**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM10-KSB**

 

| **ý** | ** ** | **ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED APRIL 30, 2004** |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                   |
| **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 ItsCharter)

 

| **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 AreaCode)

 

Securities registered pursuant to Section12(b) of the Exchange Act:

**None**

 

Securities registered pursuant to Section12(g) of the Exchange Act:

**Units (each consisting of one share of CommonStock, $0.01 par value, and one redeemable Class A Warrantto purchase one share of Common Stock), Common Stock ($0.01 par value) andredeemable 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 $3,410,975.

 

Theaggregate market value of the common equity held by non-affiliates of theissuer as of July 23, 2004, was approximately $11,727,222, based upon the saleprice of one unit on such date.

 

Asof July 23, 2004 the issuer had outstanding 10,730,833 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**

 

None.

 

 

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**TABLE OF 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 |   |
|              | ITEM 8A | CONTROLS AND PROCEDURES |   |
|              |    |   |   |
| 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 | PRINCIPAL ACCOUNTANT FEES AND SERVICES |   |
| SIGNATURES        |    |
| INDEX TO EXHIBITS |    |

 

*We have used, and therefore claim common law rights in, the followingtrademarks:*

*GLIDETHRU, ULTRAPURE and ATRILAZE.*

 

*We also have Federal Registration for the marks:*

*MEDICALCV, OMNICARBON and INTERFACE.*

 

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*The following discussion contains variousforward-looking statements within the meaning of Section 21E of the ExchangeAct.  Although we believe that, in makingany such statement, our expectations are based on reasonable assumptions, anysuch statement may be influenced by factors that could cause actual outcomesand results to be materially different from those projected.  When used in the following discussion, thewords “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates” andsimilar expressions, as they relate to us or our management, are intended toidentify such forward-looking statements. These forward-looking statements are subject to numerous risks anduncertainties that could cause actual results to differ materially from thoseanticipated.  Factors that could causeactual results to differ materially from those anticipated, certain of whichare beyond our control, are set forth under the caption “Management’s Discussionand Analysis or Plan of Operation — Cautionary Statement.”*

 

*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 by forward-lookingstatements will occur or, if any of them do occur, what impact they will haveon us.  We caution you to keep in mindthe cautions and risks described in our Cautionary Statement and to refrainfrom attributing undue certainty to any forward-looking statements, which speakonly as of the date of the document in which they appear.*

 

**PART I**

 

**ITEM1****             DESCRIPTION OFBUSINESS**

 

**Overview**

 

Our primary objective is to develop cardiac products for improvedpatient outcomes by early treatment of cardiac disorders.  Historically, we have developed, marketed andsold mechanical heart valves known as the Omnicarbon® 3000 and 4000 heartvalves.  Our long-range strategy,however, is to achieve profitability by diversifying into high growth marketsin cardiothoracic surgery.  Near-term, weplan to develop and introduce products targeting treatment of atrialfibrillation and heart valve repair.

 

We currently sell the Omnicarbon 3000 valve in the U.S. and Japan, andthe Omnicarbon 4000 internationally.  TheOmnicarbon 3000 is manufactured using pyrolytic carbon components manufacturedby a third party, with the remaining manufacturing completed by ourcompany.  In contrast, the Omnicarbon4000 is completely manufactured by us, which includes our proprietary carboncoating process.  We are seeking anamendment from the U.S. Food and Drug Administration (“FDA”) to the OmnicarbonPMA to use our own proprietary carbon coating process, which we believe will beobtained by late calendar year 2004.  Suchapproval would allow us to sell the Omnicarbon 4000 in the U.S., and therebyenable us to significantly decrease the manufacturing cost of the Omnicarbonheart valves sold in the United States. We believe our proprietary carbon coating technology, excellent recordof quality and the established superior clinical performance of the Omnicarbonvalve versus leading mechanical heart valves give us a strategic position forworldwide growth.

 

Approximately 36,000 Omnicarbon heart valves have been implanted worldwide.  Sales of heart valves have been primarily tocustomers in Europe, South Asia, the Middle East and the Far East.  Although we derived 43 percent of our netsales in fiscal year 2004 from Europe, we have established a U.S. salesorganization, consisting primarily of independent sales representatives who areexperienced in marketing products to cardiothoracic surgeons.  We commenced marketing the Omnicarbon 3000heart valve in the U.S. in late January 2002.

 

To reduce our dependence on sales of heart valves, we have developed astrategy to broaden our product offerings to the cardiothoracic surgeon bydeveloping, acquiring or licensing additional technologies.  In August 2003, we acquired a technologyplatform for the treatment of atrial fibrillation from LightWave AblationSystems, Inc., a private research-based corporation focused on new devices forthe treatment of cardiovascular diseases. Atrial fibrillation is a common irregular heart rhythm condition amongthe U.S. population and is a significant, worldwide healthcare challenge.

 

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Our company was incorporated in Minnesota on March 30, 1992, under thename CV Dynamics, Inc.  In April 1992, weacquired all of the tangible and intangible assets of Omnicor, Inc.  Omnicor resulted from the corporate andfinancial restructuring of a predecessor company called Medical Incorporated,which was organized in 1971 to develop and market the Lillehei-Kaster heartvalve, licensed from the University of Minnesota.  Our company changed its name to MedicalCV, Inc.in February 2000.  Our corporateheadquarters is located at 9725 South Robert Trail, Inver Grove Heights, MN55077.

 

**Industry Trends**

 

We compete in the large, growing market of cardiovascular medicaldevices, which is a global market place. Revenue growth globally for cardiovascular medical devices is projectedto be in the range of 8 to 10 percent for the next several years.  The developing markets are projected toconsume an increasing percentage of the world’s production of medical devicesas the economies of these countries strengthen. The developing countries are projected to be the fastest-growing marketsfor medical devices in the world, averaging 10 to 15 percent growth per year.

 

Cardiovascular disease is one of the most prevalent diseases in theworld, as well as the leading killer in the industrialized world.  As a result, the market for cardiovascularimplants is large and growing.  Heartdisease is the major cause of death and morbidity in most developed countries,and the aging population in these countries will fuel this trend.  Many developing countries are now spendingmore money on healthcare and starting to use or implant significant numbers ofdevices targeted at cardiovascular disease.

 

We believe there are a number of factors that will influence markettrends in the worldwide cardiovascular surgery category:

 

•                                         The globalpopulation is aging; heart disease will continue to be the major cause of deathin most developed countries

 

•                                         As developingcountries continue to increase spending on healthcare and build out capacityfor cardiac surgery, their consumption of cardiovascular devices will increase;the prevalence of rheumatic fever in these countries will further increase thistrend with regard to heart valve disease

 

•                                         Worldwide pricepressures on healthcare will force innovations in marketing new products andmanufacturing efficiencies

 

•                                         The medicalcommunity is increasingly recognizing the benefits of and need for earlyintervention in conditions that may lead to congestive heart failure such asatrial fibrillation and valve disease

 

•                                         Minimallyinvasive, beating heart and robotic surgeries will become more common, makingit possible to offer surgical interventions in patients too ill to undergo openheart surgery and may encourage patients with heart disease to undergoprocedures earlier in the course of treatment

 

•                                         Cardiothoracicsurgeons will be receptive to products and procedures that will enable them toregain business from interventional cardiologists

 

•                                         The globalmarket for cardiovascular devices is generally controlled by large companies

 

•                                         The pendulumof market preference for tissue versus mechanical heart valves has been movingin the direction of tissue valves for several years and may be near or at itspeak

 

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In order to achieve and maintain global leadership in thecardiovascular device market, we believe, there are several strategicprerequisites for long-term success:

 

•                                         Control overtechnology allowing innovation in product development

 

•                                         Productionefficiencies:  low cost production

 

•                                         Globalpresence, including developing countries

 

•                                         Bundling ofcardiovascular device products

 

We are positioning ourselves to achieve the first three criteria andwill be developing new product offerings to achieve bundling capabilitieslong-range.

 

**Product and Technology Diversification**

 

Our company acquired a laser-based technology platform in August 2003for the treatment of atrial fibrillation which will provide a basis for us todevelop products for entry into a market that is estimated at $250 million inopen chest applications and over $1.0 billion in minimally invasiveapplications.  Atrial fibrillation (“AF”)is a common irregular heart rhythm condition among the U.S. population and is asignificant, worldwide healthcare challenge. AF is one of the major precursors to congestive heart failure and can bepartially traced to concomitant damage to the heart from a heart attack(myocardial infarction or “MI”) and/or diseased valves, all of which can createan enlarged heart and inappropriate electrical signals.  This technology adds an important long-termgrowth platform to our company and supports the vision of dealing withconditions at an early stage that can lead to congestive heart failure.  Subject to successful product development andregulatory approval, the technology will be introduced in two stages.  The first stage will involve a product foropen heart procedures.  The second stagewill focus on a much larger patient population which will be accessible usingminimally invasive techniques.

 

**Product Portfolio**

 

***Laser Technology for the Treatment of Atrial Fibrillation***

 

*Overview*

* *

Atrial fibrillation is the most common irregular heart rhythm in theUnites States.  It describes thecondition of an abnormal heart rhythm originating in the atria.  Instead of the electrical impulse travelingin an orderly manner through the heart, many impulses begin and spread throughthe atria causing a rapid and disorganized, chaotic heartbeat.

 

The occurrence of atrial dysrhythmias, notably AF, is now recognized tohave a significant impact on patient morbidity and the economics ofhealthcare.  The reduction of diastolicventricular filling associated with AF can increase the occurrence of congestiveheart failure and worsen its symptoms. In addition, patients with AF are subject to wide swings in heart rate,the risk of thromboembolism and stroke, and the complications associated withchronic anticoagulation.  Termination ofAF and restoration of sinus rhythm, where the heart beats with a normal rhythm,have a direct clinical impact on decreasing patient morbidity, improvingfunctional activity and decreasing the cost of healthcare.

 

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*Non-Surgical Ablation of Atrial Fibrillation*

 

The three major goals of medical treatment of AF are restoration ofnormal sinus rhythm, control of ventricular rate, and prevention of blood clotformation.  Procedures and therapies thatare currently used to treat AF have high risk factors to patients.  Surgical procedures are highly invasive anddrug therapies must be taken continuously and can have side effects for thepatient.

 

Currently there are several ablation devices for the surgical treatmentof atrial fibrillation.  Radio frequency(“RF”) is the most frequently used energy source, but suffers from somesignificant draw backs, including wide ablation lines and the inability toablate on a beating heart.

 

Other devices utilize microwave, cryoablation, ultrasound, andlaser.  Laser enables the creation ofvery thin lesion lines, reducing collateral tissue damage.  This is important as there have been severalcases of collateral damage with RF which has led to restrictions on its use inat least one major country in Europe. The laser’s major surgical advantage is that it can be used on a beatingheart, thus avoiding cardiopulmonary bypass, which could access a much largerpatient market.

 

Though devices have been on the market for a number of years, thissurgical technique is only now gaining popularity.  A quickly growing number of surgeons haveadopted this procedure into their practice.

 

*RegulatoryRequirements*

* *

The U.S. regulatory pathway for our laser technology is a 510(k)submission.  This requires the necessarysafety and performance testing.  However,no specific treatment claims can be made. This is the same pathway Medtronic, Edwards Lifesciences Corp. andBoston Scientific Corp. have taken to expedite commercialization of open chestatrial fibrillation products.  Itnormally takes from six to twelve months for the FDA to review and clear a510(k) submission.  In May 2004, wesubmitted a 510(k) for the current device configuration and manufacturingprocess.  If it is determined that wewould like to make specific treatment claims, a post-market IDE can besubmitted, subject to approval of our 510(k) submission.  We will use the knowledge gained from openchest procedures to begin clinical work on the minimally invasive system.  For distribution in the European Community,the CE Mark will require the preparation of a technical dossier to submit tothe European Union’s Notified Body (TÜV Product Service).

 

The equipment portion of the system must meet several ASME and ULsafety requirements to be tested by a third party.

 

See “Government Regulation” for a moredetailed discussion of the regulatory processes applicable to our products.

 

*Conclusions*

* *

We believe that the surgical treatment of AF is gaining acceptance bythe cardiothoracic community.  The success(absence of atrial fibrillation) without pharmacological agents at six monthfollow-up is 50 to 90 percent.  This isequivalent to, or better than, catheter-based procedures, depending upon theprocedure or device used.

 

Laser energy to treat AF offers advantages over non-laser technologybecause it the current competition.  Itcan consistently create a very thin (3mm) transmural lesion.  The lesion successfully blocks the inappropriateelectrical signals.  The lesion can bemade epicardially (outside of the heart) on a beating heart.  It limits the risk of perforating nearbytissue due to the physics of this energy source.

 

Assuming successful product development and regulatory approval(s), weplan to sell the new atrial fibrillation ablation laser into a market that webelieve will approximate two times the size of the projected worldwidemechanical heart valve market by 2008. The potential sales of this device may surpass those of the Omnicarbonvalve, adding considerable revenue, especially if a device for minimallyinvasive procedures is

 

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developed.  We believe surgeonsare eager to enter this field.  We intendto change the perception of our company from old technology to innovator, withthe goal of becoming an industry leader in the AF ablation market.

 

*Heart Valves*

* *

Our current lead product platform is mechanical heart valves.  We manufacture two tilting disc (monoleaflet)heart valves:  the Omnicarbon Series 3000and the Omnicarbon Series 4000.  Oursales strategy has been to market through independent distributorsinternationally and manufacturer’s representatives domestically.

 

Both versions of the Omnicarbon valve address the primary needs ofreplacing dysfunctional or degenerated heart valves.  Our tilting disc design consists of a single,hingeless disc contained within a one-piece housing.  Data from independent clinical studies havedemonstrated that the Omnicarbon valve offers significant advantages incomplication rates compared to popular bileaflet heart valves currently on themarket.

 

Omnicarbon 3000 valves were granted approval for sale in the U.S. bythe FDA in July 2001, and we launched this version in the U.S. in earlycalendar year 2002.  Omnicarbon 3000valves are manufactured using pyrolytic carbon components that we purchase froma third party.

 

Our Omnicarbon heart valves are designed to replace heart valves thathave been made defective by disease or congenital origin.  Cardiovascular disease is one of the mostprevalent diseases in the world and is a leading cause of death in humans.  The aging population in most developedcountries will fuel the market for cardiovascular implants.  Developing countries and eastern Europeancountries are expected to increase spending on health care and may increasetheir consumption of mechanical heart valves due to the prevalence of rheumaticfever and other diseases.  These globalmarkets for cardiovascular devices are characterized by large multinational manufacturersand industry consolidation.  Among themajor product segments are pace makers, heart valves, angioplasty products,coronary stents and the emerging market of atrial fibrillation products.  A number of the major manufacturers, such asMedtronic, Inc., St. Jude Medical, Inc., Guidant Corp. and Boston Scientific,Inc., have medical device lines which include all or most of these products.

 

Potential complications or side effects with all mechanical heart valveimplants include, but are not limited 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.

 

*Heart ValveRepair System*

* *

In October 2002, we acquired from Segmed, Inc., a new annuloplastytechnology for the repair of mitral and tricuspid heart valves.  During fiscal years 2003 and 2004, wecompleted engineering on the product, tested the product, and in November 2003,submitted a 510(k) application to the FDA. The product (prototypes) was successfully implanted in eight patients inEurope.  Given our other productopportunities, and the financial obligations associated with going forward withthis product, we are currently re-evaluating its commercial viability.  We are also evaluating other technologies forheart valve repair on a beating heart. If we do not pursue commercialization of this technology, the inventormay obtain, upon request, a non-exclusive license to utilize the technology.

 

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**Patents and Proprietary Rights**

 

We believe strongly in protecting our intellectual property and willseek patent protection for new products and processes under developmentwhenever we believe it is advisable.  Wehave one U.S. patent on our pyrolytic carbon coating apparatus and two foreignpatent applications.  Our atrialfibrillation technology has one U.S. patent application.  Our current patents will begin to expire in2015.  We cannot assure you that anypatents held by us will be valid, enforceable or otherwise be of value to us inrelation to products of our competitors or the market in general, or that anypatent for which we have applied or may apply will be granted.  Obtaining patent coverage for our AFtechnology will be critical to the success of our AF product.

 

We have no patents covering the design of our Omnicarbon heart valvesand we do not intend to seek such patents. Because heart valves of this design have been sold in the marketplacefor many years, patent protection is no longer obtainable.  We do not believe that protecting the designof a heart valve is critical for the success of a heart valve manufacturer.  We believe that the key to success lies in avertically integrated infrastructure, the soundness of design, clinical safetyand efficacy of performance of the heart valve and the manufacturer’s abilityto successfully build product awareness.

 

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

 

We have used,and therefore claim common law rights in, the following trademarks:  GLIDETHRU, ULTRAPURE and ATRILAZE.  We also have a Federal Registration for themarks: MEDICALCV, OMNICARBON and INTERFACE.

 

**Marketing and Sales**

 

Our sales and marketing plan focuses on:

 

•                                         creatingwidespread awareness of and demand for our products among cardiovascularsurgeons, cardiologists and medical treatment organizations that make medicaldevice purchasing decisions;

 

•                                         capitalizingon our quality record 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 agingpopulation and increases in health care spending in developing countries andeastern Europe; and

 

•                                         expanding ourproduct offering for the cardiothoracic surgeon.

 

Our goal is to reach cardiothoracic surgeons, organizations that makepurchasing decisions with regard to medical devices and third party payers whopay for such treatment to make them aware of the advantages of ourproduct.  To reach these groups, we areusing our corporate marketing and technical personnel, sales managers, salesrepresentatives and clinical advisory board members.  In addition, we:

 

•                                         supportvarious clinical studies;

 

•                                         exhibit ourproducts at major cardiovascular meetings;

 

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•                                         host a websitetargeting both physicians and patients.

 

*United States*.  As of April 30, 2004, our U.S. sales weresupported by 19 independent sales representatives located throughout the U.S.,who are experienced in marketing medical devices to cardiothoracicsurgeons.  We provide to our salesrepresentatives training programs, marketing aides, educational materials forthe medical community and sales literature.

 

*International*.  We market and sell our products primarily inEurope, South Asia, the Middle East and the Far East.  As of April 30, 2004, we had a network of 37distributors.  We generally require nocollateral from our customers with respect to trade accounts receivable.  We maintain an allowance for doubtfulaccounts based upon our historical experience and the expected collectibilityof all accounts receivable.

 

**Manufacturing and Supply**

 

We manufacture and assemble our products at our facility in Inver GroveHeights, Minnesota.  We manufacture ourOmnicarbon 4000 heart valve in its entirety, utilizing our proprietarypyrolytic carbon process.  We assembleour Omnicarbon 3000 heart valve using our own proprietary suture ring andpyrolytic carbon components purchased historically from Snia S.p.A.Carbomedics.  We plan to purchasecomponents to our specifications and assemble them in our facility for ouratrial fibrillation products.

