected them, we may face substantialproduct liability claims.** Substantial product liability litigation exists within the medicaldevice industry.  Mechanical heartvalves are life-sustaining devices, and their failure may result in patientdeath.  We have had product liabilityclaims in the past, which have been resolved without material financial cost tous.  We cannot assure you, however, thatfuture product liability claims will not exceed the limits of our insurancecoverage or that such insurance will continue to be available on commerciallyreasonable terms, or at all. Consequently, a product liability claim or other claim with respect touninsured liabilities, or in excess of insured liabilities, could have amaterial adverse effect on our business, financial condition, operating resultsand cash flows.  In addition, adversepublicity resulting from product liability litigation may materially adverselyaffect us regardless of whether the claims are valid or whether we areliable.  These claims may divert ourfinancial and management resources that would otherwise be used to benefit thefuture performance of our operations.

 

23

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**Key employees could leave our companyat any time, impairing our development and profitability**.  We depend heavily on the technical knowledgeand industry expertise of our management team. The development and execution of our business plan depends upon theseindividuals.   We do not have employmentagreements with most of our key employees. The departure of key people could adversely affect our business,financial condition, operating results and cash flows.

 

**We may be unable to recruit, motivateand retain qualified employees.**  Our success depends upon our ability to attract, motivate andretain a sufficient number of qualified employees, including those whoconcentrate in research and development, sales, marketing and manufacturing, tokeep pace with our product development schedules.  Even though we have not experienced shortages of qualified peopleto date, qualified individuals needed to fill these positions could be in shortsupply in our market.  Our inability torecruit, motivate and retain such individuals may delay the planned launch ofnew products or result in high employee turnover, either of which could have amaterial adverse effect on our business, financial condition, operating resultsand cash flows.  Additionally,competition for qualified employees could require us to pay higher wages andprovide additional benefits to attract sufficient employees.

 

**We may be unable to collect on ourloan to UROPACE, Inc. **InJuly 1995, we established a wholly-owned subsidiary called UROPACE, Inc.  On November 1, 2000, we completed a spin-offof UROPACE to our existing shareholders. As part of this spin-off, we agreed to loan UROPACE up to $356,250 at avariable interest rate.  As of April 30,2003, we had loaned UROPACE $235,000.** **Principaland interest on the note is payable in installments equal to 5 percent of UROPACE’sfuture annual net sales until the note is paid in full.  Due to the development stage of UROPACE, itis uncertain whether we will be able to collect on this loan.  For financial reporting purposes, we haverecorded an allowance for the entire balance of the loan at April 30, 2003.

 

***Risks related to our securities***

 

**Fluctuations in our operating resultsmay result in decreases in the price of our securities.**  Our operating results have and will continueto fluctuate significantly because of several factors, including the timing ofFDA clearance, government policies regarding payment for our products and newtechnology.  Consequently, our operatingresults may fall below the expectations of public market analysts andinvestors.  In that event, the price ofour securities would likely decrease.

 

**No public market exists for ourcommon stock or Class A Warrants, and an active market may not develop for ourunits. **We cannotassure you that a public market for our common stock or Class A Warrants willdevelop in the future or that an active market for our units will develop.  Before our initial public offering, therewas no public market for our units.  Asa result, we arbitrarily established the offering price for the units and theexercise price of the Class A Warrants through negotiations with ourunderwriter.  Such prices were not basedupon our assets, earnings history or book value.

 

**Youmay have difficulty reselling your securities**.  Our securities are subject to certain rulesof the SEC relating to “penny stocks.” Such rules require broker-dealers to make a suitability determinationfor purchasers and to receive the purchaser’s prior written consent for apurchase transaction, thus restricting the ability to purchase or sell oursecurities in the open market.  Inaddition, trading in our securities is conducted in the over-the-counter marketon the OTC Bulletin Board, which was established for securities that do notmeet Nasdaq listing requirements. Selling our securities may be difficult because of the quantity ofsecurities that may be bought and sold, the possibility that transactions maybe delayed, and the low level of security analyst and news media coverage givento over-the-counter stocks.  Thesefactors could contribute to lower prices and larger spreads in the bid and askprices for our securities.

 

**Our existing shareholders havesignificant control, which could reduce your ability to receive a premium foryour securities through a change in control.**  Officers and directors of our companybeneficially own approximately 46 percent of our common stock.** **Asa result, they may be able to control our company and direct our affairs,including the election of directors and approval of significant corporatetransactions.  This concentration ofownership could also delay, defer or prevent a change in control of our company,and make some transactions more difficult or impossible without theirsupport.  These transactions mightinclude proxy contests, tender offers, open market purchase programs or othershare purchases that could give our shareholders the opportunity to realize apremium over the then prevailing market price of our securities.  As a result, this concentration of ownershipcould depress the price of our securities.

 

**Minnesota law and our ability toissue preferred stock could deter a take-over or acquisition of our company**.  Our articles of incorporation authorize theissuance of shares of preferred stock. Our board of directors, without any action by our shareholders, isauthorized to designate and issue the preferred stock in such classes or seriesas it deems appropriate and establish the rights and privileges of such shares,including liquidation and voting rights. Our ability to designate and issue preferred stock having preferentialrights over our common stock could adversely affect the voting power and otherrights of holders of common stock, should we determine to issue preferredstock.  We are also subject to theMinnesota Business

 

24

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Corporation Act, which includes provisions that limit the voting rightsof persons acquiring specified percentages of shares of an issuing publiccorporation in a “control share acquisition” and restrict “businesscombinations” between issuing public corporations and specified personsacquiring their securities.  Our abilityto issue preferred stock and the application of the provisions of Minnesota lawdiscussed above could impede or deter another company from making a tenderoffer or other proposal to take us over.

 

**We may redeem the Class A Warrants ata nominal price. **Wemay redeem the Class A Warrants at $0.01 per warrant at any time, upon tenbusiness days’ notice, if the closing price of our common stock or unitsexceeds $8.50, subject to customary anti-dilution adjustments, for any tenconsecutive trading days before such notice. If we redeem the Class A Warrants, you will lose your right to exercisethe Class A Warrants except during the ten business day notice period.  Our redemption of the Class A Warrants couldforce you to exercise the Class A Warrants at a time when it may bedisadvantageous for you to do so, to sell the Class A Warrants at the thencurrent market price or to accept the redemption price, which could besubstantially less than the market value of the Class A Warrants at the time ofredemption.

 

**If we do not maintain an effective prospectus,you will be unable to exercise your Class A Warrants.**  You will be able to exercise the Class AWarrants, and we will be able to issue shares to you upon such exercise, onlyif a current prospectus relating to the shares underlying the Class A Warrantsis then in effect and only if such securities are qualified for sale or exemptfrom qualification under the applicable securities laws of the state in whichyou reside.

 

25

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**ITEM 7****                                                        FINANCIAL STATEMENTS**

 

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**

 
| **MedicalCV, Inc.**                                                        |
|----------------------------------------------------------------------------|
| Report of Independent Auditors                                             |
| Consolidated Financial  Statements                                         |
| Consolidated  Balance Sheet                                                |
| Consolidated  Statement of Operations                                      |
| Consolidated Statements of Changes in Shareholders’  Equity (Deficit) |
| Consolidated  Statement of Cash Flows                                      |
| Notes to Consolidated Financial Statements                                 |

 

26

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**Report of Inde****pendent A****uditors**

 

To the Board of Directors andShareholders of MedicalCV, Inc.

 

In our opinion, the accompanyingconsolidated balance sheets and the related consolidated statements ofoperations, of changes in shareholders’equity (deficit) andof cash flows present fairly, in all material respects, the financial positionof MedicalCV, Inc. at April 30, 2003 and 2002, and the results of its operations and its cash flows forthe years then ended in conformity with accounting principles generallyaccepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is toexpress an opinion on these financial statements based on our audits.  We conducted our audits of these statementsin accordance with auditing standards generally accepted in the United Statesof America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

The accompanying financial statements have been prepared assumingthat the 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 andhas insufficient funds to finance its working capital and capital expenditureneeds, which raises substantial doubt about the Company’sability to continue as a going concern. Management’splans in regard to these matters are also described in Note 1.  The financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 
| /s/ PricewaterhouseCoopers  LLP                                        |   |
|------------------------------------------------------------------------|--------|
| PricewaterhouseCoopers LLP                                             |
| Minneapolis,  Minnesota                                                |
| June 6, 2003, except as to Note  16 for which the date is July 8, 2003 |

 

27

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**MEDICALCV,INC.**

 

**ConsolidatedBa****lance Sheet**

 
|                                                                                                  |   | **April 30,** |      |
|-------------------------------------------------------------------------------------------------------|--------|---------------|-----------|
|                                                                                                  |   | **2003**      |      | **2002** |   |
| **ASSETS**                                                                                            |   |          |      |   |   |
| Current  assets:                                                                                      |   |          |      |   |   |
| Cash  and cash equivalents                                                                            |   | $             | 184,227   |   | $ | 2,781,675 |   |
| Trade  accounts receivable, net                                                                       |   | 1,472,995     |      | 1,258,616 |   |
| Inventories                                                                                           |   | 2,782,613     |      | 2,322,535 |   |
| Prepaid  expenses and other current assets                                                            |   | 183,856       |      | 78,993 |   |
| Total  current assets                                                                                 |   | 4,623,691     |      | 6,441,819 |   |
|                                                                                                  |   |          |      |   |   |
| Property,  plant and equipment, net                                                                   |   | 1,368,240     |      | 1,575,153 |   |
| Deferred  financing costs                                                                             |   | 62,989        |      | 72,860 |   |
| Other  assets                                                                                         |   | —        |      | 1,394 |   |
| Total  assets                                                                                         |   | $             | 6,054,920 |   | $ | 8,091,226 |   |
|                                                                                                  |   |          |      |   |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY (DEFICIT)**                                              |   |          |      |   |   |
| Current  liabilities:                                                                                 |   |          |      |   |   |
| Accounts  payable                                                                                     |   | $             | 895,405   |   | $ | 589,520 |   |
| Short-term  debt with related party                                                                   |   | 943,333       |      | — |   |
| Current  portion of related party lease obligation                                                    |   | 273,843       |      | — |   |
| Current  portion of long-term debt                                                                    |   | —        |      | 2,542,460 |   |
| Current  portion of capital lease obligations                                                         |   | 42,069        |      | 59,854 |   |
| Accrued  expenses                                                                                     |   | 813,539       |      | 491,760 |   |
| Total  current liabilities                                                                            |   | 2,968,189     |      | 3,683,594 |   |
|                                                                                                  |   |          |      |   |   |
| Long-term  debt, less current portion                                                                 |   | —        |      | 339,523 |   |
| Capital  lease obligations, less current portion                                                      |   | —        |      | 42,069 |   |
| Related  party lease obligation, less current portion                                                 |   | 3,472,661     |      | — |   |
| Total  liabilities                                                                                    |   | 6,440,850     |      | 4,065,186 |   |
|                                                                                                  |   |          |      |   |   |
| Shareholders’  equity (deficit):                                                                 |   |          |      |   |   |
| Preferred  stock, $.01 par value; 5,000,000 shares authorized; no shares issued and  outstanding      |   | —        |      | — |   |
| Common  stock; $.01 par value; 95,000,000 shares authorized; 7,843,834 shares issued  and outstanding |   | 78,438        |      | 78,438 |   |
| Additional  paid-in capital                                                                           |   | 16,613,337    |      | 16,362,050 |   |
| Deferred  stock-based compensation                                                                    |   | (4,610        | )         | (9,062 | ) |
| Accumulated  deficit                                                                                  |   | (17,073,095   | )         | (12,405,386 | ) |
| Total  shareholders’ equity (deficit)                                                            |   | (385,930      | )         | 4,026,040 |   |
| Total  liabilities and shareholders’ equity (deficit)                                            |   | $             | 6,054,920 |   | $ | 8,091,226 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