 

Pyrolytic carbon has been used in mechanical heart valves forapproximately 30 years.  Pyrolytic carboncoating on such components as heart valve housings and heart valve leaflets isformed by the pyrolysis of carbon.  Webegan to develop our own pyrolytic carbon coating process in 1995.  Our process involves heating propane to ahigh temperature, which breaks it down into hydrogen and carbon.  The hydrogen is then vented and the carbonatoms are deposited on the surface of graphite substrate shaped as a disc orhousing ring.  Pyrolytic carbon coatinghas greater blood compatibility compared to other materials historically usedin heart valves, resulting in a lower incidence of thromboembolism and otherpotential complications.  Pyrolyticcarbon components have been tested to last longer than any patient’slifetime.  We also manufacture knitted,seamless Teflon® tubings which are used in constructing suture rings tocorrespond with various heart valve sizes. We have developed and instituted a complete, vertically integratedmanufacturing and quality control system for our Omnicarbon 4000 heartvalves.  The pyrolytic carbon componentswe have purchased from Snia S.p.A. Carbomedics for our Omnicarbon 3000 heartvalves are tested under the same rigorous requirements as our Omnicarbon 4000heart valves.

 

We ship all of our products from our facility either to distributors ordirectly to hospitals.  We generally donot have a significant backlog of orders and maintain a sufficient inventory ofproducts which enables us to ship within 24 to 48 hours of receipt of orders.

 

We assemble our Omnicarbon 3000 and 4000 heart valves in a controlledclean room environment in our facility, where we fabricate the sewing cuff,conduct final cleaning and inspection and package the finished heartvalves.  The packaged heart valves arethen sterilized.  We believe that ourmanufacturing facilities meet applicable standards for “good manufacturingpractices” established by the FDA and other applicable governmentstandards.  In the normal course, ourfacility is frequently subject to inspections by the FDA and foreign regulatoryagencies in connection with their reviews of our products.

 

We believe that the raw materials and components used in manufacturingour Omnicarbon 4000 heart valves are readily available.  However, we have purchased the pyrolyticcarbon parts for our Omnicarbon 3000 heart valves only from Snia S.p.A.Carbomedics, a supplier whose materials and manufacturing meet FDA regulationsfor inclusion in our medical devices.  Wehad purchased these components under an original equipment manufacturing supplycontract which expired in December 2003. Under this contract, we were obligated to purchase minimum quantities ofcarbon-coated components, manufactured pursuant to our specifications,exclusively from Snia S.p.A. Carbomedics. We have not renewed this contract and we have no other supplier ofpyrolytic carbon parts for our Omnicarbon 3000 heart valves; however, webelieve we have sufficient Omnicarbon 3000 heart valves to carry us through FDApremarket approval of our Omnicarbon 4000 valves for sale in the U.S.  Nevertheless, we may be required to negotiatefor future product purchases from Snia S.p.A. Carbomedics.

 

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**Government Regulation**

 

The medical devices we manufacture and market are subject to regulationby the FDA and, in most instances, by state and foreign authorities or theirdesignated representatives.  Under theU.S. Federal Food, Drug and Cosmetic Act and the regulations promulgatedthereunder, as a manufacturer of medical devices, we must comply with policiesand procedures that regulate the manufacturing, composition, labeling, testing,packaging and distribution of medical devices. In addition, medical devices are subject to different levels ofgovernment approval requirements, the most comprehensive of which requires thecompletion of an FDA approved clinical evaluation program and submission, andapproval of a premarket approval application before a device may becommercially marketed.  The FDA alsoconducts inspections before approving a premarket approval application todetermine compliance with the quality system regulations which covermanufacturing and design.  Our heartvalves are subject to this level of approval.

 

After premarket approval is received, the FDA may require testing andsurveillance programs to monitor the effectiveness of approved products whichhave been commercialized.  It has thepower to prevent or limit further marketing of a product based on the resultsof such post-marketing programs.  Inaddition, 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 recordkeeping for medical devices and reviewshospital and manufacturers’ required reports of adverse experiences to identifypotential problems with FDA-authorized devices. Some of the products that we intend to develop and market can be clearedunder Section 510(k) of the Federal Food, Drug and Cosmetic Act.  The process of obtaining Section 510(k)clearance typically requires less time and expense than the premarket approvalprocess.  Section 510(k) clearancenormally takes from six to twelve months, but can take years, and generallyrequires the submission of supporting data, which in some cases can beextensive.  In addition, the FDA mayrequire review by an advisory panel as a condition for Section 510(k)clearance.  We intend to rely on theSection 510(k) process with regard to certain products, such as our atrialfibrillation technology.  However, we maydevelop and produce enhancements to our products that will require clearanceunder the FDA’s lengthier and expensive premarket approval process, which cantake a number of years and can require extensive supporting documentation.  If we encounter difficulties in the premarketapproval process, the commercial marketing of a product could be substantiallydelayed or prevented.

 

International sales of our products are also subject to extensiveregulation.  Foreign regulatory bodieshave established varying regulations governing product standards, packagingrequirements, labeling requirements, import restrictions, tariff regulations,duties and tax requirements.  Generally,the extent and complexity of the regulation of medical devices is increasingworldwide, with regulations in some countries already nearly as extensive asthose in the U.S.  This trend maycontinue, and the cost and time required to obtain marketing approval in anygiven country thus may increase.  Wecannot assure you that any foreign approvals will be allowed on a timely basis,or at all.

 

To market our products in countries of the European Union, we arerequired to obtain CE mark certification. CE mark certification is the international symbol of adherence tocertain quality assurance standards and compliance with European medical devicedirectives.  In June 1995, we receivedISO 9001 and EN 46001 qualification of our quality system for our manufacturingprocesses in our facility in Inver Grove Heights,

 

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Minnesota.  We obtained the CEmark for our Omnicarbon 3000 heart valve on June 27, 1995, and for ourOmnicarbon 4000 heart valve on April 8, 1999.

 

We derive the great majority of our revenues from sales of Omnicarbonheart valves outside the U.S.  Ourinability, or the failure of our foreign distributors, to comply with varyingforeign regulations or the imposition of new regulations could restrict thesale of our products internationally and thereby materially adversely affectour business, financial condition, operating results and cash flows.

 

**Competition**

 

The cardiovascular device market is highly competitive, with St. JudeMedical, Inc. supplying the majority of mechanical heart valves soldworldwide.  Other competitors in themechanical heart valve field include Snia S.p.A. Carbomedics, Edwards LifeSciences, Inc., Medtronic, Inc., Sorin Biomedica spa in Italy, ATS Medical,Inc. and MCRI, Inc.  In addition to manyof the companies mentioned above, Boston Scientific Corp. and Guidant Corp. aredeveloping products for the treatment of AF. Our competitors in the mechanical heart valve field also offer repairproducts.  All of these competitors have:

 

•                                         greater nameand product recognition;

 

•                                         greaterfinancial, manufacturing and marketing resources;

 

•                                         greaterregulatory compliance capabilities;

 

•                                         strongerphysician relationships; and

 

•                                         broader andmore established product lines than we have.

 

Most of our competitors manufacture bileaflet heart valves for whichthere is a market preference.  Some ofthese competitors also market tissue heart valves and are currently pursuingnew mechanical heart valve designs, biocompatible coatings for mechanical heartvalves, longer lasting tissue heart valves and surgical alternatives toimplanting prosthetic heart valves.  Itis possible that developments by our competitors could render our heart valves,atrial fibrillation technology and/or other future products obsolete.  We cannot assure you that we will be able tocompete against such competitors.

 

**Product Liability and Insurance**

 

The development and sale of medical devices entails significant risk ofproduct liability claims and, sometimes, product failure claims.  We face an inherent business risk offinancial exposure to product liability claims if the use of our productsresults in personal injury or death.  Wealso face the possibility that defects in the design or the manufacturing ofour products could necessitate a product recall.  We have not, to date, experienced significantproduct liability claims, and we have never had a product recall.  We cannot assure you, however, that we willnot experience losses in the future due to product liability claims or recalls.

 

We currently maintain product liability insurance with coverage limitsof $5,000,000 in the aggregate annually. We cannot assure you that such coverage limits will be adequate.  In addition, trends regarding claims anddamages in the medical device industry could increase the cost of insurance,which is already expensive, and may make insurance coverage difficult for us toobtain in the future on acceptable terms, or at all.  Any claims against us, regardless of theirmerit or eventual outcome, could involve a significant financial outlay inconnection with the investigation of claims or payment of deductible amounts toinsurance companies.  A significant claimcould involve payment of an amount which could have a material adverse effectupon our business, financial condition, operating results and cash flows.  In addition, adverse publicity resulting fromproduct liability litigation may materially and adversely affect us, regardlessof whether the claims are valid or whether we are liable.

 

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**Employees**

 

As of April 30, 2004, we had 36 full-time employees, including 24 whowere in manufacturing and research and development, and the remainder of whowere in administration, regulatory/clinical and sales/marketing.  We are not a party to any collectivebargaining agreement and believe that our relations with employees are good.

 

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**ITEM2****             DESCRIPTION OFPROPERTY**

 

We lease a 55,000 square foot production and administrative facilitylocated in Inver 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 Property Financing transaction to PKM Properties, LLC, an entitycontrolled by Paul K. Miller, one of our directors and the largest beneficialowner of our securities.  We signed alease with an initial 10-year lease term, with options to renew or repurchasethe facility.  See the notes to ourConsolidated Financial Statements for the year ended April 30, 2004.

 

**ITEM3****             LEGAL PROCEEDINGS**

 

As of July 23, 2004, we were not a party to any material litigation.

 

**ITEM4****             SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS**

 

Not applicable.

 

**Executive Officers of the Registrant**

 

The following table provides information with respect to our executiveofficers as of July 23, 2004.  Eachexecutive officer has been appointed to serve until his successor is dulyappointed by the board or his earlier removal or resignation from office.

 
| **Name**           | ** ** | **Age** | ** ** | **Position with MedicalCV**                                    |
|--------------------|------------|---------|------------|----------------------------------------------------------------|
| Lawrence L. Horsch |       | 69      |       | Chairman of the Board and Acting Chief Executive Officer       |
| John H. Jungbauer  |       | 55      |       | Vice President, Finance, Chief Financial Officer and Secretary |
| Richard W. Kramp   |       | 59      |       | President and Chief Operating Officer                          |

 

*Lawrence L. Horsch*,who became our Acting Chief Executive Officer in April 2004, became one of ourdirectors and Chairman of the Board in August 2003.  He served as a director of Boston ScientificCorporation from February 1995 to May 2003. He was one of the founding directors of SciMed Life Systems, Inc. andserved as Chairman of the Board from 1977 to 1994, and Acting Chief FinancialOfficer from 1994 to 1995.  Since 1990,Mr. Horsch has served as Chairman of Eagle Management & Financial Corp., amanagement consulting firm.  Mr. Horschhas been involved as a director or consultant to numerous early-stage companiesin the Twin Cities area.

 

*John H. Jungbauer*joined our company as Vice President, Finance, Chief Financial Officer andSecretary in February 2004. Mr. Jungbauer came to our company with over 26 years of experiencein financial management and long-range planning, internationalfinancial/treasury operations, information technology systems.  From 1990 to 2002, Mr. Jungbauer was VicePresident of Finance and Chief Financial Officer with ATS Medical, Inc.  During 1988 and 1989, he was Executive VicePresident of Titan Medical, Inc.  From1977 to 1987, he held several financial management positions at St. JudeMedical, Inc., including Vice President of Finance and Chief Financial Officerfrom 1981 to 1987.

 

*Richard W. Kramp*joined us as Vice President of New Technology Development in December 2003,became President of our New Technology Division in April 2004, and became ChiefOperating Officer in July 2004.  He hasover 30 years of experience in the medical device field.  From 1988 to 2003, Mr. Kramp was with ATSMedical, Inc., where he served as the Chief Executive Officer and ChiefOperating Officer.  He has extensiveexperience in the development and sales of technical products.  Prior to ATS, Mr. Kramp served nine years atSt. Jude Medical, Inc., with seven of those years as Vice President of Salesand Marketing.  Mr. Kramp has also held managementpositions at Life Instruments, Inc. and Cardiac Pacemakers Inc./Guidant, Inc.

 

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**PART II**

 

**ITEM5****             MARKET FOR COMMONEQUITY AND RELATED SHAREHOLDER MATTERS**

 

Our units were listed on The Nasdaq SmallCap Market under the symbol“MDCVU” from the completion of our initial public offering in November 21,2001, until March 19, 2003.  Our unitsare now traded under the same symbol on the OTC Bulletin Board (“OTCBB”).  Each publicly traded unit consists of oneshare of common stock and one Class A Warrants to purchase a share of our commonstock for $6.50.  The following tablesets forth the approximate high and low closing prices as reported by TheNasdaq SmallCap Market and the approximate high and low bid prices as reportedby the OTCBB for our units for the periods indicated.  Such quotations reflect inter-dealer prices,without retail mark-up, mark-down or commission, and may not represent actualtransactions.

 
| **Period**       | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------|------------|----------|------------|---------|------------|
| 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 |   |
| Fiscal Year 2004 |       |     |       |    |       |
| First Quarter    |       | $        | 1.55       |    | $          | 0.30 |   |
| Second Quarter   |       | $        | 2.45       |    | $          | 1.40 |   |
| Third Quarter    |       | $        | 2.60       |    | $          | 1.15 |   |
| Fourth Quarter   |       | $        | 2.30       |    | $          | 1.10 |   |

 

As of May 31, 2004, we had 130 shareholders of record and approximately330 beneficial owners.

 

We have never declared or paid cash dividends.  We currently intend to retain futureearnings, if any, to operate and expand our business, and we do not anticipatepaying cash dividends on our common stock in the foreseeable future.  Any payment of cash dividends in the futurewill be at the discretion of our board of directors and will depend upon ourresults of operations, earnings, capital requirements, contractual restrictionsand other factors deemed relevant by our board.

 

**Sales of Unregistered Securities during theFourth Quarter of Fiscal Year 2004**

 

On February 3, 2004, we issued to PKM a ten-year warrant to purchase330,933 shares of our common stock at an exercise price of $2.00 per share.  We issued this warrant in connection with theextension of the maturity date of the January Discretionary Credit Agreement toJune 30, 2005.

 

On February 3, 2004, we issued to Peter L. Hauser a ten-year warrant topurchase 136,000 shares of our common stock at an exercise price of $2.00 pershare.  We issued this warrant inconnection with the extension of the maturity date of the $1.0 million Hauserfinancing to June 30, 2005.

 

Between February 2004 and May 2004, we conducted a private placement toaccredited investors of units, each unit consisting of one share of commonstock and one warrant to purchase one share of common stock.  We sold 2,730,763 units for aggregate grossproceeds of $4,014,222.  The five-yearwarrants sold with the common stock are exercisable to purchase an aggregate of2,730,763 shares of common stock at an exercise price of $1.60 per share.  In connection with such placement, we issuedour agent a five-year warrant to purchase 123,272 units at an exercise price of$1.8375 per share, paid our agent cash commissions of $181,210 and paid ouragent a non-accountable expense allowance of $67,954.  In connection with such placement, we issuedour finder a five-year warrant to purchase 95,189 units at an exercise price of$1.8375 per unit, paid our finder a finder’s fee of $140,928 and reimbursed ourfinder for expenses of $4,163.  Thewarrants underlying the unit warrants issued to the agent and the finder areexercisable for a period of five-years at an exercise price of $1.8375 pershare.

 

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Each of the foregoing issuances was made in reliance upon the exemptionprovided in Section 4(2) and/or the safe harbor provided by Rule 506 of theSecurities Act.  Such securities arerestricted as to sale or transfer, unless registered under the Securities Act,and certificates representing such securities contain restrictive legendspreventing sale, transfer or other disposition unless registered under theSecurities Act.  In addition, the recipientsof such securities received, or had access to, material information concerningMedicalCV, Inc., including, but not limited to, our reports on Form 10-KSB, For10-QSB and Form 8-K, as filed with the SEC, including amendments to suchreports.  Other than as noted above, nounderwriting commissions or discounts were paid with respect to the issuancesof such securities.

 

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**ITEM6****             MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION**

 

*The following discussion contains variousforward-looking statements within the meaning of Section 21E of the ExchangeAct.  Although we believe that, in making any such statement, ourexpectations are based on reasonable assumptions, any such statement may be influencedby factors that could cause actual outcomes and results to be materiallydifferent from those projected.  When used in the following discussion,the words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates”and similar expressions, as they relate to us or our management, are intendedto identify such forward-looking statements.  These forward-lookingstatements are subject to numerous risks and uncertainties that could causeactual results to differ materially from those anticipated.  Factors thatcould cause actual results to differ materially from those anticipated, certainof which are beyond our control, include those discussed in our CautionaryStatement as well as those discussed elsewhere in this Form 10-KSB.*

 

*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 ofthe events anticipated by forward-looking statements will occur or, if any ofthem do occur, what impact they will have on us.  We caution you to keepin mind the cautions and risks described in our Cautionary Statement as well asthose discussed elsewhere in this Form10-KSB and to refrain from attributingundue certainty to any forward-looking statements, which speak only as of thedate of the document in which they appear.*

 

**Overview**

 

We are a cardiovascular surgery device company.  For the pastseveral years substantially all of our revenue has come from the sale ofmechanical heart valves known as the Omnicarbon® Series 3000 (“OC3000”) andSeries 4000 (“OC4000”), which we manufacture and market.  Our heart valvesare used to treat heart failure caused by the aging process, heart diseases,prosthetic heart valve failure and congenital defects.  To date, we havedistributed the Omnicarbon 3000 and 4000 heart valves primarily in Europe,South Asia, the Middle East and the Far East.

 

On July 26, 2001, the FDA gave us notice of premarket approval to sellour OC 3000 heart valve in the U.S., the largest geographic market formechanical heart valves.  In the nearly three years since then we haverecorded a cumulative revenue of approximately $900,000 from U.S. sales of theOC 3000.  During those same three years we have invested heavily in recruitingand training U.S. distributors and promoting the valve to U.S. surgeons.

 

The worldwide heart valve market is highly competitive.  Inaddition, technology and competitive offerings, such as new tissue heartvalves, place increased pressure on us as we seek to increase our market shareand revenue.  For more information regarding these risks, you shouldreview our Cautionary Statement.

 

We are also attempting to add other cardiovascular products.  InAugust 2003, we acquired a laser-technology platform which we hope to developinto products that will be used for the surgical treatment of atrialfibrillation from LightWave Ablation Systems, Inc.  We have applied forFDA 510(k) clearance to market this device for soft tissue ablation includingcardiac ablation and, assuming receipt of such clearance, we expect to begincommercialization of our initial AF treatment in the fall of 2004.  Weexpect to build on this technology to develop a second product for minimallyinvasive, beating heart treatment of atrial fibrillation.  Thisapplication will require substantially more development and rigorous regulatorysubmissions including opening an IDE, conducting a clinical study and filing aPMA.  We believe these and other products we may acquire or develop arecritical to increasing revenues and reducing losses and ultimately achievingprofitability.