28

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**MedicalCV,Inc.**

**ConsolidatedStatemen****t of Operations**

 
|                                                                     |   | **Year ended April 30,** |       |
|--------------------------------------------------------------------------|--------|--------------------------|------------|
|                                                                     |   | **2003**                 |       | **2002** |   |
|                                                                     |   |                     |       |   |   |
| Net sales                                                                |   | $                        | 3,135,041  |   | $ | 2,982,198 |   |
| Cost of goods sold                                                       |   | 1,715,402                |       | 2,109,453 |   |
|                                                                     |   |                     |       |   |   |
| Gross profit                                                             |   | 1,419,639                |       | 872,745 |   |
|                                                                     |   |                     |       |   |   |
| Operating expenses:                                                      |   |                     |       |   |   |
| Sales and marketing                                                      |   | 2,864,747                |       | 2,089,104 |   |
| General and  administrative                                              |   | 1,926,418                |       | 1,594,968 |   |
| Engineering and  regulatory                                              |   | 876,686                  |       | 779,038 |   |
|                                                                     |   |                     |       |   |   |
| Total operating  expenses                                                |   | 5,667,851                |       | 4,463,110 |   |
|                                                                     |   |                     |       |   |   |
| Loss from operations                                                     |   | (4,248,212               | )          | (3,590,365 | ) |
|                                                                     |   |                     |       |   |   |
| Other (expense) income:                                                  |   |                     |       |   |   |
| Interest expense                                                         |   | (467,315                 | )          | (463,388 | ) |
| Interest income                                                          |   | 12,705                   |       | 47,414 |   |
| Loss from early extinguishment  of convertible subordinated bridge notes |   | —                   |       | (335,410 | ) |
| Other income, net                                                        |   | 35,113                   |       | 44,084 |   |
|                                                                     |   |                     |       |   |   |
| Total other expense                                                      |   | (419,497                 | )          | (707,300 | ) |
|                                                                     |   |                     |       |   |   |
| Net loss                                                                 |   | $                        | (4,667,709 | ) | $ | (4,297,665 | ) |
|                                                                     |   |                     |       |   |   |
| Basic and diluted net  loss per share                                    |   | $                        | (.60       | ) | $ | (.62 | ) |
|                                                                     |   |                     |       |   |   |
| Shares used in  computing basic and diluted net loss per share           |   | 7,843,834                |       | 6,980,820 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

29

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**MedicalCV, Inc.**

**Consolidated Stat****ements of Changes in Shareholders’ Equity (Deficit)**

 
|                                                                                                             |   |             |       |       |       | **Additional****Paid-inCapital** |       | **Deferred****Stock-BasedCompensation** |       | **(Accumulated****Deficit)** |       | **Total**  |       |
|------------------------------------------------------------------------------------------------------------------|--------|------------------|------------|------------|------------|----------------------------------|------------|-----------------------------------------|------------|------------------------------|------------|------------|------------|
|                                                                                                             |   | **Common Stock** |       |       |       |                             |       |
|                                                                                                             |   | **Shares**       |       | **Amount** |       |                             |       |                                    |       |
|                                                                                                             |   |             | ** ** |       | ** ** |                             | ** ** |                                    | ** ** |                         | ** ** |       | ** ** |
| **Total, April 30, 200****1**                                                                                    |   | 6,343,834        |       | $          | 63,438     |                             | $          | 10,490,378                              |       | $                            | (16,824    | )          | $          | (8,107,721 | ) | $ | 2,429,271 |   |
| Net loss                                                                                                         |   |             |       |       |       |                             |       |                                    |       | (4,297,665                   | )          | (4,297,665 | )          |
| Common stock issued, net of  issuance costs of $1,353,515                                                        |   | 1,500,000        |       | 15,000     |       | 5,381,485                        |       |                                    |       |                         |       | 5,396,485  |       |
| Warrants issued in connectionwith issuance of commonstock                                                        |   |             |       |       |       | 50                               |       |                                    |       |                         |       | 50         |       |
| Amortization of stock-basedcompensation                                                                          |   |             |       |       |       |                             |       | 7,762                                   |       |                         |       | 7,762      |       |
| Stock options issued to non-employees                                                                            |   |             |       |       |       | 69,844                           |       |                                    |       |                         |       | 69,844     |       |
| Discount on convertiblesubordinated bridge notes                                                                 |   |             |       |       |       | 497,125                          |       |                                    |       |                         |       | 497,125    |       |
| Warrants issued in connectionwith convertiblesubordinated bridge notes                                           |   |             |       |       |       | 500                              |       |                                    |       |                         |       | 500        |       |
| Repurchase of beneficialconversion feature relatedto early extinguishment ofconvertible subordinatedbridge notes |   |             |       |       |       | (77,332                          | )          |                                    |       |                         |       | (77,332    | )          |
| **Total, April 30, 200****2**                                                                                    |   | 7,843,834        |       | 78,438     |       | 16,362,050                       |       | (9,062                                  | )          | (12,405,386                  | )          | 4,026,040  |       |
| Net loss                                                                                                         |   |             |       |       |       |                             |       |                                    |       | (4,667,709                   | )          | (4,667,709 | )          |
| Amortization of stock-basedcompensation                                                                          |   |             |       |       |       |                             |       | 4,452                                   |       |                         |       | 4,452      |       |
| Stock options issued to non-employees                                                                            |   |             |       |       |       | 20,329                           |       |                                    |       |                         |       | 20,329     |       |
| Warrants issued in connection with sale-leaseback  transaction                                                   |   |             |       |       |       | 89,602                           |       |                                    |       |                         |       | 89,602     |       |
| Warrants issued in connection with short-term debt  with related party                                           |   |             |       |       |       | 128,995                          |       |                                    |       |                         |       | 128,995    |       |
| Warrants issued in connection with technology  purchase                                                          |   |             |       |       |       | 12,361                           |       |                                    |       |                         |       | 12,361     |       |
|                                                                                                             |   |             |       |       |       |                             |       |                                    |       |                         |       |       |       |
| **Total, April 30, 200****3**                                                                                    |   | 7,843,834        |       | $          | 78,438     |                             | $          | 16,613,337                              |       | $                            | (4,610     | )          | $          | (17,073,095 | ) | $ | (385,930 | ) |

 

The accompanying notes are an integral part of these financialstatements.

 

30

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**MedicalCV, Inc.**

**Consolidated State****ment of Cash Flows**

 
|                                                                                                                   |   | **Year  ended April 30,** |       |
|------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|------------|
|                                                                                                                   |   | **2003**                  |       | **2002** |   |
| Cash  flows from operating activities:                                                                                 |   |                      |       |   |   |
| Net  loss                                                                                                              |   | $                         | (4,667,709 | ) | $ | (4,297,665 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities:                                           |   |                      |       |   |   |
| Loss  on early extinguishment of convertible subordinated bridge notes                                                 |   | —                    |       | 335,410 |   |
| Depreciation                                                                                                           |   | 335,873                   |       | 290,049 |   |
| Amortization  of discount on convertible subordinated bridge notes                                                     |   | —                    |       | 84,383 |   |
| Provision  for doubtful accounts                                                                                       |   | 47,132                    |       | 133,360 |   |
| Return  of inventory                                                                                                   |   | (92,000                   | )          | — |   |
| Provision  for inventory obsolescence                                                                                  |   | —                    |       | 37,584 |   |
| Stock-based  compensation                                                                                              |   | 24,780                    |       | 77,606 |   |
| Warrants  issued in connection with technology purchase                                                                |   | 12,361                    |       | — |   |
| Interest  expense associated with warrant grants and other costs                                                       |   | 201,855                   |       | 222,191 |   |
| Changes  in assets and liabilities:                                                                                    |   |                      |       |   |   |
| Accounts  receivable                                                                                                   |   | (261,511                  | )          | (185,416 | ) |
| Inventories                                                                                                            |   | (368,078                  | )          | (188,084 | ) |
| Prepaid  expenses and other assets                                                                                     |   | (169,875                  | )          | 48,361 |   |
| Accounts  payable                                                                                                      |   | 305,885                   |       | 78,180 |   |
| Accrued  expenses                                                                                                      |   | 321,779                   |       | 177,236 |   |
|                                                                                                                   |   |                      |       |   |   |
| Net  cash used in operating activities                                                                                 |   | (4,309,507                | )          | (3,186,805 | ) |
|                                                                                                                   |   |                      |       |   |   |
| Cash  flows from investing activities:                                                                                 |   |                      |       |   |   |
| Purchase  of property, plant and equipment                                                                             |   | (128,960                  | )          | (384,024 | ) |
| Loan  to UROPACE                                                                                                       |   | —                    |       | (81,000 | ) |
|                                                                                                                   |   |                      |       |   |   |
| Net  cash used in investing activities                                                                                 |   | (128,960                  | )          | (465,024 | ) |
|                                                                                                                   |   |                      |       |   |   |
| Cash  flows from financing activities:                                                                                 |   |                      |       |   |   |
| Borrowings  on line of credit with related party                                                                       |   | 1,243,333                 |       | 1,570,000 |   |
| Borrowings  on short-term debt with related party                                                                      |   | 60,000                    |       | — |   |
| Principal  payments on short-term debt with related party                                                              |   | (360,000                  | )          |   |   |
| Principal  payments on bank line of credit                                                                             |   | —                    |       | (475,000 | ) |
| Principal  payments on other long-term debt                                                                            |   | (42,460                   | )          | (42,464 | ) |
| Proceeds  from sale-leaseback transaction with related party, net                                                      |   | 1,000,000                 |       | — |   |
| Borrowings  on bridge loans, net                                                                                       |   | —                    |       | 438,885 |   |
| Principal  payments on bridge loans                                                                                    |   | —                    |       | (500,000 | ) |
| Principal  payments under capital lease obligations                                                                    |   | (59,854                   | )          | (66,929 | ) |
| Issuance  of common stock, net of issuance costs                                                                       |   | —                    |       | 5,396,485 |   |
| Issuance  of warrants                                                                                                  |   | —                    |       | 550 |   |
|                                                                                                                   |   |                      |       |   |   |
| Net  cash provided by financing activities                                                                             |   | 1,841,019                 |       | 6,321,527 |   |
|                                                                                                                   |   |                      |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                                                                  |   | (2,597,448                | )          | 2,669,698 |   |
|                                                                                                                   |   |                      |       |   |   |
| Cash  and cash equivalents at beginning of year                                                                        |   | 2,781,675                 |       | 111,977 |   |
|                                                                                                                   |   |                      |       |   |   |
| Cash  and cash equivalents at end of year                                                                              |   | $                         | 184,227    |   | $ | 2,781,675 |   |
|                                                                                                                   |   |                      |       |   |   |
| Supplemental  disclosure of cash flow information:                                                                     |   |                      |       |   |   |
| Cash  paid during the year for:                                                                                        |   |                      |       |   |   |
| Interest                                                                                                               |   | $                         | 265,460    |   | $ | 241,197 |   |
| Income  taxes                                                                                                          |   | 250                       |       | 1,256 |   |
|                                                                                                                   |   |                      |       |   |   |
| Non-cash  investing and financing activities:                                                                          |   |                      |       |   |   |
| Capital  lease obligations incurred for the purchase of property, plant, and equipment                                 |   | —                    |       | 34,796 |   |
| Discount  on convertible subordinated bridge notes related to warrants and beneficial  conversion feature              |   | —                    |       | 497,125 |   |
| Repurchase  of beneficial conversion feature related to early extinguishment of  convertible subordinated bridge notes |   | —                    |       | 77,332 |   |
| Warrants  issued in connection with sale-leaseback transaction with related party                                      |   | 89,602                    |       | — |   |
| Payments/assumptions  of debt made in connection with the related party lease (See note 6):                       |   |                      |       |   |   |
| Assumption  of line of credit obligation by purchaser                                                                  |   | 2,500,000                 |       | — |   |
| Assumption  of Dakota Electric and Dakota County debt by purchaser                                                     |   | 336,105                   |       | — |   |

 

The accompanying notes are an integral part of these financialstatements.

 

31

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**MedicalCV, Inc.**

**Notes to Consolidate****d Financial Statements**

 

**1.****                                     ****Business Description**

 

MedicalCV, Inc. (the Company) is a corporation engagedin the manufacture and marketing of cardiothoracic surgery devices primarily inEurope, SouthAsia, the Middle East andthe Far East.  The primary product ofthe Company is a mechanical heart valve.

 

The Company’s consolidatedfinancial statements for the year ended April 30, 2003, have been prepared on agoing 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, 2003, the Company had anaccumulated deficit of $17,073,095, and had insufficient funds to meet therequirements of its short-term debt, and finance its working capital andcapital expenditure needs.  Accordingly,these matters raise substantial doubt about the Company’s ability to continueas a going concern.  The Company iscurrently pursuing the refinancing of its short-term debt and seeking otherfinancing to fund its operations and working capital requirements.  If the Company is unable to refinance itsshort-term debt and obtain funds beginning in September 2003, it will berequired to significantly revise its business plans and drastically reduceoperating expenditures such that it may not be able to develop or enhance itsproducts, gain market share in the United States or respond to competitivepressures or unanticipated requirements, which could seriously harm itsbusiness, financial position and results of operations.

 

The Company is subject to risks and uncertaintiescommon to medical technology-based companies, including rapid technologicalchange, dependence on one principal product, new product development andacceptance, actions of competitors, dependence on key personnel and UnitedStates market penetration.

 

**2.****                                      Summaryof Significant Accounting Policies**

 

**Principles of Consolidation**

 

The Company’s consolidated financial statementsinclude the accounts of MedicalCV, Inc. and its wholly-owned subsidiaries, CVHoldings, Inc., which was liquidated in fiscal year 2002, and CVDInternational, Inc., which was liquidated in fiscal year 2003 with no materialimpact to the financial statements.  Allsignificant intercompany transactions and balances have been eliminated inconsolidation.

 

**Use of Estimates**

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.

 

**Fair Value of Financial Instruments**

 

The Company’s financial instruments consist primarilyof cash and cash equivalents, trade accounts receivable and accounts payablefor which the current carrying amounts approximate fair value.  Additionally, the borrowing rates currentlyavailable to the Company approximate current rates for debt agreements withsimilar terms and average maturities.

 

**Cash and Cash Equivalents**

 

Cash and cash equivalents consist of checking accountsand a money market account, all of which are held in two depositoryinstitutions.  The Company considers allhighly-liquid investments with originalmaturities of three months or less to be cash equivalents.  The carrying value of cash equivalentsapproximates fair value because of the short maturity of these instruments.  The majority of the Company’s cash and cash equivalents are held intwo financial institutions.  Deposits inthese institutionsmay exceed the amount of federal insurance provided on such deposits.

 

32

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**Inventories**

 

Inventories consist of various mechanical heart valvesand other medical items that are stated at the lower of cost or market, withcost determined utilizing standard costs, which approximate the first-in,first-out method of inventory valuation.

 

**Property, Plant and Equipment**

 

Property, plant and equipment is stated at cost.  Depreciation and amortization is computedusing the straight-line method over the estimated useful lives of the relatedassets.  The building is depreciatedover a 30-year life.  Machinery andequipment, furniture and fixtures, and tooling and software are depreciatedover five-year lives.  Maintenance andrepairs are charged to current operations when incurred.  The cost and related accumulateddepreciation or amortization of assets disposed of are removed from the relatedaccounts and any resulting gains or losses are recorded to the statement ofoperations.

 

**Long-Lived Assets**

 

The Company periodically evaluates the carrying valueof long-lived assets to be held and used, including but not limited to, capitalassets and intangible assets, when events and circumstances warrant such areview.  The carrying value of along-lived asset is considered impaired when the anticipated undiscounted cashflow from such asset is separately identifiable and is less than its carryingvalue.  In that event, a loss isrecognized based on the amount by which the carrying value exceeds the fairvalue of the long-lived asset.  Fairvalue is determined primarily using the anticipated cash flows discounted at arate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in asimilar manner, except that fair values are reduced for the cost todispose.  No losses from impairment havebeen recognized in the financial statements.

 

**Revenue Recognition**

 

The Company recognizes revenues from the sale of its mechanical heart valvesprovided that the Company has received a purchase 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 sales upon shipment.  The Company’s products are not subject toany customer acceptance process.  Thereare no rights of return unless the product does not perform according tospecifications.

 

**Research and Development**

 

Research and development costs are expensed asincurred.

 

**Stock-Based Compensation**

 

The Company accounts for stock-based employeecompensation arrangements in accordance with the provisions of AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” and complies with the disclosure provisions of SFAS No. 123,“Accounting for Stock-Based Compensation” and SFAS No. 148 “Accounting forStock-Based Compensation-Transition and Disclosure, an amendment of FASBStatement No. 123.”

 

The Company has adopted the disclosure-only provisionsof SFAS No. 123.  For purposes ofthe 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’sstock options been recognized based on the fair value at the grant dateconsistent with the provisions of SFAS No. 123, the Company’s net losswould have been adjusted to the pro forma amounts indicated below:

 

33

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|                                                                                               |   | **For the Years Ended April 30,** |       |
|----------------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                               |   | **2003**                          |       | **2002** |   |
| Net  loss reported                                                                                 |   | $                                 | (4,667,709 | ) | $ | (4,297,665 | ) |
| Less:  stock-based employee compensation benefit  included in operating results, as reported: |   | —                            |       | — |   |
| Less:  Pro forma stock based employee compensation  (cost) benefit                            |   | (294,142                          | )          | (951,779 | ) |
|                                                                                               |   |                              |       |   |   |
| Net  loss - pro forma                                                                              |   | (4,961,851                        | )          | (5,249,444 | ) |
|                                                                                               |   |                              |       |   |   |
| Net  loss per common share – basic and diluted                                                |   |                              |       |   |   |
| As  reported                                                                                       |   | (.60                              | )          | (.62 | ) |
| Pro  forma                                                                                         |   | (.63                              | )          | (.75 | ) |
|                                                                                                    |        |                                   |            |  |  |  |  |

 

**Income Taxes**

 

Deferred income taxes are recorded to reflect the taxconsequences on future years of differences between the tax bases of assets andliabilities and their financial reporting amounts at each year-end, based onenacted tax laws and statutory tax rates applicable to the periods in which thedifferences are expected to affect taxable income.  Deferred tax assets are reduced by a valuation allowance when, inthe opinion of management, it is more likely than not that some portion or allof the deferred tax asset will not be realized.  Income tax expense or benefit is the tax payable or refundablefor the year and the change during the year in deferred tax assets andliabilities.

 

**Comprehensive Income (Loss)**

 

Comprehensive income(loss) includes net income (loss) and items defined as other comprehensiveincome (loss).  Items defined as othercomprehensive income (loss) include items such as foreign currency translationadjustments and unrealized gains and losses on certain marketable securities.  For the years ended April 30, 2003 and 2002,there were no adjustments to net loss to arrive at comprehensive loss.