 

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**Critical Accounting Policies**

 

*The preparation of our financial statementsin conformity with accounting principles generally accepted in the UnitedStates requires management to make estimates and assumptions that affect theamounts reported in the consolidated financial statements and accompanyingnotes.  We believe our estimates and assumptions are reasonable; however,actual results and the timing of the recognition of such amounts could differfrom those estimates.  We have identified the following criticalaccounting policies and estimates utilized by management in the preparation ofour financial statements: revenue recognition, accounts receivable allowance,inventory obsolescence and deferred income tax assets.  Actual amountscould differ significantly from management’s estimates.*

 

***Revenue Recognition***. We recognize revenue using guidance from SEC Staff Accounting Bulletin No. 104“Revenue Recognition in Financial Statements.”  Revenue from the sale ofour mechanical heart valves is recognized provided that we have received awritten order, the price is fixed, title has transferred, collection of theresulting receivable is probable and there are no remaining obligations. Transfer of title occurs for substantially all international sales uponshipment.  Our products are not subject to any customer acceptanceprocess.  There are no rights of return unless the product does notperform according to specifications.  Inthe United States we consign valves to hospitals and record the sale when thehospital notifies us of patient implant. In prior periods, we paid marketing support to distributors in somemarkets.  Such payments are reported as areduction in our revenues in accordance with EITF 01-9.

 

***Accounts ReceivableAllowance***.  In determining the adequacy ofour allowance for doubtful accounts, management considers a number of factors,including the aging of our receivable portfolio, customer payment trends, thefinancial condition of our customers and economic conditions in our customers’countries.  Our analysis in determining the allowance for doubtfulaccounts is performed by management on a customer-by-customer basis. Although our recorded allowance includes our best estimates, we cannot predictthe resolution of these matters with certainty.  As of April 30, 2004 andApril 30, 2003, our allowance for doubtful accounts was $102,869 and $113,295,respectively.

 

***InventoryObsolescence***.  In determining the appropriatecarrying value of our inventories, management considers a number of factors,including the aging of our inventory, recent sales trends, industry marketconditions and economic conditions.  Our analysis requires us to estimaterevenues by type of mechanical heart valve.  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 30,2004, we recorded a provision for inventory obsolescence of $125,563.

 

***Deferred Income TaxAssets***.  In assessing the realizability ofour deferred tax assets, management considers whether it is more likely thannot that our deferred income tax assets will be realized.  The ultimaterealization of deferred income tax assets is dependent on the generation offuture taxable income, which must occur prior to the expiration of our netoperating loss and credit carryforwards, which comprise the majority of thedeferred tax assets.  As of April 30, 2004, we had established a valuationallowance of $7,659,740 to fully offset our deferred tax assets due touncertainty about generating sufficient future taxable income necessary torealize these deferred tax assets, particularly in light of our history ofsignificant operating losses.  In addition, future utilization ofavailable net operating loss carryforwards may be limited under InternalRevenue Code Section 382 as a result of future changes in ownership.

 

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**Results of Operations as a Percentage ofTotal Revenue for the Fiscal Years Ended April 30, 2004 and 2003**

 

Our operating results, expressed as a percentage of total revenue, wereas follows:

 
| ** **                 | ** ** | **Year Ended April 30,** | ** ** |
|----------------------------|------------|--------------------------|------------|
| ** **                 | ** ** | **2004**                 | ** ** | **2003** | ** ** |
|                       |       |                     |       |   |   |
| Net sales                  |       | 100.0                    | %          | 100.0 | % |
| Cost of goods sold         |       | 64.6                     | %          | 70.1 | % |
|                       |       |                     |       |   |   |
| Gross profit               |       | 35.4                     | %          | 29.9 | % |
|                       |       |                     |       |   |   |
| Operating expenses:        |       |                     |       |   |   |
|                       |       |                     |       |   |   |
| Sales and marketing        |       | 58.5                     | %          | 89.5 | % |
| General and administrative |       | 70.2                     | %          | 71.2 | % |
| Engineering and regulatory |       | 26.7                     | %          | 34.0 | % |
|                       |       |                     |       |   |   |
| Total operating expense    |       | 155.4                    | %          | 194.7 | % |
|                       |       |                     |       |   |   |
| Loss from operations       |       | (120.0                   | )%         | (164.8 | )% |
|                       |       |                     |       |   |   |
| Other income (expense):    |       |                     |       |   |   |
|                       |       |                     |       |   |   |
| Interest expense           |       | (26.9                    | )%         | (18.1 | )% |
| Interest income            |       | .2                       | %          | .5 | % |
| Other income (expense)     |       | (36.1                    | )%         | 1.4 | % |
|                       |       |                     |       |   |   |
| Total other expense, net   |       | (62.8                    | )%         | (16.2 | )% |
|                       |       |                     |       |   |   |
| Net loss                   |       | (182.8                   | )%         | (181.1 | )% |

 

**Results of Operations for the Fiscal YearsEnded April 30, 2004 and 2003**

 

*Net Sales*.  Netsales for the fiscal year ended April 30, 2004, increased 32 percent to$3,410,975 from $2,578,063 for the fiscal year ended April 30, 2003.  Netsales in the U.S. increased 135 percent for the fiscal year ended April 30,2004, compared to the year ended April 30, 2003.  U.S. sales for the yearended April 30, 2004, represented 19 percent of sales compared to 11 percent ofsales for the year ended April 30, 2003.  For the year ended April 30,2004, sales to our European customers decreased 0.6 percent compared to theprior year.  The percentage decrease for the fiscal year ended April 30,2004, was affected by the fact that our largest European customer did notpurchase any valves in the quarter ended October 31, 2002 (fiscal year2003).  Sales to our other European customers declined 18 percent for theyear ended April 30, 2004 compared to fiscal year 2003.  Unit sales forthe year ended April 30, 2004, increased 27 percent compared to unit sales forthe year ended April 30, 2003.  Average selling prices increased for theyear ended April 30, 2004, compared to the year ended April 30, 2003, primarilyas a result of the increase in the proportion of sales made in the U.S. whereour selling prices are generally higher than in most European countries, andthe increase in total European sales which generate higher selling prices thanall other non-U.S. countries.

 

Substantially all of our sales are denominated in U.S. dollars. Fluctuations in foreign currency exchange rates have not resulted insignificant losses or gains on outstanding trade accounts receivable.  Allof our

 

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distributors are required topay for our products in U.S. dollars, other than our Japanese distributor,which pays in Japanese yen, and one European customer, who pays in euros.

 

*Cost of Goods*. We assemble heart valves with components we manufacture for the Omnicarbon 4000and components supplied by  Snia S.p.A.Carbomedics (“Carbomedics”) for the Omnicarbon 3000.  The cost of selfmanufactured components is approximately 1/3 the cost of components purchasedfrom Carbomedics.  The cost of self-manufactured components is dependentupon volume.  We have produced level quantities of components during thepast two years. Accordingly the cost of self manufactured components has not changedsignificantly between fiscal years 2003 and 2004.

 

During the years ended April 30, 2004 and 2003, we were required topurchase minimum quantities of components for the OC3000 fromCarbomedics.  Because our sales of the OC3000 did not grow as quickly aswe had anticipated, we did not purchase the minimum quantity of components andwe incurred penalties payable to Carbomedics totaling $147,434 for the yearended April 30, 2004, and $ 138,738 for the year ended April 30, 2003. The penalties were charged directly to cost of goods sold.  We believe wewill receive FDA approval for our self-production process for the OC4000 duringthe fiscal year ending April 30, 2005, and have not entered into a new supplyagreement with Carbomedics because we expect to begin self-producing the OC4000and stop selling the OC3000.  We have sufficient inventory of the OC3000and will not have a similar penalty charged to cost of goods in fiscal year2005.

 

*Gross Profit*. Gross profit margins in 2004 were 35.4 percent compared to 29.9 percent infiscal year 2003.  The gross profit on valves we sell in the U.S. ishigher than in other geographic regions as we sell directly to hospitals andselling prices in the U.S. are generally higher due in part to governmentregulations and reimbursement.  Selling prices for heart valves varysignificantly around the world.  Our gross profit is subject tofluctuations as the geographic mix of sales fluctuates.  Our gross margin increased in fiscal year2004 principally because we generated a higher proportion of our fiscal year2004 revenues from sales to U.S. customers, and a 31 percent increase in salesto our largest European customer from whom we generate higher margins than ourother international customers.  Ourstrategy is to pursue FDA approval of our proprietary pyrolytic carbonmanufacturing process in order to lower our cost to produce and market theOC4000 in the U.S.  Due to its lower manufacturing cost, we believe theOC4000 will generate significantly higher gross profit margins when sold in theU.S. than the OC3000 heart valve.  Approximately 70 percent of ourinventory at April 30, 2004, was the OC3000, which is made with componentspurchased from Carbomedics.  Assuming ourcarbon and manufacturing facility are approved by the FDA, we will be able tosell either the Omnicarbon 3000 or 4000 in all of our current markets with theexception of Japan.  Our gross marginwill improve when we sell OC4000s in the U.S., but we intend to continue tosell our remaining inventory of OC3000s.

 

*Sales and Marketing*. For the year ended April 30, 2004, sales and marketing expenses totaled$1,996,406 or 58.5 percent of net sales, compared to $2,307,769 or 89.5 percentof net sales in the fiscal year 2003.  The decrease in sales and marketingexpenses and the decrease in sales and marketing expenses as a percentage ofnet sales related to a more focused Omnicarbon marketing effort in the U.S. andinternational markets.  The reduction in sales and marketing expenses canbe directly attributable to four areas: compensation, travel, consulting andpromotional expenses.  We downsized our sales management group whichresulted in a $24,264 decrease in travel expense and a $52,938 decrease inemployee compensation expense in fiscal year 2004 compared to fiscal year2003.  We also reduced our use of outside consultants which reduced ourconsulting expenses by $110,792 in fiscal year 2004 compared to fiscal year2003.  Promotional expenses were down $61,000 from fiscal year 2003 tofiscal year 2004.  Fiscal year 2003 salesand marketing expenses include $51,000 in demonstration costs for items givento sales representatives.  Our heartvalve marketing strategy is to promote the clinical results of the Omnicarbonheart valve and the technical strengths of our company in designing andmanufacturing mechanical heart valves.  We have determined that the levelof market penetration does not justify continued spending on sales andmarketing at the level of 2003 and 2004 for the heart valve products.  Wewill incur additional sales and marketing expenses as we introduce our newproducts, which will partially offset savings in our planned reductions inmarketing expenses related to our valve products.

 

*General and Administrative*. For the year ended April 30, 2004, general and administrative expenses totaled$2,395,062 or 70.2 percent of net sales, compared to $1,834,418 or 71.2 percentof net sales in the same 

 

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period last year.  The primary components of the increase ingeneral and administrative expenses were increased audit fees of $112,000,increased outside consulting fees of $275,000 related to enhancement of oursenior management team and activities related to seeking additional sources offinancing and increased insurance costs of $40,000.

 

*Engineering and Regulatory*. Engineering and regulatory expenses increased to $910,646 for the year endedApril 30, 2004 compared to $876,686 for the year ended April 30, 2003. The increase in these costs reflected our increased development efforts relatedto the atrial fibrillation technology purchased during fiscal year 2004.  For the year ended April 30, 2004 engineeringand regulatory expenses included charges of $83,930 associated with theacquisition of the LightWave technology.  For the year ended April 30,2003, engineering and regulatory expenses included $29,094 of expensesassociated with the purchase of the Northrup Universal Heart Valve RepairSystemTM and the IMA AccessTM Retractor Device.  We are committed to futurepayments for the LightWave technology acquisition contingent upon ourachievement of certain developmental milestones. We estimate that such milestonepayments will result in additional charges of approximately $125,000 in fiscalyear 2005. Regulatory expenses accounted for $188,992 or 21 percent and$318,545 or 36 percent, respectively, of the total engineering and regulatoryfor the years ended April 30, 2004 and 2003.

 

*Loss from Operations*. For the year ended April 30, 2004, operating expenses of $5,302,114 exceededgross profit of $1,205,982 resulting in a loss from operations of$4,096,132.  For the year ended April 30, 2003, operating expenses of $5,018,873exceeded gross profit of $770,661 resulting in a loss from operations of$4,248,212.  As of April 30, 2004, we had an accumulated deficit of $23,312,085. We have incurred losses in each of the last eight fiscal years.

 

*Other Income (Expense)*. Other expense, net, consisting primarily of interest expense and losses onextinguishment of debt, increased to $2,142,858 for the year ended April 30,2004 from $419,497 for the year ended April 30, 2003. The increase resultedfrom an increase in interest expense and a $1,235,813 loss we recorded when weextended the terms of some of our debt.  The increase in interest expenseof $450,712 in the fiscal year 2004 was attributed to higher financing costsassociated with the additional short-term debt obtained in fiscal year 2004 andthe related-party property financing transaction consummated in fiscal year2003.  In addition, interest expense related to the issuance of warrantsrelated to debt financing totaled $522,619 for the year ended April 30, 2004,compared to $266,458 for the year ended April 30, 2003.  The losses on extinguishment of debt resultedfrom the issuance of warrants to lenders in connection with extension of theloan maturity dates.

 

*Income Tax Provision*. In light of our history of operating losses, we recorded a valuation allowanceto fully offset our deferred tax assets in fiscal year 2000.  We havecontinued to provide a full valuation allowance throughout fiscal year 2004 dueto uncertainty about our ability to generate sufficient future taxable incomenecessary to realize our deferred tax assets.  We have recorded no taxprovision in fiscal years 2004 or 2003 due to net operating losses generatedfor income tax reporting purposes.

 

**Liquidity and Capital Resources**

 

Cash and cash equivalents increased to $659,856 at April 30, 2004, from$184,227 at April 30, 2003.  This increase in cash and cash equivalents of$475,629 was due to the following:

 
| Net cash used in operating activities     |   | $         | (3,716,592 | )      |
|-------------------------------------------|--------|-----------|------------|--------|
| Net cash used in investing activities     |   | (81,434   | )          |
| Net cash provided by financing activities |   | 4,273,655 |       |
| Net increase                              |   | $         | 475,629    |   |

 

Net cash used in operating activities decreased $592,915 to $3,716,592in the year ended April 30, 2004, from $4,309,507 in the year ended April 30,2003.  The use of cash in operations in both fiscal years 2004 and 2003was primarily due to net losses of $6,238,990 and $4,667,709, respectively. Thecash effect of these net losses was partially offset by non-cash expenses of $1,938,218associated with the issuance of common stock and warrants to purchase commonstock in fiscal year 2004, and $238,996 in fiscal year 2003

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and also by non-cash chargesrelated to depreciation of $314,056 and $335,873 in fiscal years 2004 and 2003.

 

Net cash used in investing activities was $81,434 in the year endedApril 30, 2004.  Net cash used in investing activities was $128,960 in theyear ended April 30, 2003.  In both periods, the cash was used for capitalexpenditures. We expect our capital expenditures in fiscal year 2005 to be lessthan $250,000.

 

Net cash provided by financing activities was $4,273,655 in the yearended April 30, 2004, and consisted of net proceeds from equity sales inFebruary and April 2004 of $1,618,424, long-term borrowings of $3,150,000, partiallyoffset by principal payments of $150,000 on debt and $333,152 of payments onlease obligations.  In the year ended April 30, 2003, net cash provided byfinancing activities was $1,841,019 consisting of borrowings from relatedparties of $1,303,333 combined with net proceeds from the related partysale-leaseback transaction of $1,000,000; partially offset by principalpayments of $462,314.

 

*Recent Financing Activities*

 

We have invested a significant amount of cash to attempt to penetratethe U.S. heart valve market, build our U.S. sales organization and improve ourinternational distribution capabilities especially in Europe.  We havealso invested in new products and technologies in an effort to broaden our productofferings.  During the last two fiscal years, to improve our capitalstructure and provide working capital for operations, we completed thefollowing transactions with PKM Properties, LLC (“PKM”), an entity controlledby Paul K. Miller, one of our directors and the largest beneficial owner of oursecurities, Draft Co. (“Draft”), an unrelated third party, and Peter L. Hauser(“Hauser”), a beneficial owner of our securities.

 

•                  InJanuary 2003, we established a discretionary line of credit with PKM.  Asof April 30, 2004 and 2003, we had borrowed $943,333 and $943,333, under thisline of credit.  This line of credit, as amended, requires the payment ofinterest at a rate of 10 percent per year, matures on June 30, 2005, and iscollateralized by substantially all of our assets.

 

•                  InApril 2003, we also completed a 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 alease with PKM to lease back the facility and a portion of the land.

 

•                  InJuly 2003, we established a $1.0 million term debt with PKM.  This termdebt, which was amended in November 2003 to provide for an additional $500,000of borrowing, requires the payment of interest at a rate of 10 percent peryear, matures on June 30, 2005, and is collateralized by substantially all ofour assets.

 

•                  Ina simultaneous July 2003 transaction, we entered into a loan agreement andborrowed $1.0 million from Peter L. Hauser pursuant to the terms of asubordinated note with an interest rate of 10 percent per year.  Pursuantto an intercreditor agreement with PKM, the loan is collateralized bysubstantially all of our assets. This loan, as amended, matures on June 30,2005.

 

•                  Wealso borrowed $500,000 in November 2003 from Draft Co., under a note thatmatured on June 30, 2004, which had an interest at a rate of 10 percent peryear.  The Draft loan was collateralized by substantially all our assetspursuant to a restated intercreditor agreement among PKM, Hauser, and Draft.This note was repaid on June 30, 2004.

 

•                  InApril 2004, we issued a short-term promissory note to PKM in the principalamount of $150,000.  The note required the payment of interest at a rateof 10 percent per year.  This note was repaid during April 2004.

 

•      InFebruary, April and May, 2004, we conducted a private placement to accreditedinvestors of units, each unit consisting of one share of common stock and onecommon stock purchase warrant to purchase one share of common stock. In this placement, we sold 2,730,763 units for aggregate gross proceeds of$4,014,222. During fiscal year 2004 we received gross proceeds from thisprivate placement of $1,749,099. The five-year warrants sold with the commonstock are exercisable to

 

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purchase an aggregate of 2,730,763 shares of common stock at anexercise price of $1.60 per share.  In connection with such placement, weissued our agent a five-year warrant to purchase 123,272 units at an exerciseprice of $1.8375 per unit, paid our agent cash commissions of $181,210 and paidour agent a non-accountable expense allowance of $67,954.  In connectionwith such placement, we issued our finder a five-year warrant to purchase 190,378units at an exercise price of $1.8375 per unit, paid our finder a finder’s feeof $140,928 and reimbursed our finder for expenses of $4,163.  Thewarrants underlying the unit warrants issued to the agent and the finder areexercisable for a period of five-years at an exercise price of $1.8375 pershare.