 

**Concentration of Credit Risk**

 

At April 30, 2003 and2002, approximately 38 percent and 54 percent, respectively, ofthe Company’s accounts receivable were due from one distributor thatindividually accounted for 10percent or more of the Company’s trade accounts receivable ineach respective fiscal year (see Note 13). The Company generally requires no collateral from its customers withrespect to trade accounts receivable. The Company maintains an allowance for doubtful accounts based upon itshistorical experience and the expected collectibility of all accountsreceivable.

 

**Net Income (Loss) Per Share**

 

Net income (loss) pershare is computed under the provisions of SFAS No. 128, “Earnings PerShare.”  Basic net income (loss) percommon share is computed using net income (loss) and the weighted-averagenumber of shares of common stock outstanding. Diluted earnings per share reflect the potential dilution of securitiesthat could share in the earnings of an entity. Diluted net loss per common share does not differ from basic net lossper common share in the years ended April 30, 2003 and 2002 since 4,300,940 and 3,551,390,respectively, of potential dilutive shares of common stock from the exercise ofstock options and warrants were excluded from the computation because they areanti-dilutive.

 

**Reclassifications**

 

Certainamounts previously reported have been reclassified to conform to the fiscalyear 2003presentation.  These reclassificationshad no effect on net loss, cash flows or shareholders’ equity as previously reported.

 

**New Accounting Pronouncements**

 

In June 2002, the FASB issuedSFAS No. 146, “Accounting for Exit or Disposal Activities.”  The new statement addresses the accountingfor costs associated with exit or disposal activities.  The provisions of the statement wereeffective for disposal activities initiated after December 31, 2002.  The adoption of SFAS No. 146 did not have animpact on the Company’s financial position or results of operations.  The new standard principally affects theCompany’s timing of when charges are recorded as opposed to the amount of theultimate charge.  There have been noexit or disposal activities subsequent to December 31, 2002.

 

34

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The Company adopted theprovisions of FASB Interpretation No. 45, “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others” in the third quarter of fiscal year 2003.  The disclosure provisions of theinterpretation are effective for the Company’s financial statements for thethird quarter of fiscal year 2003.  Theprovisions for initial recognition and measurement are effective on aprospective basis for guarantees that are issued or modified after December 31,2002.  The implementation of thisaccounting pronouncement did not have a material effect on the Company’sresults of operations, financial position or cash flows.

 

In December2002, the FASB issuedSFAS No. 148, “Accountingfor Stock-Based Compensation - Transition and Disclosure — an amendment of FAS 123.” SFAS No. 148 provides alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation and amends certain disclosurerequirements of SFAS No. 123. The transition provisions ofthis statement areeffective for fiscal years ending after December 15, 2002, and the disclosurerequirements of thisstatement are effective for interimperiods beginning after December 15, 2002.  TheCompany currently plans to continue to apply the intrinsic-value based methodto account for stock options. The Company implemented the year-end disclosure provisions included inNote 2 as of April 30, 2003 and will implement the interim period disclosureprovisions in the quarter ending July 31, 2003.

 

In January 2003, the FASB issued FIN No. 46,“Consolidation of Variable Interest Entities, an interpretation of AccountingResearch Bulletin No. 51.” FIN No. 46 requires certain variable interestentities (VIEs), to be consolidated by the primary beneficiary of the entity ifthe equity investors in the entity do not have the characteristics of acontrolling financial interest or do not have sufficient equity at risk for theentity to finance its activities without additional subordinated financialsupport from other parties.  FIN No. 46is effective for all VIEs created or acquired after January 31, 2003.  For VIEs created or acquired prior to February1, 2003, the provisions of FIN No. 46 must be applied for the first interim orannual period beginning after June 15, 2003. The Company currently has no contractual relationship or other businessrelationship with a VIE and therefore the adoption of FIN No. 46 did not have amaterial effect on its consolidated financial position, results of operationsor cash flows.  However, should theCompany enter into any such arrangement with a VIE in the future, its consolidatedfinancial position or results of operations may be adversely effected

 

**3.****                                      SupplementalFinancial Statement Information**

 

Certain balance sheetcomponents consist of the following at April 30:

 

| **Trade Accounts Receivable, Net** |   | **2003**  |       | **2002** |       |
|------------------------------------|--------|-----------|------------|----------|------------|
|                               |   |      | ** ** |     | ** ** |
| Related  parties                   |   | $         | 557,899    |     | $          | 700,581 |   |
| Other                              |   | 1,028,391 |       | 756,692  |       |
| Allowance  for doubtful accounts   |   | (113,295  | )          | (198,657 | )          |
|                               |   |      |       |     |       |
|                               |   | $         | 1,472,995  |     | $          | 1,258,616 |   |

 

| **Inventories** |   | **2003**  |      | **2002**  |   |
|-----------------|--------|-----------|-----------|-----------|--------|
|            |   |      |      |      |   |
| Raw  materials  |   | $         | 377,961   |      | $      | 436,855 |   |
| Work-in-process |   | 529,668   |      | 551,561   |   |
| Finished  goods |   | 1,874,984 |      | 1,334,119 |   |
|            |   |      |      |      |   |
|            |   | $         | 2,782,613 |      | $      | 2,322,535 |   |

 

35

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| **Property, Plant and Equipment, Net**     |   | **2003**   |      | **2002**   |   |
|--------------------------------------------|--------|------------|-----------|------------|--------|
|                                       |   |       |      |       |   |
| Land                                       |   | $          | 182,000   |       | $      | 182,000 |   |
| Building                                   |   | 1,251,601  |      | 1,225,190  |   |
| Machinery  and equipment                   |   | 1,558,442  |      | 1,512,611  |   |
| Furniture  and fixtures                    |   | 182,243    |      | 177,513    |   |
| Tooling                                    |   | 116,363    |      | 100,263    |   |
| Software                                   |   | 146,159    |      | 112,271    |   |
|                                       |   |       |      |       |   |
|                                       |   | 3,438,808  |      | 3,309,848  |   |
|                                       |   |       |      |       |   |
| Accumulated  depreciation and amortization |   | (2,070,568 | )         | (1,734,695 | )      |
|                                       |   |       |      |       |   |
|                                       |   | $          | 1,368,240 |       | $      | 1,575,153 |   |

 

**4.****                                      Returnof Inventory**

 

During the quarter ended July31, 2002, the Company obtained inventories from two former internationaldistributors with an original cost to the Company of approximately$92,000.  The heart valves were sold tothese customers during fiscal year 2000 and the first half of fiscal year2001.  Due to financial difficultiesexperienced by these distributors, the Company provided allowances for theremaining uncollected accounts receivable balances in fiscal years 2001 and2002.  The Company did not anticipatethe return of these products at the time the uncollectible accounts wereestablished.  Upon obtaining title tothe heart valves from these former distributors during the quarter ended July31, 2002, the Company increased its inventories and reduced cost of goods soldby its original cost of $92,000.

 

**5.****                                      Short-termDebt with Related Party**

 

In January 2003, the Company established adiscretionary line of credit with PKM Properties, LLC (PKM), an entitycontrolled by Paul K. Miller.  Mr.Miller serves on the Company’s Board of Directors and is its largestshareholder.  This line of creditinitially matured on  April 17,2003.  On April 15, 2003, the maturitydate was extended to September 17, 2003. As of April 30, 2003, the Company hadborrowed $943,333 under the line of credit.  Inaddition, the Company incurred direct financing costs of $67,828, which wereamortized to interest expense over the original three-month life of the line ofcredit.  The line of credit bearsinterest at the higher of 7 percent or 1 percent above a bank reference rate (7percent is the rate in effect as of April 30, 2003).  PKM was issued a second mortgage on the Company’s real estate anda security interest in all remaining assets.

 

In connection with the line of credit, the Companyalso issued a warrant to PKM with a five-year term to purchase 350,000 sharesof the Company’s common stock at an exercise price of $0.596 per share.  The allocated fair value of the warrants was$128,995 using the Black-Scholes valuation model and using assumptionsconsistent with those disclosed in Note 10 and was accounted for as adiscount on the borrowings under the line of credit.  This discount was amortized to interest expense over the originalthree-month life of the line of credit. As of April 30, 2003, the discount was fully amortized.

 

The Company also received a $60,000 unsecured advancein December 2002 from an executive officer to fund working capitalrequirements.  This loan was repaid infull in early April 2003.

 

**6.****                                      RelatedParty Lease Obligation**

 

On April 4, 2003, the Company sold its corporateheadquarters and manufacturing facility and surrounding land in Inver GroveHeights, Minnesota, to PKM (see Note 5 for additional information on PKM).

 

In connection with the transaction, the Companyreceived total consideration of $3.84 million consisting of (1) $1.0 million incash, (ii) PKM’s assumption of the Company’s $2.5 million outstandingindebtedness to Associated Bank (see Note 6), and (iii) PKM’s assumption of theCompany’s promissory note with Dakota Electric Association and land specialassessments payable to Dakota County aggregating $336,105.   Also in connection with the transaction, theCompany issued to PKM a five-year warrant for the purchase of 350,000 shares ofthe Company’s common stock at an exercise price of $0.625 per share.   These warrants had an allocated fair valueof $89,602 using the Black-Scholes valuation model and using assumptionsconsistent with those disclosed in Note 10.

 

36

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Simultaneous with thesale of the facility, the Company entered into a lease with PKM to lease backthe facility and a portion of the land. The lease has a ten-year initial term with options for the Company toextend the lease up to ten additional years. Under certain conditions, the Company also has an option to purchase thebuilding at the end of the initial ten-year term at the fair value at thattime.

 

Due to the Company’s continued involvement with theproperty including the ability to buy back the property at a future date, thetransaction is accounted for as a financing of the property sold and leasedback.  Accordingly, the net book valueof the facility and land sold to PKM with a net book value of $759,146 (grossvalue of $1,433,601 net of accumulated depreciation of $674,455) continues tobe presented as part of the Company’s property, plant and equipment balance(see Note 3).  The related party leaseobligation of $3,779,100 represents the minimum amounts due PKM for the initialten year term discounted at 4.4 percent and additional payments to be paid toPKM for the Dakota Electric Association and Dakota County obligations assumedby PKM.