 

*Analysis*

 

Even with the net proceeds from our recently completed privateplacement, we anticipate that we will need to raise additional capital in thesecond quarter of fiscal year 2005.  We expect to face substantialdifficulty in raising funds in the current market environment, and we cannotprovide any assurance that such additional financing will be available on termsacceptable to us or at all.  In addition, the report of our independentregistered public accounting firm for fiscal year 2004 includes an explanatoryparagraph expressing doubt about our ability to continue as a going concern.

 

We expect that our operating losses and negative operating cash flowwill continue through fiscal year 2005 as we continue adding staff to supportthe development and launch of our atrial fibrillation technology.  Weanticipate that our sales and marketing and general and administrative expenseswill continue to constitute a material use of our cash resources.  The actualamounts and timing of our capital expenditures will vary significantlydepending upon progress on our product development projects, the speed at whichwe are able to expand our distribution capability in domestic and internationalmarkets and the availability of financing.

 

Our capital requirements may vary depending upon the timing and thesuccess of the implementation of our business plan, regulatory, technologicaland competitive developments, or if:

 

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

 

•                                         operatinglosses exceed our projections;

 

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

 

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

 

•                                         wecontinue to experience substantial difficulty in gaining U.S. market acceptanceor delays in obtaining FDA clearance of our proprietary carbon coating processfor heart valves sold in the U.S. market.

 

By broadening our portfolio of cardiothoracic surgery products, we hopeto reduce our dependence on sales of heart valves and reduce our reliance uponfinancing transactions, which may not be available to us.  We cannot,however, assure you that our efforts to diversify our product offerings will:

 

•                                         beattainable;

 

•                                         beprofitable;

 

•                                         reduceour reliance upon financing transactions; or

 

•                                         enableus to continue operations.

 

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Our ability tocontinue as a going concern depends upon our ability to obtain additional debtand/or equity financing in the second quarter of fiscal year 2005.  We will be seeking a minimum of $3,000,000 tofund our operations and working capital requirements through April 2005.  We cannot provide any assurances, 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 line of credit with PKMand our term debt with PKM and Hauser, all of which is due on June 30, 2005,unless otherwise extended or restructured to continue operations.

 

We expect toface substantial difficulty in raising funds in the current market environmentand we have no commitments at this time to provide the required financing.  If we obtain the foregoing financing, we believewe will have sufficient capital resources to operate and fund the growth of ourbusiness for the remainder of fiscal year 2005.

 

The amount ofcapital needed for fiscal year 2006 is difficult to estimate and will bedependent on our efforts to reduce losses in our heart valve operations,  the introduction of our open-heart atrialfibrillation product and development costs on our minimally invasive atrialfibrillation products.

 

We cannotassure you that we will be able to raise sufficient additional capital on termsthat we consider acceptable, or at all. The terms of any equity financing are expected to be highly dilutive toour existing security holders.  Thedelisting of our securities from the Nasdaq SmallCap Market that occurred inMarch 2003 will negatively affect our ability to raise capital.  If we are unable to obtain adequate financingon acceptable terms, we will be unable to continue operations.

 

**Commitments and Contingent Liabilities**

 

*Related Party Lease Obligation*. On April 4, 2003, we sold our corporate headquarters, manufacturing facilityand surrounding land in Inver Grove Heights, Minnesota, to PKM.  Inconnection with the transaction, we received total consideration of $3.84million consisting of (i) $1.0 million in cash, (ii) PKM’s assumption of our$2.5 million outstanding indebtedness to Associated Bank which eliminated ourindebtedness to Associated Bank, and (iii) PKM’s assumption of our promissorynote with Dakota Electric Association and land special assessments payable toDakota County aggregating $336,105.

 

We simultaneously leased back our facility pursuant to a ten-yearlease, with options to renew and an option to repurchase the facility.  Wewill continue to utilize the facility as we did prior to the financingtransaction, with no change in operations.

 

*Clinical Studies*. We entered into agreements with several large non-U.S. hospitals to conductclinical studies regarding certain aspects of our Omnicarbon heart valve’sclinical performance.  The agreements run through fiscal year 2006. In general, recipients of clinical study payments are required to purchase ourproducts in order to complete their studies and collect and submit dataaccording to a study protocol.

 

*Debt with Related Parties*. We entered into agreements with PKM and Hauser in July and November of 2003 toprovide $2.5 million of bridge financing.  We previously established aline of credit in January 2003 with PKM and have entered into various otherfinancing transactions with PKM as described above.

 

*Other Short-Term Debt*.  We entered into an agreement with Draft Co.,in November 2003, to provide $500,000 in bridge financing.  We repaid this debt on June 30, 2004.

 

*Atrial Fibrillation Technology PurchaseAgreement*.  We entered into an agreement withLightWave Ablation Systems, Inc. (“LightWave”) in August 2003 to purchasetechnology for the treatment of atrial fibrillation.  We issued 15,000shares of common stock and a warrant to purchase 25,000 shares of common stock,and made an initial payment of $10,000 to LightWave for the worldwidetechnology distribution rights.  In April 2004, we paid $15,000 coincidentwith the filing of a 510(k) application with the FDA pertaining to anapplication of the LightWave technology. Pursuant to terms of the agreement, additional cash payments will bemade and warrants to purchase shares of our common stock may be issued toLightWave in the event that we meet certain

 

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development and marketingmilestones, including obtaining a CE Mark, receipt of 510(k) clearance, andissuance of a U.S. Patent.  Upon the first commercial sale in the U.S. orEurope utilizing the purchased technology, a payment of $125,000 will be dueand an additional $385,000 will be due when cumulative gross sales ofdisposable products utilizing the purchased technology reach $1,500,000. In addition, for a period of 10 years measured from the first commercial saleutilizing the purchased technology, we will make a payment totaling 2 to 6percent of net sales of disposable products.  Following the firstcommercial sale utilizing the purchased technology, the timing of which isindeterminable, minimum payments under this provision would total $2,325,000over nine years.

 

The following table summarizes our contractual obligation as of April30, 2004:

 
| ** **                                            | ** ** | **Payments Due By Period** | ** ** |
|-------------------------------------------------------|------------|----------------------------|------------|
| **Summary of Contractual  Obligations**               | ** ** | **TOTAL**                  | ** ** | **Less than One Year** | ** ** | **Two to Three Years** | ** ** | **Four or More Years** | ** ** |
| Related Party Lease Obligation(1)                     |       | $                          | 3,774,924  |   | $ | 424,104 |   | $ | 864,048 |   | $ | 2,486,772 |   |
| Clinical Studies                                      |       | 10,100                     |       | 10,100 |   |   |   |   |   |
| Consulting                                            |       | 17,308                     |       | 17,308 |   |   |   |   |   |
| Atrial Fibrillation Technology Purchase  Agreement(2) |       | 15,000                     |       | 15,000 |   |   |   |   |   |
| Debt with Related Parties                             |       | 3,443,333                  |       |   |   | 3,443,333 |   |   |   |
| Other Short-Term Debt                                 |       | 500,000                    |       | 500,000 |   |   |   |   |   |
| TOTAL CONTRACTUAL OBLIGATIONS                         |       | $                          | 7,760,665  |   | $ | 966,512 |   | $ | 4,307,381 |   | $ | 2,486,772 |   |

 

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(1)           Futurepayments include interest due.

(2)           Excludesup to $2,325,000 of payments that are contingent upon achievement of futuredevelopment and sales milestones, as described above.

 

**Qualitative and Quantitative Disclosuresabout Market Risk**

 

We develop our products in the U.S. and market our productsglobally.  Because we continue to derive our revenue primarily fromsources outside of the U.S., our financial results could be affected by manyfactors, such as changes in currency exchange rates or weak economic conditionsin foreign markets.  Substantially all of our sales are denominated inU.S. dollars.  A strengthening of the U.S. dollar could make our productsless competitive in foreign markets.  We do not currently participate inany currency hedging activities to mitigate this risk.  We assess the needto use financial instruments to hedge our exchange rate exposure on an ongoingbasis.  In addition, we continually evaluate selling prices and billingcurrencies to monitor our exchange rate exposure.  Our interest income issensitive to changes in the general level of U.S. interest rates.  All of our outstanding debt instruments havefixed interest rates and are, therefore, not sensitive to changes in marketinterest rates.  Based on the current nature and levels of our investmentsand debt, we believe that we currently have no material market risk exposure.

 

Our generalinvesting policy is to limit market and credit risk and the risk of principalloss.  All liquid investments with original maturities of three months orless are considered to be cash equivalents.

 

**Cautionary Statement**

 

*MedicalCV, Inc., or persons acting on ourbehalf, or outside reviewers retained by us making statements on our behalf, orunderwriters of our securities, from time to time, may make, in writing ororally, “forward-looking statements” as defined under the Private SecuritiesLitigation Reform Act of 1995.  ThisCautionary 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.*

 

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

 

**We anticipate future losses and negative cashflows, which may limit or delay our ability to become profitable**.  We have incurred losses in each of the lasteight fiscal years.  We had net losses of$6,238,990 in the fiscal year ended April 30, 2004, and $4,667,709 for thefiscal year ended April 30, 2003.  As ofApril 30, 2004, we had an accumulated deficit of $23,312,085.  If we fail to obtain additional financingwhen required, we may not be able to develop or enhance our existing and proposedproducts, including the development and introduction of our atrial fibrillationproducts.  Additional financing will beneeded to gain market share for our heart valve products and to respond tocompetitive pressures or unanticipated requirements, which could seriously harmour business, financial position and results of operations.  We expect to incur additional net lossesuntil we are able to generate and sustain substantially higher revenues whilemaintaining reasonable expense levels, both of which involve uncertainty.  We cannot assure you that our revenues willgrow in future periods or that we will ever become profitable.  If we do achieve profitability, we cannot assureyou that we would be able to sustain or increase profitability on a quarterlyor annual basis in the future.  Inaddition, the report of our independent registered public accounting firm forfiscal year 2004 includes an explanatory paragraph expressing doubt about ourability to continue as a going concern.

 

**Substantially all of our assets are pledgedto lenders and subject to risk of loss**.  In connection with various bridge loantransactions entered into during 2003, substantially all of our assets werepledged to secure our indebtedness to PKM, an entity controlled by Paul K.Miller, one of our directors and the largest beneficial owner of oursecurities, and Peter L. Hauser, who following the transaction in which heparticipated became the beneficial owner of over 10 percent of our securities.  As of July 27, 2004, we were indebted tothese lenders in the principal amount of $3,443,333. 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 on June 30,2005, the lenders may elect to exercise their rights as secured creditors,which may include 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.

 

**If we are unable to fund our significantcapital needs, we may be required to cease operations**.  Our ability to continue as a going concerndepends upon our ability to obtain additional debt and/or equity financing inthe second quarter of fiscal year 2005. We are required to pay approximately $500,000 in interest to holders ofoutstanding debt during fiscal year 2005. The terms of any future equity financing are expected to be highlydilutive to our existing security holders. The delisting of our securities from the Nasdaq SmallCap Market thatoccurred in March 2003 negatively affects our ability to raise capital.  We expect to face substantial difficulty inraising funds in the current market environment and we cannot provide anyassurance that such additional financing will be available on terms acceptableto us or at all.  If we are unable toobtain adequate financing on acceptable terms, we will be unable to continueoperations.

 

**We rely upon sales of our Omnicarbon heartvalves for substantially all of our revenue and we will need regulatoryapproval to sell our atrial fibrillation technology or other products**.  Our results of operations materially dependon the success of the OC 3000 and OC 4000 heart valves, which accounted forsubstantially all of our operating revenue for the fiscal years ended April 30,2004 and 2003.  A significant reductionin sales of Omnicarbon heart valves for any reason, including the introductionof additional competing products, would have a material adverse effect onus.  We need to obtain regulatoryapproval before we can sell our atrial fibrillation technology or otherproducts.  Given the time-consuming andtechnical nature of the regulatory clearance process, we cannot be certainwhen, or whether, we will be permitted to sell such products.  We also anticipate that research anddevelopment and clinical and regulatory expenses will continue to rise infuture periods.

 

**We may be unsuccessful in our efforts toshift our business model to target high growth markets in cardiothoracicsurgery**.  We maybe unsuccessful in our efforts to diversify, prompting continued reliance on 

 

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financing activities to fund operations.  Unless the level of U.S. market acceptance ofour heart valves increases and the FDA approves our pyrolytic carbon process,we anticipate that we will continue to depend upon cash provided by financingactivities to address our working capital requirements.  By broadening our portfolio of cardiothoracicsurgery products, we hope to reduce our dependence on sales of heart valves andreduce our reliance upon financing transactions, which may not be available tous.  We cannot, however, assure you thatour efforts to diversify our product offerings will:

 

•              be attainable;

 

•              be profitable;

 

•              reduce our relianceupon financing transactions; or

 

•              enable us tocontinue operations.

 

**We cannot assure you that our efforts tointroduce our atrial fibrillation technology or other products will besuccessful**.  Weseek to develop, acquire or license new technologies to broaden our productofferings to the cardiothoracic surgery market. We cannot assure you that we will succeed in introducing our newproducts, that such new products will gain market acceptance, or that suchproducts will significantly contribute to our operating results; nor can weassure you that we will be able to recover the cost of investing in the developmentand introduction of such products. Further, we may determine not to pursue development of any product linesbeing manufactured or currently under development.  For example, we recently determined tosuspend development of our annuloplasty product in an effort to reallocate ourcapital resources.

 

**We cannot assure you that our atrialfibrillation treatment 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 cardiovascular surgery devices will gain any significant degree ofphysician acceptance, or that users will accept our systems as preferable toalternative products or methods of treatment. Physician acceptance of our products depends upon our ability todemonstrate the clinical advantages of such systems.

 

**Our business is vulnerable to risks resultingfrom international political and economic conditions**.  Most of our revenue is derived from customersin Europe, South Asia, the Middle East and the Far East.  Our ability to continue to do business withcurrent customers for our heart valves as well as our ability to introduce newproducts and secure distribution channels may be adversely affected bypolitical turmoil, terrorism and economic instability in those regions.

 

**Because we do not have FDA clearance tomarket our Omnicarbon heart valves manufactured with our proprietary pyrolyticcarbon process for sale in the U.S., we depend upon a third party supplier forcritical components**. We market our OC 3000 heart valves, which we sell in the U.S., withpyrolytic carbon components produced by Snia S.p.A. Carbomedics, a third partysupplier which sells competing heart valves. Although we believe we have sufficient OC 3000 heart valves to carry usthrough FDA premarket approval of our OC 4000 valves for sale in the U.S., thesupply contract pursuant to which we had purchased such components from SniaS.p.A. Carbomedics expired in December 2003. Given the absence of FDA-cleared alternative sources for pyrolyticcarbon components for our OC 3000 heart valves, any disruption of our supplywould have a material adverse effect on our continued ability to sell OC 3000heart valves.  Further, we cannot assureyou that we will be able to obtain FDA clearance to manufacture Omnicarbonheart valves for sale in the U.S. using our own pyrolytic carbon process.  Our future success will depend, in part, onobtaining FDA clearance to manufacture carbon components for heart valves forsale in the U.S.

 

**We may need to fund multiple research studiesthroughout the lifecycle of each of our products, providing statisticallysignificant scientific data to regulatory agencies and cost effectiveness datato third party payers**. The FDA, foreign regulatory agencies and third party health care payersmay require scientific clinical outcomes data and cost effectiveness data.  We will need to provide this data throughoutour products’ 

 

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lifecycles.  Payers andgovernmental agencies may change the frequency and breadth of clinical researchrequired, potentially significantly increasing our costs.  Without adequate positive outcomes data thatdemonstrate advantages from the use of our Omnicarbon heart valves, we may notachieve any significant market penetration. We cannot assure you that our outcomes data will be adequate to meetpresent or future medical device utility requirements.  If our outcomes data does not meet suchrequirements, we may be unable to sell our products or obtain third partyreimbursement for the costs of our products.

 

**Intense competition in the prosthetic heartvalve industry could prevent us from successfully marketing our products orrender our products obsolete**.  We compete in mature, highly competitivemarkets in which substantially all of our competitors have well-known andestablished products.  To competesuccessfully in these markets, we must maintain competitive pricing anddemonstrate the advantages of our Omnicarbon heart valves in terms ofpost-surgical complications.  Severalcompanies are currently pursuing new mechanical heart valve designs, blood compatiblecoatings for mechanical heart valves, longer lasting tissue heart valves andsurgical alternatives to implanting prosthetic heart valves.  It is possible that technological advances byour competitors, or advances in surgical procedures that delay the need forreplacing heart valves, could render our Omnicarbon heart valves noncompetitiveor obsolete.

 

Our primary competitors, St. Jude Medical, Inc., Medtronic, Inc. andSnia S.p.A. Carbomedics, dominate the market and control most of the mechanicalheart valve market worldwide.  Our competitorshave extensive clinical data demonstrating the performance of their heartvalves and internal carbon manufacturing capabilities.  Our atrial fibrillation technology and oursoft tissue ablation system are also likely to experience competition from theproduct offerings of these and other companies. The companies with which we compete have many additional competitiveadvantages over us, including:

 

•              greater namerecognition and product market acceptance;

 

•              more establishedphysician relationships;

 

•              broader productlines;

 

•              greater distributioncapabilities;

 

•              greater regulatorycompliance capabilities;

 

•              larger marketing,research and development staffs and facilities; and

 

•              greater financialresources.

 

We cannot assure you that we will be able to compete against suchcompetitors or their products.

 

**The small number of distributors operating inforeign markets that currently generate substantially all of our revenues posea concentration of credit risk and could leave us at any time, impairing ourbusiness**. Substantially all of our sales originate from approximately 37distributors who market our OC 4000 heart valves in Europe, South Asia, theMiddle East and the Far East.  Because wedo not control the amount or timing of the resources such parties allocate tosales of our product, any revenues we derive from such relationships dependupon the efforts of such distributors. If we could not locate a replacement on a timely basis, the loss of aninternational distributor could adversely affect us.

 

Mercé v. Electromedicina, S.L. is one of our significant internationaldistributors.  Salvador Mercé Cervelló,Managing and General Director of Mercé v. Electromedicina, is one of our boardmembers.  This distributor made netpurchases of product from our company, equal to approximately 29.4 percent ofour net sales in the fiscal year ended April 30, 2004.  During the fiscal year ended April 30, 2003,such distributor made net purchases of product from our company equal toapproximately 29.6 percent of our net sales. Our accounts receivable with this distributor accounted forapproximately 33.4 and 37.9 percent of our accounts receivable at and 

 

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April 30, 2004 and 2003,respectively.  Obligations to us from ourdistributors are unsecured.  Distributorscould fail to pay receivables or cease distributing our products at any time,thereby materially and adversely affecting our business, financial condition,operating results and cash flows.