 

Scheduled maturities of the related party leaseobligation is as follows:

 
| **Year Ending April 30,** |   | **Amount** |       |
|---------------------------|--------|------------|------------|
|                      |   |       | ** ** |
| 2004                      |   | $          | 273,843    |   |
| 2005                      |   | 285,154    |       |
| 2006                      |   | 307,675    |       |
| 2007                      |   | 320,327    |       |
| 2008                      |   | 333,473    |       |
| Thereafter                |   | 2,226,032  |       |
|                      |   |       |       |
|                      |   | $          | 3,746,504  |   |

 

**7.****                                      Long-Term Debt and Convertible Subordinated BridgeNotes**

 

Long-term debts consist of the following at April30:

 
|                                                                                                                                                                                                                                    |   | **2003** |   | **2002**   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|------------|--------|
|                                                                                                                                                                                                                                    |   |     |   |       |   |
| Revolving  credit line with Associated Bank, interest payable monthly with the principal  due November 2002, collateralized by the Company’s real estate and other  business assets excluding accounts receivable                  |   | $        | — |       | $      | 2,500,000 |   |
|                                                                                                                                                                                                                                    |   |     |   |       |   |
| Promissory  note with Dakota Electric Association, principal and interest due in monthly  installments through May 2009, interest at 5.75%, collateralized by the  Company’s lighting equipment and rooftop air-conditioning units |   | —   |   | 165,983    |   |
|                                                                                                                                                                                                                                    |   |     |   |       |   |
| Land  special assessments payable to Dakota County, principal and interest due in  semi-annual installments through May 2010, interest at 8%                                                                                            |   | —   |   | 216,000    |   |
|                                                                                                                                                                                                                                    |   |     |   |       |   |
|                                                                                                                                                                                                                                    |   | —   |   | 2,881,983  |   |
|                                                                                                                                                                                                                                    |   |     |   |       |   |
| Less  current maturities                                                                                                                                                                                                                |   | —   |   | (2,542,460 | )      |
|                                                                                                                                                                                                                                    |   |     |   |       |   |
|                                                                                                                                                                                                                                    |   | $        | — |       | $      | 339,523 |   |

 

On November 23, 1999, the Company obtained a $2,500,000 revolving creditline with Associated Bank.  The line ofcredit was due November 23, 2002, and was collateralized by the Company’s realestate and other business assets,excluding accounts receivable.  Inaddition, a shareholder and amember of the Board of Directors of the Company provided a $2,000,000 personal guaranteeand pledged marketable securities with a guaranteed value of $1,100,000 to supportrepayment of borrowings on the credit line. Interest was required to be paid monthly and accrued at the Wall StreetJournal Prime Rate.  The interest rateat April 30, 2002 was 4.75 percent.  As part of the credit agreement, the Companywas formerly required to maintain a minimumtangible net worth of not less than $3,000,000 on a quarterly basis.  On April 4, 2003, the Company’s outstandingobligation under this credit line was assumed by the buyer in connection withthe sale of the Company’s headquarters and manufacturing facility (see Note6).  Accordingly, as of April 30, 2003,the line of credit was repaid in full and closed.

 

37

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In connection with the sale of the Company’s corporateheadquarters and manufacturing facility (see Note 6) the promissory note withDakota Electric and the land special assessments payable to Dakota County wereassumed by the purchaser of the property.

 

**Convertible Subordinated Bridge Notes**

 

On August 21, 2001, the Company sold units of convertiblesubordinated bridge notes with an aggregate principal amount of $500,000 andredeemable warrants to purchase an aggregate of 500,000 shares of the Company’scommon stock for total proceeds of $500,500. Each unit consisted of a $25,000 principal amount 10 percent convertiblesubordinated bridge note and redeemable warrants to purchase 25,000 shares ofthe Company’s commonstock at a price of $6.50 per share. The notes wereunsecured and were due in August 2002. The Company had the option to prepay the notes without premium orpenalty.

 

The allocated fair value of the warrants of $308,236 and the valueof the beneficial conversion feature of $188,889 as of August 21, 2001 wasaccounted for as a discount on the convertible subordinated bridge notes.  This discount, which was presented as a reduction of the facevalue of the Notes on the consolidated balance sheet, wasfully amortized as part of interest expense over the one-yearlife of the Notes using the effective interest method.

 

During the fourth quarter of 2002, the Company early extinguishedthe convertible subordinated bridge notes. On the date ofextinguishment, $77,332 of the remaining discount, representing the repurchaseof the beneficial conversion feature, was treated as a reduction of AdditionalPaid-in Capital with the balance of the discount of $335,410 being charged toother expense.

 

**8.****                                      Leases**

 

**Operating Leases**

 

The Company leased certain manufacturing equipmentunder various operating lease agreements which expired at various dates infiscal year 2003.  At the end of thelease terms, the Company has the option to renew the leases, purchase theequipment at fair value, or return the equipment.

 

Rental expense under operating leases was $21,935 and$66,874 in fiscal years 2003 and 2002, respectively.

 

**Capital Leases**

 

The Company leases certain manufacturing equipmentunder various capital leases.  Theequipment is leased under agreements expiring through fiscal year 2004 withimplicit interest rates ranging from 8.9 percent to 10.0 percent. The Company may elect to purchase the equipment under bargain purchaseoptions at the end of the lease terms. The leases are collateralized by the underlying equipment with a totalcost of $181,420 and accumulated amortization of $125,998 and $89,714 at April 30, 2003 and2002, respectively.

 

As of April 30, 2003, remaining scheduled leasepayments under capital lease obligations continue into fiscal year 2004 andaggregate $42,069 (net of interest portion of $1,799).

 

38

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**9.****                                      Income Taxes**

 

The components ofdeferred income tax assets at April 30 are as follows:

 
|                                               |   | **2003**   |      | **2002**   |   |
|----------------------------------------------------|--------|------------|-----------|------------|--------|
|                                               |   |       |      |       |   |
| Federal  net operating loss carryforwards          |   | $          | 4,706,100 |       | $      | 3,863,200 |   |
| Research  and experimentation credit carryforwards |   | 524,200    |      | 524,200    |   |
| State  net operating loss carryforwards            |   | 243,400    |      | 245,800    |   |
| Other  carryforwards                               |   | 76,700     |      | 78,800     |   |
| Inventories                                        |   | 57,200     |      | 86,000     |   |
| Allowance  for uncollectible accounts              |   | 118,400    |      | 147,400    |   |
| Property,  plant and equipment                     |   | 80,600     |      | 44,900     |   |
| Accrued  expenses and other                        |   | 15,300     |      | 37,400     |   |
|                                               |   |       |      |       |   |
| Total  deferred tax assets                         |   | 5,821,900  |      | 5,027,700  |   |
|                                               |   |       |      |       |   |
| Valuation  allowance                               |   | (5,821,900 | )         | (5,027,700 | )      |
|                                               |   |       |      |       |   |
| Net  deferred tax asset                            |   | $          | —    |       | $      | — |   |

 

TheCompany has established valuation allowances to fully offset tax assets due to theinherent uncertainty of predicting the sufficiency of future taxable incomenecessary to realize these deferred tax assets, particularly in light of theCompany’s recent history of significant operating losses.  In addition, future utilization of availablenet operating loss carryforwards may be limited under Internal Revenue Code 382as a result of future changes in ownership.

 

The Company’s federal net operating loss carryforwardsof approximately $11,362,327 and state net operating loss carryforwards of$4,190,389 expire in fiscal years 2013 through 2023.  Available research and experimentation credits at April 30, 2003represent federal and state amounts of $354,603 and $111,930, respectively, with expiration datesin fiscal years 2010 through 2021.

 

The reconciliation of the U.S. statutory federalincome tax rate with the effective rate for the years ended April 30, 2003and 2002, is as follows:

 
|                                                               |   | **2003** |       | **2002**  |       |
|--------------------------------------------------------------------|--------|----------|------------|-----------|------------|
|                                                               |   |     | ** ** |      | ** ** |
| Tax  benefit at statutory rate                                     |   | $        | (1,475,500 | )         | $          | (1,355,000 | ) |
|                                                               |   |     |       |      |       |
| Research  and experimentation tax credits                          |   | —   |       | (55,200   | )          |
| State  taxes, net of federal benefit                               |   | (50,200  | )          | (76,300   | )          |
| Nondeductible  expenses                                            |   | 24,200   |       | (97,700   | )          |
| Gain  on sale of corporate headquarters and manufacturing facility |   | 718,800  |       | —    |       |
| Other                                                              |   | (11,500  | )     | (12,600   | )          |
| Change  in valuation allowance                                     |   | 794,200  |       | 1,596,800 |       |
|                                                               |   |     |       |      |       |
| Total  income tax (benefit) provision                              |   | $        | —     |      | $          | — |   |

 

**10.****                               Shareholders’Equity**

 

**Common Stock**

 

On January 25, 2001, the Company gave a stock bonus of15,000 shares of the Company’s common stock to an officer of the Company.  The estimated fair value of the shares of$42,000 was recorded as a general and administrative expense.

 

On November27, 2001, the Company closed on its initial public offering.  In connection with the initialpublic offering, the Company issued1,500,000 units at a price of $4.50 per unit for gross proceeds of$6,750,000.  After offering costs, theCompany received net proceeds of $5,396,485. Each unit consisted of one share of common stock and one redeemableClass A Warrant.  Each Class A Warrantbecame exercisableand separable from thecommon stock on May 20, 2003.  The holder of each Class AWarrant is entitled to purchase, atany time until November 20, 2004, one share of common stock at an exerciseprice of $6.50 per share, subject to customary anti-dilution adjustments.  The Company may redeem the

 

39

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Class A Warrants for $0.01 per warrant atany time,  upon ten business days’ written notice, if the closing price ofthe Company’s commonstock or units exceeds $8.50, subject to customary anti-dilution adjustments,for any ten consecutive trading days before such notice.

 

**Stock Options**

 

The Company has authorized the issuance of stockoptions for the aggregate purchase of 2,653,034 shares of common stock undervarious plans covering certain employees, members of the Board of Directors andcertain independent contractors approved by the Board of Directors.  Options are typically granted at prices notless than fair market value at the date of grant.  Options generally become exercisable between one to three yearsafter grant date and have a maximum term of three to ten years depending on theplan.

 

The following is a summary of stock option activitywith respect to the Company’s various plans and includes option activity foremployees, directors and non-employees:

 

|                         |   | **Options** |   | **Weighted  Average  Exercise Price  Per Share** |   |
|------------------------------|--------|-------------|--------|--------------------------------------------------|--------|
|                         |   |        |   |                                             |   |
| Outstanding,  April 30, 2001 |   | 455,140     |   | $                                                | 3.03   |   |
|                         |   |        |   |                                             |   |
| Granted                      |   | 591,250     |   | 3.79                                             |   |
| Expired                      |   | (5,000      | )      | 5.00                                             |   |
|                         |   |        |   |                                             |   |
| Outstanding,  April 30, 2002 |   | 1,041,390   |   | $                                                | 3.46   |   |
|                         |   |        |   |                                             |   |
| Granted                      |   | 179,500     |   | .75                                              |   |
| Expired                      |   | (134,950    | )      | 3.89                                             |   |
|                         |   |        |   |                                             |   |
| Outstanding,  April 30, 2003 |   | 1,085,940   |   | $                                                | 2.98   |   |

 

At April 30, 2003 and 2002, 603,034 and 655,534 options, respectively, were available for grant under theCompany’s stockoption plans.  On August 9, 2001, theCompany’sshareholders approved the 2001 Equity Incentive Plan (2001 Plan) and reserved500,000 shares of common stock for issuance upon exercise of stock options tobe granted under the 2001 Plan to employees, officers, consultants, advisors,employee and non-employee directors 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 common stock on such date, unless theBoard of Directors sets the increase at a lower number of shares.  On January 1, 2003, the number of shares available under the 2001 Plan increased by 274,534shares pursuant to the foregoing provision.

 

The following table summarizes information about stockoptions outstanding and exercisable at April 30, 2003:

 
|                          |   | **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** |   |
|                          |   |                    | ** ** |                                                        | ** ** |   | ** ** |   | ** ** |   | ** ** |
| $0.51  – $0.98           |   | 179,500                 |       | 7.45                                                        |       | $ | 0.74 |   | 67,500 |   | $ | 0.78 |   |
| $2.36  – $5.00           |   | 906,440                 |       | 3.69                                                        |       | $ | 3.43 |   | 649,144 |   | $ | 3.74 |   |
|                          |   | 1,085,940               |       |                                                        |       |   |   | 716,644 |   |   |   |

 

During the yearsended April 30, 2003 and 2002, the Company issued fully vested, four and five-yearoptions to purchase an aggregate of 42,500 and 37,500 shares of the Company’s common stock at exercise prices of $0.51 to $0.87 and $2.53 to $4.50 per share, respectively, to certain non-employees whoprovided technical advisory services to the Company.  The aggregate fair value of the options using the Black-Scholesvaluation model was $20,329 and $69,844 and were fully expensed in fiscal years 2003 and 2002. The following assumptionswere used to value the options for the years endedApril 30, 2003 and 2002:

 

40

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|                    |   | **200****3**  |   | **200****2**  |   |
|-------------------------|--------|---------------|--------|---------------|--------|
| Dividend yield rate     |   | 0 percent     |   | 0 percent     |   |
| Risk free interest rate |   | 3.26 percent  |   | 4.71 percent  |   |
| Expected life           |   | 4 to 10 years |   | 4 to 10 years |   |
| Volatility              |   | 85 percent    |   | 85 percent    |   |

 

Deferredcompensation relating to stock options granted with exercise prices below fair value during the year ended April 30, 2001 was$20,075.  Such deferred compensationwill be amortized over the vesting periods of the related stock options, whichgenerally range from three to five years. This compensation is recognized on an accelerated basis in accordancewith FASB Interpretation (FIN) No. 28. Compensation expense relating to stock options granted below fair marketvalue of $4,452 and $7,762 was recognized during the years endedApril 30, 2003 and2002.

 

During the yearended April 30, 2003, for purposes of determining fair valueusing the Black-Scholes option pricing model as prescribed by SFAS No. 123, theCompany used the contractual life of the options as the expected holding periodfor employees and the life of the options for directors.  Therisk-free interest rate for 2003 was 3.26 percent, the dividend yield used was 0 percent and thevolatility factor was 85 percent.

 

During the yearended April 30, 2002, for purposes of determining fair value using theBlack-Scholes option pricing model as prescribed by SFAS No. 123, the Companyused the contractual life of the options as the expected holding period foremployees and the life of the options for directors.  The risk-free interest rate for 2002 was 4.71 percent, the dividend yield used was0 percent and the volatility factor was 85 percent.

 

**Stock Warrants**

 

At April 30, 2003and 2002, the Companyhad outstanding and exercisable warrants to purchase 3,215,000 and 2,510,000 shares, respectively, of the Company’s common stock at prices ranging from $0.60 to $6.75 per share.  Thewarrants expire at various dates through April 4, 2008. At April 30, 2003 and 2002, theweighted average remaining contractual life of the warrants was 1.68 and 3.14 years and the weighted average exercise price of thewarrants was $4.58and $5.91,respectively.

 

In January 2003, the Company entered into adiscretionary credit line with PKM (see Note 5 for additional information onPKM).  In connection with thisdiscretionary credit line, the Company issued fully vested five-year warrantsto purchase a total of 350,000 shares of common stock exercisable at $0.596 pershare.  The Company also completed arefinancing transaction in which its headquarters facility was sold in asale-leaseback transaction to this same entity in April 2003.  As part of the transaction the Companyissued an additional five-year warrant to purchase 350,000 shares of common stockat $0.625 per share.

 

The fair value of the warrants was calculated usingthe Black-Scholes valuation model and $218,597 was capitalized as deferredfinancing costs in fiscal year 2003. The deferred financing costs are being amortized to interest expenseover the life of the discretionary credit line and property lease,respectively.  The following assumptionswere used to value the warrants: dividend yield 0 percent, risk free interest rate of 3.03 percent,expected life equal to the contractual term of five years and volatility of 85percent.  As of April 30, 2003, theremaining balance of deferred financing costs was $89,602.

 

In November 1999 and December 2000, the Company issuedfully vested four-year warrants to purchase an aggregate of 100,000 shares ofcommon stock exercisable at $2.00 per share to a board member in connectionwith a bank line of credit guarantee. The fair value of the warrants was calculated using the Black-Scholesvaluation model and $76,622 was capitalized as deferred financing costs infiscal year 2001.  The deferredfinancing costs are being amortized to interest expense on a straight-linebasis over the life of the guarantee. The following assumptions were used to value the warrants:  dividend yield of 0 percent, risk-free interest rate of 5.69 percent, expected lifeequal to the contractual life of four years and volatility of 69 percent.  At April 30, 2003, the balance was fully amortized.

 

**11.****                               Research and Development Costs**

 

Research andDevelopment costs principally consist of engineering costs,included as part of engineering and regulatory in the Consolidated Statement ofOperations, totaled $558,141 and$491,278for the fiscal yearsended April 30, 2003 and 2002, respectively.  Research andDevelopment costs relate primarily to product and process developmentinitiatives.

 

41

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**12.****                               SupplyAgreement**

 

In July 1998, the Company entered into a three-yearsupply agreement with Snia S.p.A. Carbomedics, Inc. (Carbomedics), the sourceof certain raw material components associated with the manufacture of certainof the Company’s heart valves.  Thesupply agreement was extended for an additional two years in March 2001, andexpires December 31, 2003. 

 

This agreement providesthat the Company purchase a minimum number of raw material units each calendaryear through 2003.  Under the terms ofthe agreement, the Company is required to compensate Carbomedics for anypurchase shortfalls up to a maximum of $200,000 per year.  The Company has not met the minimum purchase requirement for the last three calendar yearsand does not believe it will meet the minimum purchase requirement for calendaryear 2003.  As a result, the Companyexpensed $138,738 and $148,991 relatedto these purchase shortfalls to cost of goods sold in fiscalyears 2003 and 2002, respectively.

 

**13.****                               Segment and Related PartyInformation**

 

The Company views its operations and manages itsbusiness as one segment, the manufacturing and marketing of cardiothoracicsurgery devices.  Factors used toidentify the Company’s single operating segment include the organizationalstructure of the Company and the financial information available for evaluationby the chief operating decision maker.The following table summarizes net sales by geographic area:

 

|         |   | **For the Years Ended  April 30,** |      |
|--------------|--------|------------------------------------|-----------|
|         |   | **2003**                           |      | **2002** |   |
|         |   |                               |      |   |   |
| Europe       |   | $                                  | 1,949,313 |   | $ | 1,938,847 |   |
| South  Asia  |   | 414,455                            |      | 488,940 |   |
| Middle  East |   | 420,765                            |      | 209,346 |   |
| Far  East    |   | 60,348                             |      | 306,735 |   |
| Other        |   | 290,160                            |      | 38,330 |   |
|         |   |                               |      |   |   |
| Total        |   | $                                  | 3,135,041 |   | $ | 2,982,198 |   |

 

At April30, 2003 and 2002, substantially all of the Company’s operationsand assets are based in the United States.

 

The Company distributes its products primarily throughdistributor organizations that, in turn, market the product directly to medicalinstitutions.  One of these distributorsis a shareholder of the Company with an ownership interest of approximately 6.6percent.  An affiliate of this shareholder distributoris also a member of the Company’s Board of Directors.  Sales to distributors that individually account for 10 percent or more of theCompany’s net sales in each respective fiscal year are as follows:

 

|                            |   | **2003** |       | **2002** |       |
|---------------------------------|--------|----------|------------|----------|------------|
|                            |   |     | ** ** |     | ** ** |
| Distributor  #1 (related party) |   | $        | 973,600    |     | $          | 1,421,960 |   |
| Distributor  #2                 |   | 363,465  |       | 443,940  |       |
| Distributor  #3                 |   | 583,800  |       | 341,800  |       |
| Distributor  #4                 |   | 348,000  |       | 101,372  |       |
|                                 |        |          |            |          |            |  |  |

 

Accounts receivable fromthe above related party distributor at April 30, 2003 and 2002totaled $557,899 and$685,365, respectively.

 

**14.****                               Spin-offof UROPACE**

 

On November 1, 2000, theCompany completed the spin-off of UROPACE, Inc. (UROPACE), a subsidiary of theCompany, to the existing shareholders of the Company.  The separation was effected by transferring from the Company toUROPACE all assets, tangible and intangible, relating to the development offemale urinary incontinence technology. Shareholders of record on September 15, 2000, received one share ofcommon stock of UROPACE for each 6.882 shares of the Company’s common stockheld on that date.