 

**We depend upon sales outside the U.S., whichare subject to a number of risks that could harm our ability to successfullycommercialize our products and could harm our business**.  We face several risks as a result of doingbusiness in foreign markets, including:

 

•              unforeseen changesin regulatory requirements and government health programs;

 

•              potentially adversetax consequences;

 

•              political andeconomic instability; and

 

•              greater difficultyin collecting payments from product sales.

 

In addition, the value of the U.S. dollar in relation to othercurrencies may also harm our sales to customers outside the U.S. because werequire substantially all of our customers to pay for our products in U.S.currency.

 

**Substantial government regulation in the U.S.and abroad may restrict our ability to sell our heart valves, our atrialfibrillation technology, our soft tissue ablation system or other products**.  The FDA and comparable regulatory authoritiesin foreign countries extensively and rigorously regulate our products, productdevelopment activities and manufacturing processes.  In the U.S., the FDA regulates theintroduction of medical devices as well as the manufacturing, labeling andrecord-keeping procedures for such products. We are required to:

 

•                                         obtainclearance before we can market and sell medical devices;

 

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

 

•                                         comply withmanufacturing and reporting requirements; and

 

•                                         undergorigorous inspections.

 

The process of obtaining marketing clearance for new medical devicesfrom the FDA can be costly and time consuming. For example, the premarket clearance process, which our heart valves andcertain other medical devices must undergo, can require numerous years tocomplete.  Although we have obtained FDAclearance for our OC 3000 heart valve, we cannot assure you that our futureproducts will obtain FDA clearance on a timely basis, or at all.  Our products must also comply with laws andregulations of foreign countries in which we market such products.  In general, the extent and complexity ofmedical device regulation is increasing worldwide.  This trend may continue, and the cost andtime required to obtain marketing clearance in any given country may increaseas a result.  We cannot assure you thatour products will obtain any necessary foreign clearances on a timely basis, orat all.

 

**Once medical devices are cleared for sale,regulatory authorities may still limit the use of such products, restrict salesto certain models or sizes, prevent the sale or manufacture of such products orrequire a recall or withdrawal of such products from the marketplace**.  Following initial clearance from regulatoryauthorities, we continue to be subject to extensive regulatoryrequirements.  Government authorities canwithdraw marketing clearance due to our failure to comply with regulatorystandards or due to the occurrence of unforeseen problems following initialclearance.  Ongoing regulatoryrequirements are wide-ranging and govern, among other things:

 

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

 

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•                                        productmanufacturing;

 

•                                        suppliersubstitution;

 

•                                        productchanges;

 

•                                        processmodifications;

 

•                                        medical devicereporting; and

 

•                                        product salesand distribution.

 

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

 

•                                         seize ourproducts;

 

•                                         require arecall;

 

•                                         withdrawpreviously granted market clearances;

 

•                                         implementprocedures to stop future violations; and/or

 

•                                         seek civil andcriminal penalties against us.

 

**The uncertainty of third party reimbursementsand possible health care reforms may adversely affect us**.  Our ability to market products successfullyin the U.S. will depend in part on the extent to which reimbursement for thecost of such products and related treatment will be available from governmenthealth administration authorities, private health insurers, health maintenanceorganizations and other third party payers. Payers may challenge the need for, and prices of, medical products andservices.  Payers may deny reimbursementfor procedures that they deem experimental or for devices used in ways other thanas cleared by the FDA or stated in their indications for use.  With respect to our products, some payerscould deny coverage until the devices become generally accepted by the medicalprofession.  The inability of hospitalsand other providers to obtain reimbursement from third party payers for ourproducts would have a material adverse impact on our business, financialcondition, operating results and cash flows.

 

Health care reform may also impact sales of new products in theU.S.  Reforms may include:

 

•                                         mandated basichealth 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 that Congress and state legislatures will continue toreview and assess alternative health care delivery systems and paymentmethodologies, and that public debate of these issues will likely continue inthe future.  Due to uncertaintiesregarding the ultimate features of reform initiatives and their enactment andimplementation, we cannot predict which, if any, of such reform proposals willbe adopted, when they may be adopted or what impact they may have on ourability to market our current and future products.  Laws resulting 

 

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from such reform initiatives could adversely impact our business,financial condition, operating results and cash flows.

 

**Despite our efforts to protect our proprietary rights, unauthorizedparties may attempt to use information that we regard as proprietary.  We also run the risk of infringing theproprietary 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 andconfidentiality agreements to protect the proprietary aspects of ourtechnology, including aspects of manufacturing. We have one U.S. patent on our pyrolytic carbon coating apparatus andtwo foreign patent applications.  Ouratrial fibrillation technology has one U.S. patent application.  We expect to seek patent protection foradditional products in the future.  Oursuccess will depend, in part, on our ability to protect our products and tomanufacture and sell them without infringing the rights of third parties.  The validity and breadth of claims covered inmedical technology patents involve complex legal and factual questions and,therefore, are highly uncertain.  Inaddition, the laws of many countries do not protect our proprietary rights toas great an extent as do the laws of the U.S. We cannot assure you that:

 

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

 

•                                             the scopeof any 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;

 

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

 

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

 

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

 

Furthermore, we cannot assure you that others have not developed orwill not develop products which may duplicate any of our products ormanufacturing processes, or that others will not design around our patents.  Other parties may independently develop orotherwise acquire substantially equivalent techniques, gain access to ourproprietary technology or disclose such technology.  In addition, whether or not we obtainadditional patents, others may hold or receive patents covering components ofproducts 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 involved in material legal proceedings.  Any such claims, with or without merit, couldbe time-consuming, result in costly litigation, cause product shipment delaysand 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 that we would be able to obtain royalty orlicensing agreements, if required, on terms acceptable to us or at all, or thatwe would be able to develop commercially acceptable non-infringing alternativeproducts.  Our failure to do so couldhave a material adverse effect upon our business, financial condition,operating results and cash flows.

 

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**If patients allege that the use of ourcardiovascular surgery devices adversely affected them, we may face substantialproduct liability claims**.  Substantial product liability litigationexists within the medical device industry. Our products are life-sustaining devices, and their failure may resultin patient death.  We have had productliability claims in the past, which have been resolved without materialfinancial cost to us.  We cannot assureyou, however, that future product liability claims will not exceed the limitsof our insurance coverage or that such insurance will continue to be availableon commercially reasonable 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 are liable.  These claims may divert our financial andmanagement resources that would otherwise be used to benefit the futureperformance of our operations.

 

**Key employees could leave our company at anytime, 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, financialcondition, operating results and cash flows.

 

**We may be unable to recruit, motivate andretain qualified employees**.  Our success depends upon our ability toattract, motivate and retain a sufficient number of qualified employees,including those who concentrate in research and development, sales, marketingand manufacturing, to keep pace with our product development schedules.  Even though we have not experienced shortagesof qualified people to date, qualified individuals needed to fill thesepositions could be in short supply in our market.  Our inability to recruit, motivate and retainsuch individuals may delay the planned launch of new products, including therecruitment of individuals to develop our atrial fibrillation product, orresult in high employee turnover, either of which could have a material adverseeffect on our business, financial condition, operating results and cashflows.  Additionally, competition forqualified employees could require us to pay higher wages and provide additionalbenefits to attract sufficient employees.

 

**Fluctuations in our operating results mayresult 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 our common stock**.  We cannot assure you that a public market forour common stock will develop.  Beforeour initial public offering, there was no public market for our units.  Our units were listed on The Nasdaq SmallCapMarket under the symbol “MDCVU” from the completion of our initial publicoffering in November 2001 until March 2003. In March 2003, our units were delisted from The Nasdaq SmallCap Marketbecause we failed to satisfy the minimum stockholders’ equity requirement forcontinued listing and because the bid price of our units had been below $1.00for 30 consecutive trading days.  Ourunits are now traded under the same symbol on the OTC Bulletin Board.

 

**You may have difficulty reselling our commonstock**.  Oursecurities are subject to certain rules of the SEC relating to “pennystocks.”  Such rules requirebroker-dealers to make a suitability determination for purchasers and toreceive the purchaser’s prior written consent for a purchase transaction, thusrestricting the ability to purchase or sell our securities in the openmarket.  In addition, trading in oursecurities is conducted in the over-the-counter market on the OTC BulletinBoard, which was established for securities that do not meet Nasdaq listingrequirements.  Selling our securities maybe difficult because of the quantity of securities that may be bought and sold,the possibility that transactions may be delayed, and the low level of securityanalyst and news media coverage given to over-the-counter stocks.  These factors could contribute to lowerprices and larger spreads in the bid and ask prices for our securities.

 

29

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**Our affiliated shareholders have significantcontrol, which could reduce your ability to receive a premium for yoursecurities through a change in control**.  As of July 23, 2004, officers and directorsof our company beneficially owned approximately 35.0 percent of our outstandingcommon stock.  As a result, they may beable to control our company and direct our affairs, including the election ofdirectors and approval of significant corporate transactions.  This concentration of ownership could alsodelay, defer or prevent a change in control of our company, and make some transactionsmore difficult or impossible without their support.  These transactions might include proxycontests, tender offers, open market purchase programs or other share purchasesthat could give our shareholders the opportunity to realize a premium over thethen prevailing market price of our securities. As a result, this concentration of ownership could depress the price ofour securities.

 

**Minnesota law and our ability to issuepreferred 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 Corporation Act, which includes provisions that limit thevoting rights of persons acquiring specified percentages of shares of anissuing public corporation in a “control share acquisition” and restrict“business combinations” between issuing public corporations and specifiedpersons acquiring their securities.  Ourability to issue preferred stock and the application of the provisions of Minnesotalaw discussed above could impede or deter another company from making a tenderoffer or other proposal to take us over.

 

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**ITEM7****                                        FINANCIALSTATEMENTS**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 

 

**MedicalCV, Inc.**

 
| Report of Independent Registered Public  Accounting Firm                                                               |   |
|------------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated Balance Sheets as of April 30, 2004 and 2003                                                              |   |
| Consolidated Statements of Operations for  the Years Ended April 30, 2004 and 2003                                     |   |
| Consolidated Statements of Changes in  Shareholders’ Equity (Deficit) for the Years Ended April 30, 2004 and 2003 |   |
| Consolidated Statements of Cash Flows for  the Years Ended April 30, 2004 and 2003                                     |   |
| Notes to Consolidated Financial Statements                                                                             |   |

 

31

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**Report of Independent Registered PublicAccounting Firm**

 

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

 

In our opinion, the accompanying consolidated balance sheets and therelated consolidated statements of operations, of changes in shareholders’equity (deficit) and of cash flows present fairly, in all material respects,the financial position of MedicalCV, Inc. at April 30, 2004 and 2003, and theresults of their operations and their cash flows for the years then ended inconformity with accounting principles generally accepted in the United Statesof America.  These financial statements are the responsibility of theCompany’s management; our responsibility is to express an opinion on thesefinancial statements based on our audits.  We conducted our audits ofthese statements in accordance with standards of the Public Company AccountingOversight Board (United States).  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement.  An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management,and evaluating the overall financial statement presentation.  We believethat our audits provide a reasonable basis for our opinion.

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern.  As discussed in Note 1 tothe financial statements, the Company has sustained losses and negative cashflows from operations in recent years and has insufficient funds to finance itsworking capital and capital expenditure needs, which raises substantial doubtabout the Company’s ability to continue as a going concern.  Management’splans in regard to these matters are also described in Note 1.  Thefinancial statements do not include any adjustments that might result from the outcomeof this uncertainty.

 
| /s/ PricewaterhouseCoopers LLP                                                                |   |
|-----------------------------------------------------------------------------------------------|--------|
| PricewaterhouseCoopers LLP                                                                    |
| Minneapolis, Minnesota                                                                        |
| June 4, 2004, except for the sixth paragraph of  Note 5 as to which the date is June 30, 2004 |

 

32

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**MEDICALCV, INC.**

 

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                      | ** ** | **April 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|
| ** **                                                                                                                                                      | ** ** | **2004**      | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                                                                      |       |          |       |   |   |
| Current assets:                                                                                                                                                 |       |          |       |   |   |
| Cash and cash equivalents                                                                                                                                       |       | $             | 659,856    |   | $ | 184,227 |   |
| Trade accounts receivable, net                                                                                                                                  |       | 1,495,401     |       | 1,472,995 |   |
| Inventories                                                                                                                                                     |       | 2,518,698     |       | 2,782,613 |   |
| Prepaid expenses and other current assets                                                                                                                       |       | 211,816       |       | 183,856 |   |
| Total current assets                                                                                                                                            |       | 4,885,771     |       | 4,623,691 |   |
|                                                                                                                                                            |       |          |       |   |   |
| Property, plant and equipment, net                                                                                                                              |       | 1,135,618     |       | 1,368,240 |   |
| Deferred financing costs                                                                                                                                        |       | 74,605        |       | 62,989 |   |
| Total assets                                                                                                                                                    |       | $             | 6,095,994  |   | $ | 6,054,920 |   |
|                                                                                                                                                            |       |          |       |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)**                                                                                                         |       |          |       |   |   |
| Current liabilities:                                                                                                                                            |       |          |       |   |   |
| Accounts payable                                                                                                                                                |       | $             | 1,498,848  |   | $ | 895,405 |   |
| Short-term debt with related party                                                                                                                              |       | —        |       | 943,333 |   |
| Current portion of related party lease  obligation                                                                                                              |       | 288,995       |       | 273,843 |   |
| Note payable                                                                                                                                                    |       | 485,708       |       |   |   |
| Current portion of capital lease  obligations                                                                                                                   |       | —        |       | 42,069 |   |
| Accrued expenses                                                                                                                                                |       | 266,671       |       | 813,539 |   |
| Total current liabilities                                                                                                                                       |       | 2,540,222     |       | 2,968,189 |   |
|                                                                                                                                                            |       |          |       |   |   |
| Long-term debt                                                                                                                                                  |       | 3,443,333     |       |   |   |
| Related party lease obligation, less  current portion                                                                                                           |       | 3,166,425     |       | 3,472,661 |   |
|                                                                                                                                                            |       |          |       |   |   |
| 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; 9,189,933 and 7,843,834 shares issued and outstanding as of April  30, 2004 and 2003, respectively |       | 91,899        |       | 78,438 |   |
| Additional paid-in capital                                                                                                                                      |       | 20,168,133    |       | 16,613,337 |   |
| Deferred stock-based compensation                                                                                                                               |       | (1,933        | )          | (4,610 | ) |
| Accumulated deficit                                                                                                                                             |       | (23,312,085   | )          | (17,073,095 | ) |
| Total shareholders’ equity (deficit)                                                                                                                       |       | (3,053,986    | )          | (385,930 | ) |
| Total liabilities and shareholders’ equity  (deficit)                                                                                                      |       | $             | 6,095,994  |   | $ | 6,054,920 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

33

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**MedicalCV, Inc.**

**Consolidated Statements of Operations**

 
| ** **                                                                      | ** ** | **Year ended April 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                      | ** ** | **2004**                 | ** ** | **2003** | ** ** |
|                                                                            |       |                     |       |   |   |
| Net sales                                                                       |       | $                        | 3,410,975  |   | $ | 2,578,063 |   |
| Cost of goods sold                                                              |       | 2,204,993                |       | 1,807,402 |   |
|                                                                            |       |                     |       |   |   |
| Gross profit                                                                    |       | 1,205,982                |       | 770,661 |   |
|                                                                            |       |                     |       |   |   |
| Operating expenses:                                                             |       |                     |       |   |   |
| Sales and marketing                                                             |       | 1,996,406                |       | 2,307,769 |   |
| General and administrative                                                      |       | 2,395,062                |       | 1,834,418 |   |
| Engineering and regulatory                                                      |       | 910,646                  |       | 876,686 |   |
|                                                                            |       |                     |       |   |   |
| Total operating expenses                                                        |       | 5,302,114                |       | 5,018,873 |   |
|                                                                            |       |                     |       |   |   |
| Loss from operations                                                            |       | (4,096,132               | )          | (4,248,212 | ) |
|                                                                            |       |                     |       |   |   |
| Other (expense) income:                                                         |       |                     |       |   |   |
| Interest expense                                                                |       | (918,027                 | )          | (467,315 | ) |
| Interest income                                                                 |       | 4,993                    |       | 12,705 |   |
| Other expenses, net                                                             |       | (1,229,824               | )          | 35,113 |   |
|                                                                            |       |                     |       |   |   |
| Total other expense, net                                                        |       | (2,142,858               | )          | (419,497 | ) |
|                                                                            |       |                     |       |   |   |
| Net loss                                                                        |       | $                        | (6,238,990 | ) | $ | (4,667,709 | ) |
|                                                                            |       |                     |       |   |   |
| Basic and diluted net loss per share                                            |       | $                        | (.78       | ) | $ | (.60 | ) |
|                                                                            |       |                     |       |   |   |
| Weighted average shares used in computing  basic and diluted net loss per share |       | 8,046,736                |       | 7,843,834 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

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**MedicalCV, Inc.**

**Consolidated Statements of Changes inShareholders’ Equity (Deficit)**

 
|                                                                          |       | ** ** | ** ** | ** ** |   | **Additional  Paid-in  Capital** | ** ** | **Deferred  Stock-Based  Compensation** | ** ** | **(Accumulated  Deficit)** | ** ** | **Total**  |    |
|-------------------------------------------------------------------------------|------------|------------|------------|------------|--------|----------------------------------|------------|-----------------------------------------|------------|----------------------------|------------|------------|---------|
| **Common Stock**                                                              |
| **Shares**                                                                    | ** ** | **Amount** |
|                                                                          |       |       |       |       |   | ** **                       | ** ** | ** **                              | ** ** | ** **                 | ** ** | ** ** |    |
| **Total, April 30, 2002**                                                     |       | 6,843,834  |       | $          | 68,438 |                             | $          | 16,362,050                              |       | $                          | (9,062     | )          | $       | (12,405,386 | ) | $ | 4,026,040 |   |
| Net loss                                                                      |       |       |       |       |   |                             |       |                                    |       | (4,667,709                 | )          | (4,667,709 | )       |
| Amortization of stock-based compensation                                      |       |       |       |       |   |                             |       | 4,452                                   |       |                       |       | 4,452      |    |
| Stock options issued to consultants                                           |       |       |       |       |   | 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     |    |
| Net loss                                                                      |       |       |       |       |   |                             |       |                                    |       | (4,667,709                 | )          | (4,667,709 | )       |
| **Total, April 30, 2003**                                                     |       | 7,843,834  |       | $          | 78,438 |                             | $          | 16,613,337                              |       | $                          | (4,610     | )          | $       | (17,073,095 | ) | $ | (385,930 | ) |
| Amortization of stock-based compensation                                      |       |       |       |       |   |                             |       | $                                       | 2,677      |                       | $          |       |    | $ | 2,677 |   |
| Common stock issued below market value to Director for cash                   |       | 85,714     |       | 857        |   | $                                | 122,571    |                                    |       |                       |       |       | 123,428 |   |
| Stock options issued to consultants                                           |       |       |       |       |   | $                                | 72,915     |                                    |       |                       |       |       | 72,915  |   |
| Warrants issued to lenders                                                    |       |       |       |       |   | 1,740,560                        |       |                                    |       |                       |       | 1,740,560  |    |
| Warrants issued for LightWave technology (Note 10)                            |       |       |       |       |   | 31,280                           |       |                                    |       |                       |       | 31,280     |    |
| Common stock issued for LightWave technology (Note 10)                        |       | 15,000     |       | 150        |   | 7,500                            |       |                                    |       |                       |       | 7,650      |    |
| Common stock issued for services                                              |       | 55,522     |       | 555        |   | 33,445                           |       |                                    |       |                       |       | 34,000     |    |
| Common stock and warrants issued for cash, net of offering costs of  $190,675 |       | 1,189,863  |       | 11,899     |   | 1,546,525                        |       |                                    |       |                       |       | 1,558,424  |    |
| Net Loss                                                                      |       |       |       |       |   |                             |       |                                    |       | (6,238,990                 | )          | (6,238,990 | )       |
|                                                                          |       |       |       |       |   |                             |       |                                    |       |                       |       |       |    |
| **Total, April 30, 2004**                                                     |       | 9,189,933  |       | $          | 91,899 |                             | $          | 20,168,133                              |       | $                          | (1,933     | )          | $       | (23,312,085 | ) | (3,053,986 | ) |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

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**MedicalCV, Inc.**

**Consolidated Statements of Cash Flows**

 
| ** **                                                                        | ** ** | **Year ended April 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                        | ** ** | **2004**                 | ** ** | **2003** | ** ** |
| Cash flows from operating activities:                                             |       |                     |       |   |   |
| Net loss                                                                          |       | $                        | (6,238,990 | ) | $ | (4,667,709 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities:      |       |                     |       |   |   |
|                                                                              |       |                     |       |   |   |
| Depreciation                                                                      |       | 314,056                  |       | 335,873 |   |
| Provision for doubtful accounts                                                   |       | 12,649                   |       | 47,132 |   |
| Return of inventory (Note 4)                                                      |       |                     |       | (92,000 | ) |
| Provision for inventory obsolescence                                              |       | 125,563                  |       |   |   |
| Common stock sold below market value to Director                                  |       | 63,428                   |       | — |   |
| Stock-based compensation                                                          |       | 75,592                   |       | 24,780 |   |
| Warrants and common stock issued in connection with technology  purchase          |       | 38,930                   |       | 12,361 |   |
| Common stock issued for services                                                  |       | 34,000                   |       | — |   |
| Interest and other expense associated with warrant grants                         |       | 1,726,268                |       | 201,855 |   |
| Changes in assets and liabilities:                                                |       |                     |       |   |   |
| Accounts receivable                                                               |       | (35,055                  | )          | (261,511 | ) |
| Inventories                                                                       |       | 138,352                  |       | (368,078 | ) |
| Prepaid expenses and other assets                                                 |       | (27,960                  | )          | (169,875 | ) |
| Accounts payable                                                                  |       | 603,443                  |       | 305,885 |   |
| Accrued expenses                                                                  |       | (546,868                 | )          | 321,779 |   |
| Net cash used in operating activities                                             |       | (3,716,592               | )          | (4,309,507 | ) |
|                                                                              |       |                     |       |   |   |
| Cash flows from investing activities:                                             |       |                     |       |   |   |
| Purchase of property, plant and equipment                                         |       | (81,434                  | )          | (128,960 | ) |
|                                                                              |       |                     |       |   |   |
| Net cash used in investing activities                                             |       | (81,434                  | )          | (128,960 | ) |
|                                                                              |       |                     |       |   |   |
| Cash flows from financing activities:                                             |       |                     |       |   |   |
| Deferred financing costs                                                          |       | (11,616                  | )          | — |   |
| Proceeds from issuance of common stock and warrants, net of offering  costs       |       | 1,618,424                |       | — |   |
| Borrowings on line of credit with related party                                   |       | —                   |       |   |   |
| Borrowings on debt with related party                                             |       | —                   |       | 60,000 |   |
| Principal payments on debt with related party                                     |       | —                   |       | (360,000 | ) |
| Borrowings on long term debt                                                      |       | 3,150,000                |       | — |   |
| Principal payments on long-term debt                                              |       | (150,000                 | )          | (42,460 | ) |
| Proceeds from sale-leaseback transaction with related party, net                  |       | —                   |       | 1,000,000 |   |
| Principal payments under related party lease obligation                           |       | (291,084                 | )          | 1,243,333 |   |
| Principal payments on capital lease obligations                                   |       | (42,069                  | )          | (59,854 | ) |
|                                                                              |       |                     |       |   |   |
| Net cash provided by financing activities                                         |       | 4,273,655                |       | 1,841,019 |   |
|                                                                              |       |                     |       |   |   |
| Net increase (decrease) in cash and cash equivalents                              |       | 475,629                  |       | (2,597,448 | ) |
|                                                                              |       |                     |       |   |   |
| Cash and cash equivalents at beginning of year                                    |       | 184,227                  |       | 2,781,675 |   |
|                                                                              |       |                     |       |   |   |
| Cash and cash equivalents at end of year                                          |       | $                        | 659,856    |   | $ | 184,227 |   |
|                                                                              |       |                     |       |   |   |
|                                                                              |       |                     |       |   |   |
| Supplemental disclosure of cash flow information:                                 |       |                     |       |   |   |
| Cash paid during the year for:                                                    |       |                     |       |   |   |
| Interest                                                                          |       | $                        | 396,442    |   | $ | 265,460 |   |
|                                                                              |       |                     |       |   |   |
| Non-cash investing and financing activities:                                      |       |                     |       |   |   |
| Warrants issued in connection with sale-leaseback transaction with  related party |       |                     |       | 89,602 |   |
| 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 partof the consolidated financial statements.

 

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**MedicalCV, Inc.**

**Notes to Consolidated Financial Statements**

 

**1.         BusinessDescription**

 

MedicalCV, Inc. (the “Company”) is a corporation engaged in themanufacture and marketing of cardiovascular surgery devices primarily inEurope, South Asia, the Middle East and the Far East.  The primary productof the Company is a mechanical heart valve.

 

The Company’s consolidated financial statements for the year endedApril 30, 2004, have been prepared on a going concern basis, which contemplatesthe realization of assets and settlement of liabilities and commitments in thenormal course of business.  The Company has sustained losses and negativecash flows from operations in recent years and expects these conditions tocontinue for the foreseeable future.  At April 30, 2004, the Company hadan accumulated deficit of $23,312,085 and had insufficient funds to finance itsworking capital and capital expenditure needs and to meet its debt servicerequirements.  These matters raise substantial doubt about the Company’sability to continue as a going concern.  The Company is currently pursuingthe refinancing of its debt and seeking other financing, in addition to theequity sales described in Note 16, to fund its operations and working capitalrequirements.  If the Company is unable to refinance its debt and obtainadditional funds in the second quarter of fiscal year 2005, it will be requiredto significantly revise its business plans and drastically reduce operatingexpenditures such that it may not be able to develop or enhance its products,gain market share in the United States of America 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 uncertainties common to medicaltechnology-based companies, including rapid technological change, dependence onone principal product, new product development and acceptance, actions ofcompetitors, dependence on key personnel and United States of America marketpenetration.

 

**2.****         Summary of Significant Accounting Policies**

 

**Principles of Consolidation**

 

The Company’s consolidated financial statements include the accounts ofMedicalCV, Inc. and its wholly-owned subsidiary, CVD International, Inc., whichwas liquidated in fiscal year 2003 with no material impact to the financialstatements.  All significant inter-company transactions and balances havebeen eliminated in consolidation.

 

**Use of Estimates**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America 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 differfrom those estimates.

 

**Fair Value of Financial Instruments**

 

The Company’s financial instruments consist primarily of cash and cashequivalents, trade accounts receivable, short and long term debt and accountspayable for which the current carrying amounts approximate fair value.  The interest rates currently available to theCompany approximate current rates for debt agreements with similar terms andaverage maturities.

 

37

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**Cash and Cash Equivalents**

 

Cash and cash equivalents consist of checking accounts and a moneymarket account, all of which are held in two depository institutions.  TheCompany considers all highly-liquid investments with original maturities ofthree months or less to be cash equivalents.  The carrying value of cashequivalents approximates fair value because of the short maturity of theseinstruments.  Deposits in these institutions may exceed the amount offederal insurance provided on such deposits.

 

**Inventories**

 

Inventories consist of various mechanical heart valves and othermedical items that are stated at the lower of cost or market, with costdetermined utilizing standard costs, which approximate the first-in, first-outmethod of inventory valuation.

 

**Property, Plant and Equipment**

 

Property, plant and equipment is stated at cost.  Depreciation andamortization is computed using the straight-line method over the estimateduseful lives of the related assets.  The building is depreciated over a30-year life.  Machinery and equipment, furniture and fixtures, toolingand software are depreciated over five-year lives.  Maintenance andrepairs are charged to current operations when incurred.  The cost andrelated accumulated depreciation or amortization of assets disposed of areremoved from the related accounts and any resulting gains or losses areincluded in the statement of operations.

 

**Long-Lived Assets**

 

The Company periodically evaluates the carrying value of long-livedassets to be held and used, including but not limited to, capital assets, whenevents and circumstances warrant such a review.  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 is recognized based on the amount by whichthe carrying value exceeds the fair value 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 tobe disposed of are determined in a similar manner, except that fair values arereduced for the cost to dispose.  No losses from impairment have been recognizedin the consolidated financial statements.

 

**Revenue Recognition**

 

The Company recognizes revenue using guidance from SEC Staff AccountingBulletin No. 104 “Revenue Recognition in Financial Statements.”  Revenuefrom the sale of its mechanical heart valves is recognized provided that theCompany has received a written order, the price is fixed, title hastransferred, collection of the resulting receivable is probable and there areno remaining obligations.  Transfer of title occurs for substantially allinternational sales upon shipment.  The Company’s products are not subjectto any customer acceptance process.  There are no rights of return unlessthe product does not perform according to specifications.  In the United States, valves are consigned tohospitals and the sale is recorded when the hospital notifies the Company ofpatient implant.  In prior periods,marketing support was paid to distributors in some markets.  Such payments are reported as a reduction inrevenues in accordance with EITF 01-9.

 

38

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**Research and Development**

 

Research and development costs are expensed as incurred.

 

**Stock-Based Compensation**

 

The Company accounts for stock-based employee compensation arrangementsin accordance with the provisions of Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees,” and itsinterpretations and complies with the disclosure provisions of SFASNo. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148 “Accountingfor Stock-Based Compensation-Transition and Disclosure, an amendment of FASBStatement No. 123.”

 

The Company has adopted the disclosure provisions of SFAS No. 123for employee stock-based compensation.  For purposes of the pro formadisclosures below, the estimated fair value of the options is amortized toexpense over the options’ vesting period.  Had compensation cost for theCompany’s stock options been recognized based on the fair value at the grantdate consistent with the provisions of SFAS No. 123, the Company’s netloss would have been adjusted to the pro forma amounts indicated in thefollowing table:

 
| ** **                                                    | ** ** | **For the Years Ended April 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                    | ** ** | **2004**                          | ** ** | **2003** | ** ** |
| Net loss reported                                             |       | $                                 | (6,238,990 | ) | $ | (4,667,709 | ) |
| Less:  Pro forma stock based employee  compensation cost |       | (364,946                          | )          | (294,142 | ) |
|                                                          |       |                              |       |   |   |
| Net loss - pro forma                                          |       | (6,603,936                        | )          | (4,961,851 | ) |
|                                                          |       |                              |       |   |   |
| Net loss per common share – basic and  diluted           |       |                              |       |   |   |
| As reported                                                   |       | (.78                              | )          | (.60 | ) |
| Pro forma                                                     |       | $                                 | (.83       | ) | $ | (.63 | ) |

 

**Income Taxes**

 

Deferred income taxes are recorded to reflect the tax consequences infuture years of differences between the tax bases of assets and liabilities andtheir financial reporting amounts at each year-end, based on enacted tax lawsand statutory tax rates applicable to the periods in which the differences areexpected to affect taxable income.  Deferred tax assets are reduced by avaluation allowance when, in the opinion of management, it is more likely thannot that some portion or all of the deferred tax asset will not be realized. Income tax expense or benefit is the tax payable or refundable for the year andthe change during the year in deferred tax assets and liabilities.

 

**Comprehensive Income (Loss)**

 

Comprehensive income (loss) includes net income (loss) and itemsdefined as other comprehensive income (loss).  Items defined as othercomprehensive income (loss) include items such as foreign currency translationadjustments and unrealized gains and losses on certain marketablesecurities.  For the years ended April 30, 2004 and 2003, there were noadjustments to net loss to arrive at comprehensive loss.

 

**Concentration of Credit Risk**

 

At April 30, 2004 and 2003, approximately 35.7 percent and 37.9percent, respectively, of the Company’s accounts receivable were due from onedistributor in each respective fiscal year (see Note 13).  The Companygenerally requires no collateral from its customers with respect to tradeaccounts receivable.  The Company maintains an allowance for doubtfulaccounts based upon its historical experience and the expected collectibilityof all accounts receivable.

 

39

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**Net Income (Loss) Per Share**

 

Basic net income (loss) per common share is computed using net income(loss) and the weighted-average number of shares of common stockoutstanding.  Diluted earnings per share reflect the potential dilution ofsecurities that could share in the earnings of an entity.  Diluted netloss per common share does not differ from basic net loss per common share inthe years ended April 30, 2004 and 2003 since 7,492,905and 4,300,940respectively, of potential dilutive shares of common stock from the exercise ofstock options and warrants were excluded from the computation because theeffect of including them in the loss per share computation would have beenanti-dilutive.

 

**3.****         Supplemental Financial Statement Information**

 

Certain balance sheet components consist of the following at April 30:

 
| **Trade Accounts Receivable, Net** | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|------------------------------------|------------|-----------|------------|-----------|------------|
|                               |       |      |       |      |       |
| Related parties                    |       | $         | 533,402    |      | $          | 557,899 |   |
| Other                              |       | 1,064,868 |       | 1,028,391 |       |
| Allowance for doubtful accounts    |       | (102,869  | )          | (113,295  | )          |
|                               |       |      |       |      |       |
|                               |       | $         | 1,495,401  |      | $          | 1,472,995 |   |

 
| **Inventories** | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|-----------------|------------|-----------|------------|-----------|------------|
|            |       |      |       |      |       |
| Raw materials   |       | $         | 97,074     |      | $          | 377,961 |   |
| Work-in-process |       | 216,324   |       | 529,668   |       |
| Finished goods  |       | 2,205,300 |       | 1,874,984 |       |
|            |       |      |       |      |       |
|            |       | $         | 2,518,698  |      | $          | 2,782,613 |   |

 
| **Property, Plant and Equipment,  Net**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|
|                                      |       |       |       |       |       |
| Land                                      |       | $          | 182,000    |       | $          | 182,000 |   |
| Building                                  |       | 1,251,601  |       | 1,251,601  |       |
| Machinery and equipment                   |       | 1,593,132  |       | 1,558,442  |       |
| Furniture and fixtures                    |       | 229,814    |       | 182,243    |       |
| Tooling                                   |       | 116,363    |       | 116,363    |       |
| Software                                  |       | 147,332    |       | 146,159    |       |
|                                      |       |       |       |       |       |
|                                      |       | 3,520,242  |       | 3,438,808  |       |
|                                      |       |       |       |       |       |
| Accumulated depreciation and amortization |       | (2,384,624 | )          | (2,070,568 | )          |
|                                      |       |       |       |       |       |
|                                      |       | $          | 1,135,618  |       | $          | 1,368,240 |   |

 

**4.****         Return of Inventory**

 

During the quarter ended July 31, 2002, the Company obtainedinventories from two former international distributors.  The heart valveswere sold to these customers during fiscal year 2000 and the first half offiscal year 2001.  Due to financial difficulties experienced by thesedistributors, the Company provided allowances for the remaining uncollectedaccounts receivable balances in fiscal years 2001 and 2002.  The Companydid not anticipate the return of these products at the time the uncollectibleaccounts were established.  Upon obtaining title to the heart valves fromthese former distributors during the quarter ended July 31, 2002, the Companyincreased its 

 

40

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inventories and recorded arecovery of its prior provision for doubtful accounts which reduced its generaland administrative costs for the year ended April 30, 2003, by $92,000representing the cost of the returned inventories.

 

**5.         Debtwith Related Parties and Note Payable**

 

**Debt with Related Parties:**

** **

In January 2003, the Company established a discretionary line of creditwith PKM Properties, LLC (PKM), an entity controlled by Paul K. Miller.  Mr. Miller serves on the Company’s Board ofDirectors and is its largest shareholder. This line of credit was initially scheduled to mature on April 17,2003.  On April 15, 2003, the maturitydate was extended to September 17, 2003. As of April 30, 2004 and 2003, theCompany had borrowed $943,333 under the line of credit.  In addition, the Company incurred directfinancing costs of $67,828, which were amortized to interest expense over theoriginal three-month term of the line of credit.  The line of credit bore interest at thehigher of 7 percent or 1 percent above a bank reference rate (7 percent as ofApril 30, 2003). The Company issued  PKMa second mortgage on the Company’s real estate and a security interest in allremaining assets of the Company.  In October2003, the Company amended the discretionary line of credit with PKM originallyestablished in January 2003 to extend the maturity date to May 27, 2004, and toincrease the interest rate to a fixed rate of 10 percent.  Additionally, on February 3, 2004, thematurity date of the line of credit was extended to June 30, 2005.  In connection with the original line ofcredit, the Company issued a warrant to PKM with a five-year term to purchase350,000 shares of the Company’s common stock at an exercise price of $0.596 pershare.  The fair value of the warrants of$128,995 was amortized to interest expense over the original three-month termof the line of credit.