 

42

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The assets transferred toUROPACE had no book value at November 1, 2000 and the operations of UROPACEprior to the spin-off had no revenues and minimal expenses during the fiscalyear ended April 30, 2001.  As a part ofthis spin-off, the Company agreed to loan UROPACE up to $356,250 at a variableinterest rate.  Principal and intereston the note will be payable in installments equal to 5 percent of UROPACE’s future annual net salesuntil the note and interest is paid in full. The Company had loaned UROPACE $235,000 and $154,000 at April 30, 2003 and2002.  Due to the development stage ofUROPACE and the uncertainty associated with the collection of this amount, theCompany has recorded an allowance for the entire balance of the loan at April30, 2003 and 2002, with the corresponding expense included in other income(expense) in the Consolidated Statement of Operations.

 

**15.****                               Savingsand Retirement Plan**

 

The Company sponsors a401(k) savings and retirement plan (the Plan) which is available to alleligible employees.  Under the Plan, theCompany may make a discretionary contribution to the Plan upon approval by theCompany’s Board of Directors.  Employeesare fully vested in their own contributions and earnings thereon and becomefully vested in the Company’s contributions and earnings thereon after threeyears of service.  The Company madecontributions to the Plan of $21,504 and $16,475 in fiscal years 2003 and 2002,respectively.

 

**16.****                               SubsequentEvent-Bridge Debt Financing**

 

On July 8, 2003, theCompany completed a $2.0 million bridge financing transaction with privateinvestors, resulting in net proceeds of approximately $1.87 million.

 

Under the terms of thefinancing, the Company established a one-year $1.0 million discretionary lineof credit with PKM (see Note 5 for additional information on PKM), a relatedparty.  The line, which requires thepayment of interest at a rate of 10 percent per year, matures on May 27, 2004,and is secured by substantially all assets of the Company.   As additional consideration for thefinancing, the Company agreed to issue PKM ten-year warrants for the purchaseof up to 380,357 shares of the Company’s common stock at an exercise price of$0.70 per share with terms and conditions that include weighted-averageanti-dilution rights.  The Company alsoagreed to modify certain terms of the warrants issued to PKM in connection witha credit facility extended by PKM in January 2003 (See Note 5), to conform tothe terms of the warrants issued as part of this bridge debt financing.

 

In a simultaneoustransaction, the Company entered into a loan agreement and borrowed $1.0million from an individual who following the transaction became the beneficialowner of approximately 10.3 percent of the Company’s securities, pursuant to aone-year subordinated note with an interest rate of 10 percent per year.  Pursuant to an intercreditor agreement withPKM, the loan is secured by substantially all assets of the Company.  The lender was issued ten-year warrants forthe purchase of 380,357 shares of common stock on terms comparable to the PKMwarrants described above.

 

**ITEM 8****                                                     CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

The disclosure called forby paragraph (a) of this item has been “previously reported” as that term isdefined in Rule 12b-2 under the Exchange Act.

 

43

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**PARTIII**

 

**ITEM 9****                                                        DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

We incorporate byreference the information contained under the captions “Proposal No. 1:Election of Directors” and “Section 16(a) Beneficial Ownership ReportingCompliance” in our definitive proxy statement for the 2003 Annual Meeting ofShareholders.

 

Information regarding ourexecutive officers is provided in Part I of this Form 10-KSB under separatecaption.

 

**ITEM 10****                                                 EXECUTIVECOMPENSATION**

 

We incorporate byreference the information contained under the caption “Executive Compensation”in our definitive proxy statement for the 2003 Annual Meeting of Shareholders.

 

**ITEM 11****                                              SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERMATTERS**

 

We incorporate byreference the information contained under the caption “Security Ownership ofCertain Beneficial Owners and Management” in our definitive proxy statement forthe 2003 Annual Meeting of Shareholders.

 

**EquityCompensation Plan Information**

 

Thefollowing table provides information as of the end of the most recentlycompleted fiscal year with respect to compensation plans under which our equitysecurities are authorized for issuance.

 
| **Plan  category**                                                          |   | **Number of securities  to be issued upon****exercise of  outstanding options,warrants and rights(a)** |   | **Weighted-average  exercise price of  outstanding  options, warrants  and rights  (b)** |   | **Number of securities  remaining available  for future issuance  under equity  compensation  plans (excluding  securities reflected in  column (a))  (c)** |    |
|-----------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|---------|
| **Equity****compensation plans approved  by security holders**              |   | 1,085,940                                                                                              |   | $                                                                                        | 2.98   |                                                                                                                                                        | 603,034 | (1) |
| **Equity****compensation  plans****not approved****by security****holders** |   | 1,215,000                                                                                              | (2)    | $                                                                                        | 1.42   |                                                                                                                                                        | 0       |   |
| **Total**                                                                   |   | 2,300,940                                                                                              |   | $                                                                                        | 2.16   |                                                                                                                                                        | 603,034 |   |

 

----

(1)          Represents 112,000shares remaining available for future issuance under our 1993 Director Stock OptionPlan and 491,034shares remaining available for future issuance under our 2001 Equity Incentive Plan.

 

(2)          Represents (a) 350,000shares of common stock underlying a 5 year warrant exercisable at $0.596 pershare issued to Paul K. Miller in connection with a line of credit with PKM Properties,which warrant expires January 17, 2008, (b) 350,000 shares of common stockunderlying a 5 year warrant exercisable at $0.6275 per share issued to Paul K.Miller in connection with a sale-leaseback transaction entered into on April 4,2003, which warrants expire on April 4, 2008, (c) 25,000 shares of common stockunderlying a seven-year warrant exercisable at $2.95 per share issued to SegmedInc. in connection with a purchase of technology, which warrants expire onAugust 7, 2009, (d) 240,000 sharesof common stock underlying a five-year warrant exercisable at $2.125 per share issued to Adel A.Mikhail, Ph.D., a director and our former chief executive officer, on February2, 2001, pursuant to a severance and consulting agreement dated November 1, 2000;(e) an aggregate of100,000 shares of common stock underlying warrants exercisable at $2.00 pershare issued to Paul K. Miller, a director, on November 22, 1999 and December6, 2000, in connection with Mr. Miller’s guarantee of a bank loan, both of which warrantsexpire on November 19, 2004; and

 

44

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(f)150,000 units underlying a warrant exercisable at $6.75 perunit issued to Equity Securities Investments, Inc. on November 20, 2001, inconnection with its services as underwriter of our initial public offering.

 

**ITEM 12****                                                 CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

We incorporate by reference the information containedunder the caption “Certain Relationships and Related Transactions” in ourdefinitive proxy statement for the 2003 Annual Meeting of Shareholders.

 

**ITEM 13**                                                 **EXHIBITS, LIST AND REPORTS ON FORM 8-K**

 

(a)                                  Exhibits

 

See “Index toExhibits.”

 

(b)                                 Reportson Form 8-K

 

We filed one CurrentReport on Form 8-K during the quarter ended April 30, 2003 relating to thecompletion of a refinancing transaction in which our headquarters andmanufacturing facility was sold in a sale-leaseback transaction to an affiliateof our company.

 

**ITEM14****                                                 CONTROLSAND PROCEDURES**

 

We maintain a system of disclosure controls andprocedures that is designed to provide reasonable assurance that information,which is required to be disclosed, is accumulated and communicated tomanagement timely.  Within the 90 daysprior to the date of this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures pursuant toExchange Act Rule 13a-15.  Based uponthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective in timelyalerting them to material information required to be included in our periodicfilings with the SEC.

 

There were no significant changes in our internalcontrols or in other factors that could significantly affect these internalcontrols subsequent to the date of our most recent evaluation.

 

45

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**SIGNA****TURES**

 

In accordance withSection 13 or 15(d) of the Exchange Act, the registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized, in the City of Inver Grove Heights, State of Minnesota, on July 29,2003.

 

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

 

**POWEROF ATTORNEY**

 

KNOW ALL BY THESEPRESENT, that each person whose signature appears below constitutes andappoints Blair P. Mowery and Jules L. Fisher as his or her true and lawfulattorney-in-fact and agent, with full powers of substitution andresubstitution, for him or her and in his or her name, place and stead, in anyand all capacities, to sign any or all amendments to this report, and to filethe same, with all exhibits thereto, and other documents in connectiontherewith, with the SEC, granting unto said attorney-in-fact and agent, fullpower and authority to do and perform each and every act and thing requisite ornecessary to be done in and about the premises, as fully to all intents andpurposes as he or she might or could do in person, hereby ratifying andconfirming all that said attorney-in-fact and agent, or her substitute orsubstitutes, may lawfully do or cause to be done by virtue hereof.