 

On July 8, 2003, the Company entered into a $1.0 million term debtagreement with PKM.  Pursuant to theagreement, the Company borrowed $764,728 during the first quarter of fiscalyear 2003 and borrowed the final draw of $235,272 on August 20, 2003.  The debt, which is collateralized bysubstantially all of the Company’s assets, bears interest at a rate of 10percent per year,  with an originalmaturity date of May 27, 2004.  Inconnection with the first quarter borrowings, the Company issued a warrant toPKM with a ten-year term for the purchase of 320,178 shares of the Company’scommon stock at an exercise price of $0.70 per share.  The Company also issued a warrant to purchasean additional 60,179 shares of the Company’s common stock on the same terms inconjunction with the final draw on August 20, 2003.  In connection with this financing, on July 8,2003, the Company agreed to extend the term of 700,000 previously issued warrantsfrom five years to ten years.  Theallocated fair value of the warrants issued prior to July 31, 2003, and theincremental value of the existing warrants was $383,361, and has been reportedas a discount on the borrowings under the term debt.  This discount, which was presented as areduction of the carrying value of the debt on the consolidated balance sheet,was being amortized as interest expense over the eleven-month term of the debt.In addition, the Company incurred direct and incremental costs of $65,000 incompleting the debt arrangement, which were included in deferred financingcosts and were being amortized as interest expense over the originaleleven-month term of the debt.  OnFebruary 3, 2004, the maturity date of the term debt was extended to June 30,2005.  In connection with the extension,the Company issued a warrant to PKM with a ten-year term for the purchase of330,933 shares of the Company’s common stock at an exercise price of $2.00 pershare. The fair value of the warrants issued was $598,179..

 

In November 2003, the Company amended the one-year $1.0 millionterm debt agreement with PKM, initiated on July 8, 2003, to provide for anadditional $500,000 of borrowings with the same terms as the July 8, 2003financing.  The Company issued, as additional consideration, a ten-yearwarrant to purchase up to 77,381 shares of common stock at an exercise price of$1.68 per share with terms and conditions that include weighted-averageanti-dilution rights.  The allocated fair value of the newly-issuedwarrant was $63,365 and is accounted for as a discount on the borrowings underthe term debt.  This discount was amortized as interest expense over theremaining term of the debt.  As of April 30, 2004, the discount was fullyamortized.

 

On July 8, 2003, theCompany also entered into a $1.0 million term debt agreement with Peter L.Hauser (“Hauser”), a principal shareholder.  The Company borrowed $1.0million under this bridge financing during the quarter ended July 31,2003.  The debt, which is collateralized by substantially all of theCompany’s assets pursuant to an intercreditor agreement with PKM, bearsinterest at a rate of 10 percent per year and had a maturity date ofJune 30, 2004.  In connection with the term debt, the Company alsoissued a warrant with a ten-year term to

 

41

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purchase up to 380,357 shares of the Company’s common stock at anexercise price of $0.70 per share.  Theallocated fair value of the warrant was $281,706 and was accounted for as adiscount on the borrowings under the term debt. This discount, which was presented as a reduction of the carrying valueof the debt on the consolidated balance sheet was being amortized as interestexpense over the original twelve-month term of the debt.  In addition, the Company incurred direct andincremental costs of $71,772 in completing the debt arrangement, which wereincluded in deferred financing costs and were being amortized as interestexpenses over the original twelve-month term of the debt. On February 3, 2004,the maturity date of the term debt was extended to June 30, 2005. In connectionwith the extension, the Company issued a warrant to Hauser with a ten-year termfor the purchase of 136,000 shares of the Company’s common stock at an exerciseprice of $2.00 per share. The fair value of the warrants issued was $245,845.

 

The extensions of the maturity dates of the term debt issued to PKM andHauser as described above was accounted for as an extinguishment of debt inaccordance with EITF 96-19 “Debtor’s Accounting for a Modification or Exchangeof Debt Instruments”.  Accordingly,unamortized discounts aggregating $391,789 and the fair value of the warrantsissued in connection with the maturity date extensions, amounting to $844,024,were included in the Company’s determination of the debt extinguishment lossrecorded in the fourth quarter of fiscal year 2004. The $1,235,813 aggregateloss from these transactions, accounted for as an extinguishment of debt, isincluded in other expenses, net in the consolidated statement of operations forthe year ended April 30, 2004.

 

**Note Payable:**

 

In November 2003, the Company also entered into a loan agreementand borrowed $500,000 from Draft Co. (“Draft”), pursuant to a note that maturedon June 30, 2004, which bore interest at an annual rate of 10percent.  Pursuant to an amended intercreditor agreement among PKM,Hauser, and Draft, the loan was collateralized by substantially all of theCompany’s assets.  The Company issued the lender warrants to purchase upto 90,909 shares of common stock at an exercise price of $1.43 per share withother terms comparable to the warrants issued to PKM as described above. Theallocated fair value of the newly issued warrants was $100,056 and wasaccounted for as a discount on the borrowings under the term debt.  Thisdiscount, which is presented as a reduction of the carrying value of the debton the consolidated balance sheet is being amortized as interest expense overthe seven-month term of the debt.  As of April 30, 2004, the unamortizedbalance of the discount was $14,292.  In addition, the Company incurreddirect and incremental costs of $31,850 in completing the debt arrangement,which are included in deferred financing costs and are being amortized as interestexpenses over the term of the debt.  Thenote was repaid in June of 2004.

 

The Company determined the fair value of allwarrants described above using the Black Scholes option pricing model and thevolatility, dividend yield and risk-free interest rate assumptions identifiedin Note 9 over the term of the applicable warrant and using a risk-freeinterest rate commensurate with that term.

 

**6.         RelatedParty Lease Obligation**

 

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

 

In connection with the transaction, the Company received totalconsideration of $3.84 million consisting of (1) $1.0 million in cash, (ii)PKM’s assumption of the Company’s $2.5 million outstanding indebtedness toAssociated Bank, and (iii) PKM’s assumption of the Company’s promissory notewith Dakota Electric Association and land special assessments payable to DakotaCounty aggregating $336,105.  Also inconnection with the transaction, the Company issued to PKM a five-year warrantfor the purchase of 350,000 shares of the Company’s common stock at an exerciseprice of $0.625 per share.  Thesewarrants had an allocated fair value of $89,602.  TheCompany determined the fair value of the warrants using the Black Scholesoption pricing model and the volatility and dividend yield assumptionsidentified in Note 9 over the five-year term and using a risk-free interestrate commensurate with that term.

 

Simultaneous with the sale of the facility, the Company entered into alease with PKM to lease back the facility and a portion of the land.  Thelease has a ten-year initial term with options for the Company to extend thelease up to

 

42

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ten additional years.  Under certain conditions, the Company alsohas an option to purchase the building at the end of the initial ten-year termat the fair value at that time.

 

Due to the Company’s continued involvement with the property includingthe ability to buy back the property at a future date, the transaction isaccounted for as a financing of the property sold and leased back. Accordingly, the net book value of the facility and land sold to PKM with a netbook value of $707,015 (gross value of $1,433,601 net of accumulateddepreciation of $726,586) continues to be presented as part of the Company’sproperty, plant and equipment balance (see Note 3).  The related partylease obligation of $3,455,420 represents the minimum amounts due PKM for theinitial ten year term discounted at 4.4 percent and additional payments to bepaid to PKM for the Dakota Electric Association and Dakota County obligationsassumed by PKM.

 

Scheduled maturities of the related party lease obligation are asfollows:

 
| **Year Ending April 30,** | ** ** | **Amount** | ** ** |
|---------------------------|------------|------------|------------|
|                      |       |       |       |
| 2005                      |       | $          | 288,995    |   |
| 2006                      |       | 311,155    |       |
| 2007                      |       | 324,183    |       |
| 2008                      |       | 334,784    |       |
| 2009                      |       | 366,198    |       |
| Thereafter                |       | 1,830,105  |       |
|                      |       | $          | 3,455,420  |   |

 

**7.****         Leases**

 

**Operating Leases**

 

The Company leased certain manufacturing equipment under variousoperating lease agreements which expired at various dates in fiscal year2004.  At the end of the lease terms, the Company exercised its option toreturn the equipment.

 

Rental expense under operating leases was $6,502 and $21,935 in fiscalyears 2004 and 2003, respectively.

 

**Capital Leases**

 

The Company leased certain manufacturing equipment under variouscapital leases.  The equipment was leasedunder agreements expiring through fiscal year 2004 with implicit interest ratesranging from 8.9 percent to 10 percent. At the end of the lease term, the Company elected to purchase theequipment under bargain purchase options. The leases were collateralized by the underlying equipment with a totalcost of $181,420 and accumulated amortization of $156,234 and $125,998 at April30, 2004 and 2003, respectively.

 

As of April 30, 2004, the Company had no remaining lease payments dueunder capital lease obligations.

 

43

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**8.****         Income Taxes**

 

The components of deferred income taxes at April 30 are as follows:

 
| ** **                                         | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|
|                                               |       |       |       |       |       |
| Federal net operating loss carryforwards           |       | 7,022,085  |       | $          | 4,706,100  |   |
| Research and experimentation credit  carryforwards |       | 466,533    |       | 524,200    |       |
| State net operating loss carryforwards             |       | 300,032    |       | 243,400    |       |
| Other carryforwards                                |       | 12,696     |       | 76,700     |       |
| Inventories                                        |       | 96,045     |       | 57,200     |       |
| Allowance for uncollectible accounts               |       | 37,033     |       | 118,400    |       |
| Property, plant and equipment                      |       | (289,293   | )          | 80,600     |       |
| Accrued expenses and other                         |       | 14,609     |       | 15,300     |       |
|                                               |       |       |       |       |       |
| Total deferred tax assets                          |       | 7,659,740  |       | 5,821,900  |       |
|                                               |       |       |       |       |       |
| Valuation allowance                                |       | (7,659,740 | )          | (5,821,900 | )          |
|                                               |       |       |       |       |       |
| Net deferred tax asset                             |       | $          | —     |       | $          | — |   |
|                                                    |            |            |            |            |            |  |  |

 

The Company has established valuation allowances to fully offset taxassets due to uncertainty about the Company’s ability to generate the futuretaxable income necessary to realize these deferred tax assets, particularly inlight of the Company’s recent history of significant operating losses.  Inaddition, future utilization of available net operating loss carryforwards maybe limited under Internal Revenue Code Section 382 as a result of changes inownership that have or may result from the issuance of common stock or commonstock options and warrants.

 

The Company’s federal net operating loss carryforwards of approximately$19,505,792 and state net operating loss carryforwards of $5,636,061 expire invarious fiscal years from 2014 through 2024.  Available research andexperimentation credit carryforwards at April 30, 2004 represent federal andstate amounts of $354,603 and $111,930, respectively, with expiration dates infiscal years 2010 through 2021.

 

**9.****         Shareholders’ Equity (Deficit)**

 

**Common Stock**

 

On November 27, 2001, the Company closed on its initial public offering. In connection with the initial public offering, the Company issued 1,500,000units at a price of $4.50 per unit for gross proceeds of $6,750,000. After offering costs, the Company received net proceeds of $5,396,485. Each unit consisted of one share of common stock and one redeemable Class AWarrant.  Each Class A Warrant became exercisable and separable from thecommon stock on May 20, 2003.  The holder of each Class A Warrant isentitled to purchase, at any time until November 20, 2004, one share of commonstock at an exercise price of $6.50 per share, subject to customaryanti-dilution adjustments.  The Company may redeem the Class A Warrantsfor $0.01 per warrant at any time, upon ten business days’ written notice, ifthe closing price of the Company’s common stock or units exceeds $8.50, subjectto customary anti-dilution adjustments, for any ten consecutive trading daysbefore such notice.

 

During the fourth quarter of fiscal year 2004 the Company closed on theprivate sale of 1,189,863 units for $1.47 per unit.  Each unit consisted of one share of commonstock and one five-year warrant to purchase a common share for $1.60 pershare.  Proceeds from the offering, netof offering costs of $190,675, were $1,558,424. In addition to cash commissions included in the offering costs, theCompany issued to the private placement agents 190,378 five-year warrants topurchase common stock for $1.8375 per share.

 

44

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

 

In September of 2003, the Company sold 85,714 shares of common stock tothe Chairman of the Board for $0.70 per share. The excess of the fair value of these shares over the selling price ($63,428) has been reported as an operating expense for the year ended April 30,2004.

 

As discussed in Note 10, during the year ended April 30, 2004 theCompany issued 15,000 shares of common stock in connection with a technologypurchase agreement.

 

**Stock Options**

 

The Company's shareholders have authorized the issuance of stockoptions for the aggregate purchase of 2,744,861 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 not less than fair market value at thedate of grant.  Options generally become exercisable between one to threeyears after grant date and have a maximum term of three to ten years dependingon the plan.

 

The following is a summary of stock option activity with respect to theCompany’s various plans and includes option activity for employees, directorsand non-employees:

 
| ** **                  | ** ** | **Options** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** |
|-----------------------------|------------|-------------|------------|--------------------------------------------------|------------|
|                        |       |        |       |                                             |       |
| 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   |       | $                                                | 3.46       |   |
|                        |       |        |       |                                             |       |
| Granted                     |       | 260,127     |       | 1.28                                             |       |
| Expired                     |       | (94,340     | )          | 5.00                                             |       |
|                        |       |        |       |                                             |       |
| Outstanding, April 30, 2004 |       | 1,251,727   |       | $                                                | 2.65       |   |

 

At April 30, 2004 and 2003, 944,768 and 603,034 options, respectively,were available for grant under the Company’s stock option plans.  OnAugust 9, 2001, the Company’s shareholders approved the 2001 Equity IncentivePlan (2001 Plan) and reserved 500,000 shares of common stock for issuance uponexercise of stock options to be granted under the 2001 Plan to employees,officers, consultants, advisors, employee and non-employee directors andemployees of certain related entities.  The number of shares reserved forissuance under the 2001 Plan increases on January 1 of each year by the greaterof 50,000 shares or 3.5 percent of the outstanding shares of the Company’scommon stock on such date, unless the Board of Directors sets the increase at alower number of shares.  On January 1, 2004 and 2003, the number of sharesavailable under the 2001 Plan increased by 279,827 shares and 274,534 shares,respectively, pursuant to the foregoing provision.

 

45

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The following table summarizes information about stock options outstandingand exercisable at April 30, 2004:

 
| ** **                     | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                     | ** ** |
|--------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|
| **Range  of  Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                           |       |                    |       |                                                        |       |   |   |   |   |   |   |
| $0.30 – $1.76             |       | 353,143                 |       | 7.30                                                        |       | $ | 0.92 |   | 219,021 |   | $ | 1.10 |   |
| $2.16 – $5.00             |       | 898,584                 |       | 3.14                                                        |       | $ | 3.32 |   | 681,284 |   | $ | 3.53 |   |
|                           |       | 1,251,727               |       |                                                        |       |   |   | 900,305 |   |   |   |

 

During the years ended April 30, 2004 and 2003, the Company issued fourand ten-year options to purchase an aggregate of 167,643 and 42,500 shares ofthe Company’s common stock at exercise prices of $0.30 to $1.68 and $0.51 to$0.87 per share, respectively, to certain non-employees who provided technicaladvisory services to the Company.  The aggregate fair value of the optionsusing the Black-Scholes valuation model was $189,312 and $20,329 and were fullyexpensed in fiscal years 2004 and 2003.  The following assumptions wereused to value the options for the years ended April 30, 2004 and 2003:

 
| ** **              | ** ** | **2004**      | ** ** | **2003**      | ** ** |
|-------------------------|------------|---------------|------------|---------------|------------|
| Dividend yield rate     |       | 0 percent     |       | 0 percent     |       |
| Risk free interest rate |       | 3.80 percent  |       | 3.26 percent  |       |
| Expected life           |       | 5 to 10 years |       | 4 to 10 years |       |
| Volatility              |       | 118 percent   |       | 85 percent    |       |

 

The Company is amortizing thisdeferred compensation over the vesting periods of the related stock options,which generally 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 $2,677 and $4,452 was recognized during the years ended April 30, 2004and 2003.

 

The Company used theBlack-Scholes option pricing model and the following assumptions for purposesof measuring the fair value of stock options issued to employees as disclosedin Note 1 to the Consolidated financial statements for the years ended April30, 2004 and 2003:

 
| ** **              | ** ** | **2004**      | ** ** | **2003**      | ** ** |
|-------------------------|------------|---------------|------------|---------------|------------|
| Dividend yield rate     |       | 0 percent     |       | 0 percent     |       |
| Risk free interest rate |       | 3.80 percent  |       | 3.26 percent  |       |
| Expected life           |       | 5 to 10 years |       | 4 to 10 years |       |
| Volatility              |       | 118 percent   |       | 85 percent    |       |

 

**Stock Warrants**

 

At April 30, 2004 and 2003, the Company had outstanding and exercisablewarrants to purchase 6,241,178 and 3,440,000 shares, respectively, of theCompany’s common stock at prices ranging from $0.60 to $6.75 per share.  The warrants expire at various dates throughFebruary 3, 2014.  At April 30, 2004 and2003, the weighted average remaining contractual life of the warrants was 4.77and 1.68 years and the weighted average exercise price of the warrants was$3.27 and $4.58, respectively.

 

As discussed above under “Common Stock” during the fourth quarter offiscal year 2004, the Company issued 1,189,863 warrants to purchase commonstock to investors and issued 190,378 warrants to purchase common stock toagents of the Company’s private placement.

 

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As discussed in Note 5, theCompany issued to certain lenders and a lessor, warrants to purchase 1,395,937common shares during the year ended April 30, 2004 and warrants to purchase 700,000common shares during the year ended April 30, 2003.

 

As discussed in Note 10, duringthe year ended April 30, 2004, the Company issued a seven-year warrant topurchase 25,000 shares of common stock in connection with a technology purchaseagreement.

 

**10.          AtrialFibrillation Technology Purchase Agreement**

 

The Company entered into an agreement with LightWave Ablation Systems,Inc. (“LightWave”) in August 2003 to purchase technology for the treatment ofatrial fibrillation.  Upon closing, theCompany issued 15,000 shares of common stock and a seven-year warrant topurchase up to 25,000 shares of common stock for $1.46 per share, and made aninitial payment of $10,000 to LightWave for the worldwide technologydistribution rights.  The Company made anadditional payment of $15,000 in the fourth quarter of fiscal year 2004 whenLightWave achieved certain U.S. regulatory milestones.  The Company is obligated to pay LightWave anadditional $15,000 in April 2005, or earlier if the Company achieves certainEuropean regulatory approvals.  Inaddition, the Company is required to pay up to an additional $510,000 and toissue warrants to purchase up to an additional 75,000 common shares at $1.46per share in the event that the Company meets certain development and salesmilestones related to the acquired technology. The Company has recorded a research and development charge of $83,930 inthe fiscal year ended April 30, 2004, to reflect the fair value of the commonshares issued, the cash issued and issuable and the fair value of the commonstock and warrants issued to LightWave. At April 30, 2004, the accrued future cash payments of $15,000 areincluded in accrued expenses.