 

In accordance with theExchange Act, this report has been signed below by the following persons onbehalf of the registrant, and in the capacities and on the date indicated.

 
| **Signature**                          |   | **Title**                                             |   | **Date**      |
|----------------------------------------|--------|-------------------------------------------------------|--------|---------------|
|                                   |   |                                                  |   |          |
| /s/ Blair P.  Mowery                   |   | President, Chief  Executive Officer and               |   | July 29, 2003 |
| Blair P. Mowery                        |   | Director (Principal  Executive Officer)               |   |          |
|                                   |   |                                                  |   |          |
| /s/ Jules L.  Fisher                   |   | Chief Financial Officer  (Principal                   |   | July 29, 2003 |
| Jules L. Fisher                        |   | Accounting Officer and  Principal  Financial Officer) |   |          |
|                                   |   |                                                  |   |          |
| /s/ Adel A.  Mikhail, Ph.D             |   | Chairman of the Board                                 |   | July 29, 2003 |
| Adel A. Mikhail,  Ph.D.                |   |                                                  |   |          |
|                                   |   |                                                  |   |          |
| /s/ Salvador  Mercé Cervelló |   | Director                                              |   | July 29, 2003 |
| Salvador Mercé Cervelló      |   |                                                  |   |          |
|                                   |   |                                                  |   |          |
| /s/ Susan L.  Critzer                  |   | Director                                              |   | July 29, 2003 |
| Susan L. Critzer                       |   |                                                  |   |          |
|                                   |   |                                                  |   |          |
| /s/ Richard A.  DeWall, M.D.           |   | Director                                              |   | July 29, 2003 |
| Richard A.  DeWall, M.D.               |   |                                                  |   |          |
|                                   |   |                                                  |   |          |
| /s/ David B.  Kaysen                   |   | Director                                              |   | July 29, 2003 |
| David B. Kaysen                        |   |                                                  |   |          |
|                                   |   |                                                  |   |          |
| /s/ Paul K.  Miller                    |   | Director                                              |   | July 29, 2003 |
| Paul K. Miller                         |   |                                                  |   |          |

 

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**INDEXT****O EXHIBITS**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |   | Restated Articles of  Incorporation of the Registrant (incorporated by reference to our  Registration Statement on Form SB-2, filed on August 31, 2001 (File No.  333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                             |
| 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)).                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 4.3                 |   | Form of Warrant  Agreement (including specimen Class A Warrant certificate) (incorporated by  reference to our Registration Statement on Form SB-2, filed on August 31,  2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.4                 |   | Specimen unit  certificate (incorporated by reference to our Registration Statement on Form  SB-2, filed on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.1                |   | Separation Agreement  and Release by and between the Registrant and Adel A. Mikhail, effective  November 1, 2000 (incorporated by reference to our Registration Statement on  Form SB-2, filed on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                   |
| 10.2                |   | 1992 Stock Option Plan  (incorporated by reference to our Registration Statement on Form SB-2, filed  on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.3                |   | 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)).                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.4                |   | 1997 Stock Option Plan  (incorporated by reference to our Registration Statement on Form SB-2, filed  on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.5                |   | 2001 Equity Incentive  Plan (incorporated by reference to our Registration Statement on Form SB-2,  filed on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.6                |   | Warrant Agreement by  and between the Registrant and Paul K. Miller, dated November 22, 1999  (incorporated by reference to our Registration Statement on Form SB-2, filed  on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                      |
| 10.7                |   | 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)).                                                                                                                                                                                                                                                                                                                                                                      |
| 10.8                |   | Warrant Agreement by  and between the Registrant and Paul K. Miller, dated December 6, 2000  (incorporated by reference to our Registration Statement on Form SB-2, filed  on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                       |
| 10.9                |   | Form of Escrow  Agreement by and between the Registrant, Paul K. Miller, Adel A. Mikhail,  Ph.D., Salvador Mercé Vives, Mercé V. Electromedicina S.L., Richard A.  DeWall, M.D., Blair P. Mowery, Salvador Mercé Cervelló, Allan R. Seck, Norman  Dann, Ronald M. Bosrock, George M. Wettstaedt, Gene E. Stobbs, Shelley  Johnson, Associated Trust Company National Association and the Commissioner  of Commerce for the State of Minnesota (incorporated by reference to our  Registration Statement on Form SB-2, filed on August 31, 2001 (File No.  333-68884)). |
| 10.10               |   | O.E.M. Supply Contract  by and between the Registrant and Snia S.p.A. Carbomedics, Inc. (f/k/a Sulzer  Carbomedics, Inc.), effective July 24, 1998 (incorporated by reference to our  Registration Statement on Form SB-2, filed on August 31, 2001 (File  No. 333-68884)).*                                                                                                                                                                                                                                                                                                     |
| 10.11               |   | First Amendment to  Supply Agreement by and between the Registrant and Snia S.p.A. Carbomedics,  Inc. (f/k/a Sulzer Carbomedics, Inc.), effective March 6, 2001 (incorporated  by reference to our Registration Statement on Form SB-2, filed on August 31,  2001 (File No. 333-68884)).*                                                                                                                                                                                                                                                                                                  |
| 10.12               |   | Promissory Note in the  principal amount of $2,500,000, issued by the Registrant, maker, to  Associated Bank Minnesota, payee, dated November 23, 1999 (incorporated by  reference to our Registration Statement on Form SB-2, filed on  August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                       |
| 10.13               |   | Commitment Letter by  and between Associated Bank Minnesota, lender, and the Registrant, borrower,  dated August 26, 1999, pertaining to proposed revised line of credit terms  (incorporated by reference to our Registration Statement on Form SB-2, filed  on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                    |
| 10.14               |   | Working Capital Line of  Credit — Change in Terms Agreement by and between Associated Bank Minnesota,  lender, and the Registrant, borrower, dated November 23, 2000 (incorporated  by reference to our Registration Statement on Form SB-2, filed on August 31,  2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                         |
| 10.15               |   | Correspondence from  Associated Bank Minnesota to the Registrant, dated December 11, 2000,  extending the line of credit maturity date (incorporated by reference to our  Registration Statement on Form SB-2, filed on August 31, 2001 (File No.  333-68884)).                                                                                                                                                                                                                                                                                                                            |
| 10.16               |   | Correspondence to Paul  Miller, dated August 31, 1999, regarding the Registrant’s compensation to Mr.  Miller for his personal guarantee of the Associated Bank Minnesota line of  credit (incorporated by reference to our Registration Statement on Form SB-2,  filed on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                     |
| 10.17               |   | Amendment to Working  Capital Line of Credit by and between Associated Bank Minnesota, lender, and  the                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |

 

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|   |   | Registrant, borrower,  dated August 24, 2001 (incorporated by reference to our Registration  Statement on Form SB-2, filed on August 31, 2001 (File No. 333-68884)).                                                                                                                           |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.18  |   | Employment Agreement by  and between the Registrant and Blair P. Mowery, effective June 15, 2001  (incorporated by reference to our Registration Statement on Form SB-2, filed  on August 31, 2001 (File No. 333-68884)).                                                                      |
| 10.19  |   | Letter Agreement by and  between the Registrant and Allan R. Seck, dated May 5, 1999 (incorporated by  reference to our Registration Statement on Form SB-2, filed on August 31,  2001 (File No. 333-68884)).                                                                                  |
| 10.20  |   | Amendment to Letter  Agreement by and between the Registrant and Allan R. Seck, dated August 30,  2001 (incorporated by reference to our Registration Statement on Form SB-2,  filed on August 31, 2001 (File No. 333-68884)).                                                                 |
| 10.21  |   | Discretionary Credit  Agreement by and between the Registrant and 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)).                                                             |
| 10.22  |   | Discretionary Credit  Note in the principal amount of $943,666, issued by the Registrant, Maker, to  PKM Properties, LLC, Payee, 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))          |
| 10.23  |   | Security Agreement by  and between the Registrant, Debtor, and PKM Properties, LLC, Secured Party, 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)).                                                 |
| 10.24  |   | Second Mortgage by the  Registrant for the benefit of 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)).                                                                         |
| 10.25  |   | 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)).                                                                    |
| 10.26  |   | Promissory Note in the  principal amount of $60,000, issued by the Registrant, Maker, to Allan R.  Seck, Payee, dated December 11, 2002 (incorporated by reference to our  Quarterly Report on Form 10-QSB/A, filed on April 4, 2003 (File No.  000-33295)).                                   |
| 10.27  |   | Working Capital Line of  Credit – Change in Terms Agreement by and between Associated Bank Minnesota,  Lender, and the Registrant, Borrower, dated November 23, 2002 (incorporated  by reference to our Quarterly Report on Form 10-QSB/A, filed on April 4, 2003  (File No. 000-33295)). |
| 10.28  |   | Commercial Guaranty  from Paul K. Miller, Guarantor, to Associated Bank Minnesota, Lender, dated  November 23, 2002 (incorporated by reference to our Quarterly Report on Form  10-QSB/A, filed on April 4, 2003 (File No. 000-33295)).                                                        |
| 10.29  |   | Loan Agreement by and  between Peter L. Hauser and the Registrant, dated July 1, 2003 (incorporated  by reference to our Current Report on Form 8-K, filed July 14, 2003 (File No.  000-33295)).                                                                                               |
| 10.30  |   | $1.0 Million  Subordinated Note issued by the Registrant, Maker, to Peter Ludwig Hauser,  Payee, dated July 1, 2003 (incorporated by reference to our Current Report on  Form 8-K, filed July 14, 2003 (File No. 000-33295)).                                                                  |
| 10.31  |   | Subordination and  Intercreditor Agreement by and between Peter L. Hauser and PKM Properties,  LLC, accepted and acknowledged by the Registrant, dated July 1, 2003  (incorporated by reference to our Current Report on Form 8-K, filed July 14,  2003 (File No. 000-33295)).                 |
| 10.32  |   | May Security Agreement  in favor of PKM Properties, LLC and Peter L. Hauser, securing property of the  Registrant, dated July 1, 2003 (incorporated by reference to our Current  Report on Form 8-K, filed July 14, 2003 (File No. 000-33295)).                                                |
| 10.33  |   | 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)).                                                   |
| 10.34  |   | May Discretionary  Credit Agreement 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)).                                                                       |
| 10.35  |   | May Discretionary  Credit Note issued by the Registrant, Maker, to PKM Properties, LLC, Payee,  dated July 1, 2003 (incorporated by reference to our Current Report on Form  8-K, filed July 14, 2003 (File No. 000-33295)).                                                                   |
| 10.36  |   | 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)).                                                                                    |
| 10.37  |   | 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)).                                                   |
| 16     |   | Letter on change in  certifying accountant from Bertram Vallez Kaplan & Talbot Ltd.  (incorporated by reference to our Registration Statement on Form SB-2, filed  on August 31, 2001 (File No. 333-68884)).                                                                               |
| 21     |   | Subsidiaries of the  Registrant (incorporated by reference to our Registration Statement on Form  SB-2, filed on August 31, 2001 (File No. 333-68884)).                                                                                                                              |
| 23     |   | Consent of Independent  Auditors.                                                                                                                                                                                                                                                              |

 

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| 24   |   | Power of Attorney  (included on signature page to Form 10-KSB).            |
|------|--------|----------------------------------------------------------------------------|
| 31.1 |   | Chief Executive Officer  Certification pursuant to Rule 13a-14.            |
| 31.2 |   | Chief Financial Officer  Certification pursuant to Rule 13a-14.            |
| 32.1 |   | Chief Executive Officer  Certification pursuant to 18 U.S.C. Section 1350. |
| 32.2 |   | Chief Financial Officer  Certification pursuant to 18 U.S.C. Section 1350. |

 

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*                                         Certainportions of this exhibit are subject to an order granting confidentialtreatment pursuant to Rule 406.

 

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