 

**11.       Researchand Development Costs**

 

Research and Development costs principally consist of engineeringcosts, included as part of engineering and regulatory in the ConsolidatedStatement of Operations, totaled $762,525 and $558,141 for the fiscal yearsended April 30, 2004 and 2003, respectively.  Research and Developmentcosts relate primarily to product and process development initiatives.

 

**12.       SupplyAgreement**

 

In July 1998, the Company entered into a three-year supply agreementwith Snia S.p.A. Carbomedics, Inc. (“Carbomedics”), the source of certain rawmaterial components associated with the manufacture of certain of the Company’sheart valves.  The supply agreement was extended for an additional twoyears in March 2001, and expired December 31, 2003.

 

This agreement provided that the Company purchase a minimum number ofraw material units each calendar year 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 hasnot met the minimum purchase requirement for the last four calendaryears.  As a result, the Company expensed $147,434 and $138,738 related tothese purchase shortfalls to cost of goods sold in fiscal years 2004 and 2003,respectively.  This agreement was notrenewed by the Company following its expiration in December 2003.

 

**13.       Segmentand Related Party Information**

 

The Company views its operations and manages its business as onesegment, the manufacturing and marketing of cardiothoracic surgerydevices.  Factors used to identify the Company’s single operating segmentinclude the organizational structure of the Company and the financialinformation available for evaluation by the chief operating decision maker. Thefollowing table summarizes net sales by geographic area:

 

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| ** **    | ** ** | **For the Years Ended  April 30,** | ** ** |
|---------------|------------|------------------------------------|------------|
| ** **    | ** ** | **2004**                           | ** ** | **2003** | ** ** |
|          |       |                               |       |   |   |
| Europe        |       | $                                  | 1,462,385  |   | $ | 1,471,015 |   |
| South Asia    |       | 479,035                            |       | 414,455 |   |
| Middle East   |       | 463,382                            |       | 342,585 |   |
| Far East      |       | 48,854                             |       | 60,348 |   |
| Other         |       | 316,341                            |       | 40,960 |   |
| United States |       | 640,978                            |       | 248,700 |   |
| Total         |       | $                                  | 3, 410,975 |   | $ | 2,578,063 |   |

 

At April 30, 2004 and 2003, substantially all of the Company’soperations and assets were based in the United States.

 

The Company distributes its products primarily through distributororganizations that, in turn, market the product directly to medicalinstitutions.  One of these distributors is a shareholder of the Companywith an ownership interest of approximately 6.6 percent.  An affiliate ofthis shareholder distributor is also a member of the Company’s Board ofDirectors.  Sales to distributors that individually account for 10 percentor more of the Company’s net sales in each respective fiscal year are asfollows:

 
| ** **                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Distributor #1 (shareholder) |       | $        | 1,002,622  |     | $          | 762,842 |   |
| Distributor #2               |       | 351,641  |       | 319,985  |       |
| Distributor #3               |       | 348,555  |       | 347,085  |       |
| Distributor #4               |       | 198,600  |       | 319,000  |       |
|                              |            |          |            |          |            |  |  |

 

Accounts receivable from distributor #1 at April 30, 2004 and 2003,totaled $533,402 and $557,899, respectively.

 

**14.       Spin-offof UROPACE**

 

On November 1, 2000, the Company completed the spin-off of UROPACE,Inc. (UROPACE), a subsidiary of the Company, to the existing shareholders ofthe Company.

 

As a part of this spin-off, the Company agreed to loan UROPACE up to$356,250 at a variable interest rate. Principal and interest on the note was payable in installments equal to5 percent of UROPACE’s future annual net sales until the note and interest waspaid in full.  The Company had loanedUROPACE $235,000 at April 30, 2003.  Dueto the development stage of UROPACE and the uncertainty associated with thecollection of this amount, the Company recorded an allowance for the entirebalance of the loan during the year ended April 30, 2003, and wrote off theentire balance during the year ended April 30, 2004.

 

**15.       Savingsand Retirement Plan**

 

The Company sponsors a 401(k) savings and retirement plan (the Plan)which is available to all eligible employees.  Under the Plan, the Companymay make a discretionary contribution to the Plan upon approval by theCompany’s Board of Directors.  Employees are fully vested in their owncontributions and earnings thereon and become fully vested in the Company’scontributions and earnings thereon after three years of service.  TheCompany made contributions to the Plan of $19,662 and $21,504 in fiscal years2004 and 2003, respectively.

 

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**16.       SubsequentEvent-Equity sale**

 

On May 21, 2004, the Company closed on the private sale of units, eachconsisting of one share of common stock and one warrant to purchase one shareof common stock.  For a price of $1.47per unit, the Company issued 1,540,900 shares of common stock and 1,540,900 fiveyear warrants for the purchase of common shares of stock at $1.60 per share.  Gross proceeds totaled $2,265,123.  In connection with this sale, the Companyissued to the agent a five year warrant to purchase 123,272 units at anexercise price of $1.8375 per unit, and the Company paid the agent a cashcommission of $181,210, and an expense allowance of $67,954.  The warrants underlying the unit warrantsissued to the agent are exercisable for a period of five years at an exerciseprice of $1.8375 per share.

 

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**ITEM8****                                                        CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

Not applicable.

 

**ITEM 8A****                                               CONTROLSAND PROCEDURES**

 

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

 

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

 

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**PART III**

 

**ITEM 9****                                       ****DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT;COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT**

 

As of July 23, 2004, our directors and executiveofficers were as follows:

 
| **Name**                          | ** ** | **Age** | ** ** | **Principal  Occupation**                                                          | ** ** | **Position  with MedicalCV**                                    | ** ** | **Director  Since** |
|-----------------------------------|------------|---------|------------|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------|
| Lawrence L. Horsch                |       | 69      |       | Chairman of the Board and Acting Chief Executive  Officer of MedicalCV, Inc.       |       | Chairman of the Board and Acting Chief Executive  Officer       |       | 2003                |
| Susan L. Critzer                  |       | 48      |       | Chief Executive Officer and Chief Financial  Officer of Restore Medical, Inc.      |       | Director                                                        |       | 2002                |
| David B. Kaysen                   |       | 54      |       | President and Chief Executive Officer of  Diametrics Medical, Inc.                 |       | Director                                                        |       | 2002                |
| Salvador Mercé Cervelló |       | 46      |       | Managing and General Director of Mercé v.  Electromedicina, S.L.              |       | Director                                                        |       | 1996                |
| Adel A. Mikhail, Ph.D.            |       | 69      |       | Technology Consultant                                                              |       | Director                                                        |       | 1992                |
| Paul K. Miller                    |       | 81      |       | President of Acton Construction Management  Company                                |       | Director                                                        |       | 1994                |
| John H. Jungbauer                 |       | 55      |       | Vice President, Finance, Chief Financial Officer  and Secretary of MedicalCV, Inc. |       | Vice President, Finance, Chief Financial Officer  and Secretary |       | N/A                 |
| Richard W. Kramp                  |       | 59      |       | President and Chief Operating Officer of  MedicalCV, Inc.                          |       | President and Chief Operating Officer                           |       | N/A                 |

 

Board of Directors

 

*LawrenceL. Horsch*, who became our Acting Chief Executive Officer inApril 2004, became one of our directors and Chairman of the Board in August2003.  He served as a director of BostonScientific Corporation from February 1995 to May 2003.  He was one of the founding directors ofSciMed Life Systems, Inc. and served as Chairman of the Board from 1977 to1994, and Acting Chief Financial Officer from 1994 to 1995.  Since 1990, Mr. Horsch has served as Chairmanof Eagle Management & Financial Corp., a management consulting firm.  Mr. Horsch has been involved as a director orconsultant to numerous early-stage companies in the Twin Cities area and has beena member of the University of St. Thomas MBA adjunct faculty since 1979.  Mr. Horsch currently serves as a director ofLeuthold Funds, Inc., a registered investment company.

 

*Susan L.Critzer*, one of our directors since August 2002, hasserved as Chief Executive Officer and Chief Financial Officer of RestoreMedical, Inc., a company focused on products for the ear, nose and throatfield, since June 2002.  From January2001 to June 2002, Ms. Critzer served as Chief Operating Officer of VenturiDevelopment Group, an incubator focused on seed level medical deviceopportunities.  Ms. Critzer has over 25years of experience in general management, manufacturing, quality assurance,engineering, and product development. Prior to joining Venturi, Ms. Critzer served as Vice President,Operations, Interim President and Acting Chief Financial Officer and Presidentand Chief Executive Officer of Integ Incorporated, a development stage glucosemonitoring company that went public in 1996 and was acquired by InvernessMedical in early 2001.  Before joiningInteg, Ms. Critzer served in various management roles at the Davis + GeckDivision of American Cyanamid Corp., Deseret Medical Inc. and Becton-DickinsonCorp.  From September 1973 to April 1986,Ms. Critzer was a manufacturing superintendent and senior administrator formanufacturing at the Saginaw Division of General Motors Corp.

 

*David B.Kaysen*, one of our directors since August 2002, serves asPresident, Chief Executive Officer and a director of Diametrics Medical, Inc.,a company that develops, manufactures and commercializes blood and tissue

 

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analysissystems that provide diagnostic results at the point of patient care.  Mr. Kaysen has more than 25 years ofexecutive management and sales and marketing experience in the medical productsand services industry, most recently serving 10 years as President, ChiefExecutive Officer and a director of Rehabilicare Inc. (now Compex Technologies,Inc.), a manufacturer and marketer of home electrotherapy equipment for thephysical therapy, rehabilitation, occupational and sports medicinemarkets.  From 1988 to 1989, Mr. Kaysenserved as President, Chief Executive Officer and a director of Surgidyne, Inc.(now Sterion, Inc.).  Mr. Kaysen has alsoheld senior management positions in sales and marketing at several medicalproduct and services companies, including Redline Healthcare, American HospitalSupply Corporation, Emeritus Corporation and Lectec/NDM Corporation.  Mr. Kaysen currently serves as a director ofZevex International, Inc., a publicly held company engaged in the business ofdesigning, manufacturing and distributing medical devices.

 

*SalvadorMercé Cervelló*, one of our directors, serves as Managing andGeneral Director of Mercé V. Electromedicina, S.L., a commercial supplier ofelectromedical products, mainly products for cardiac surgery and cardiology,including those produced by our company, in Spain.  He served on our board from November 1993 toNovember 1995 and again from December 1996 through the present.

 

*Adel A.Mikhail, Ph.D*., served as President and Chief Executive Officerof our company from March 1992 to June 2001, and Chairman of the Board fromMarch 1992 to August 2003.  Since June2001, he has provided certain consulting services to our company.  Dr. Mikhail has more than 29 years ofexperience in the mechanical heart valve industry, including 17 years with ourpredecessors, Medical Incorporated and Omnicor. Dr. Mikhail served such entities in several technical capacities,including Senior Vice President of Clinical Research and Regulatory Affairs.

 

*Paul K.Miller* has been one our directors since August 1994.  Mr. Miller has served as President of ActonConstruction Management Company, a real estate management company, since1980.  Mr. Miller has, over the course ofhis business career, been the President and majority shareholder of variouscompanies with offices in Minnesota and Texas which have been engaged in theconstruction of municipal waste water projects throughout the central UnitedStates and in the acquisition and management of real estate investments.  He is a significant investor and director ofa number of development stage companies and has served as a bondholdersrepresentative on the creditors committees of several publicly held companies.

 

Executive Officers

 

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

 

**AuditCommittee Financial Expert**

 

Our board of directors has determined that Susan L.Critzer is an “audit committee financial expert” as defined in Item 401(e) ofRegulation S-B.

 

**Code of Ethics**

 

We have adopted a Code of Ethics that is applicableto all of our employees, officers (including our principal executive officer,principal financial officer, principal accounting officer or controller, andpersons performing similar functions) and directors.  Our Code of Ethicssatisfies the requirements of Item 406(b) of Regulation S-B.  Our Code of Ethics is posted on our internetwebsite at www.medcvinc.com and is available, free of charge, upon writtenrequest to our Chief Financial Officer at MedicalCV, Inc., 9725 South RobertTrail, Inver Grove Heights, MN 55077.  We intend to disclose any amendments to or waivers from a provision ofour Code of Ethics that requires disclosure on our website at www.medcvinc.com.

 

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Section 16(a) Beneficial Ownership ReportingCompliance

 

Section 16(a) of theExchange Act requires our officers, directors and persons who own more than 10%of a registered class of our equity securities to file reports of ownership andchanges in ownership with the SEC.  Suchofficers, directors and shareholders are required by the SEC to furnish us withcopies of all such reports.  To ourknowledge, based solely on a review of copies of reports filed with the SECduring the last fiscal year, all applicable Section 16(a) filing requirementswere met, except that (i) one report on Form 4 setting forth the May 14, 2003purchase and sale of 2,000 shares of common stock by Dr. Richard A. DeWall, aformer director of our Company, (ii) one report on Form 4 setting forth theJuly 8, 2003 issuance of a warrant to purchase common stock in the amount of320,178 shares to PKM Properties, LLC, an entity over which Paul K. Miller, oneof our directors, exercises control, (iii) one report on Form 4 setting forththe August 20, 2003 issuance of a warrant to purchase common stock in theamount of 60,179 shares to PKM Properties, LLC, an entity over which Mr. Millerexercises control, and (iv) one report on Form 4 setting forth the November 11,2003 grant of a stock option for the purchase of 44,643 shares to Lawrence L.Horsch, our Chairman of the Board and Acting Chief Executive Officer, were notfiled on a timely basis.

 

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**ITEM 10****                EXECUTIVECOMPENSATION**

 

Thefollowing table sets forth information with respect to compensation paid by usto our Acting Chief Executive Officer and the other highest paid executiveofficers (the “Named Executive Officers”) during our most recent fiscalyear.  As noted below, Messrs. Mowery,Seck and Fisher have each resigned from their positions at our company.

 

SUMMARYCOMPENSATION TABLE

 
| ** **                       | ** ** | ** **       | ** ** | **Annual  Compensation** | ** ** | **Long-Term  Compensation  Awards** | ** ** | ** **                           | ** ** |
|----------------------------------|------------|------------------|------------|--------------------------|------------|-------------------------------------|------------|--------------------------------------|------------|
| **Name and Principal  Position** | ** ** | **Fiscal  Year** | ** ** | **Salary  ($)**          | ** ** | **Bonus  ($)**                      | ** ** | **Other  Annual  Compensation  ($)** | ** ** | **Securities  Underlying   Options** | ** ** | **All  Other  Compensation  ($) (1)** | ** ** |
| ** **                       | ** ** | ** **       | ** ** | ** **               | ** ** | ** **                          | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lawrence L. Horsch (2)           |       | 2004             |       | 0                        |       | 0                                   |       | 41,985                               | (3)        | 144,643 | (3) | 0 |   |
| Acting Chief                     |       | 2003             |       | 0                        |       | 0                                   |       | 0                                    |       | 18,000 | (4) | 0 |   |
| Executive Officer                |       | 2002             |       | 0                        |       | 0                                   |       | 0                                    |       | 0 |   | 0 |   |
|                             |       |             |       |                     |       |                                |       |                                 |       |   |   |   |   |
| Blair P. Mowery (5)              |       | 2004             |       | 165,006                  |       | 0                                   |       | 0                                    |       | 0 |   | 10,245 |   |
| Former President,                |       | 2003             |       | 164,372                  |       | 0                                   |       | 0                                    |       | 0 |   | 9,861 |   |
| Heart Valve Division             |       | 2002             |       | 170,298                  |       | 50,000                              |       | 0                                    |       | 300,000 |   | 0 |   |
|                             |       |             |       |                     |       |                                |       |                                 |       |   |   |   |   |
| Allan R. Seck (6)                |       | 2004             |       | 144,438                  |       | 0                                   |       | 0                                    |       | 0 |   | 2,304 |   |
| Former Vice President -          |       | 2003             |       | 143,568                  |       | 0                                   |       | 0                                    |       | 0 |   | 2,304 |   |
| Business Development             |       | 2002             |       | 139,775                  |       | 0                                   |       | 0                                    |       | 0 |   | 0 |   |
|                             |       |             |       |                     |       |                                |       |                                 |       |   |   |   |   |
| Jules L. Fisher (7)              |       | 2004             |       | 125,081                  |       | 0                                   |       | 0                                    |       | 0 |   | 1,997 |   |
| Former Chief                     |       | 2003             |       | 155,002                  |       | 0                                   |       | 0                                    |       | 0 |   | 2,155 |   |
| Financial Officer                |       | 2002             |       | 72,852                   |       | 0                                   |       | 0                                    |       | 76,000 |   | 0 |   |

 

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(1)                        Representsthe dollar value of insurance premiums paid by our company with respect to termlife insurance for the benefit of the Named Executive Officer.

(2)                        Mr.Horsch became our Acting Chief Executive Officer on April 19, 2004.

(3)                        Representsconsideration paid for consulting services provided by Mr. Horsch pursuant to aletter agreement described in Certain Relationships and Related Transactions.

(4)                        Representsconsideration paid for advisory services provided by Mr. Horsch pursuant to anadvisory agreement described in Certain Relationships and Related Transactions.  Following Mr. Horsch’s appointment asChairman of the Board, this advisory agreement terminated and vesting on thisoption ceased.  At that time, the optionhad vested to the extent of 9,000 shares.

(5)                        Mr.Mowery, who became President of ourHeart Valve Division in April 2004, formerly served as**our President and Chief ExecutiveOfficer from June 2001 to April 2004.  Heresigned from his positions at our company in July 2004.

(6)                        Mr. Seck,who became Vice President, Business Development in June 2004, formerly servedas Senior Vice President, Sales and Marketing from March 2001 to June2004.  He resigned from his position atour company in July 2004.

(7)                        Mr.Fisher, who became our Chief Financial Officer on December 17, 2001, resignedfrom his position our company in February 2004.

 

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OPTIONGRANTS IN LAST FISCAL YEAR

 

Thefollowing table sets forth information concerning grants of stock optionsduring the fiscal year ended April 30, 2004 to each Named ExecutiveOfficer.  We granted no stockappreciation rights during our last fiscal year.

 
| ** **         | ** ** | **Individual  Grants**                                   | ** ** |
|--------------------|------------|----------------------------------------------------------|------------|
| **Name**           | ** ** | **Number  of  Securities  Underlying  Options  Granted** | ** ** | **Percent  of Total  Options  Granted to  Employees in  Fiscal Year** | ** ** | **Exercise  Price  ($/share)** | ** ** | **Expiration  Date** | ** ** |
| ** **         | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lawrence L. Horsch |       | 100,000                                                  |       | 37.0 | % | 0.70 |   | 8/19/2013 |   |
|               |       | 44,643                                                   |       | 16.5 | % | 1.68 |   | 11/11/2013 |   |
| Blair P. Mowery    |       | 0                                                        |       | 0 | % | N/A |   | N/A |   |
| Allan R. Seck      |       | 0                                                        |       | 0 | % | N/A |   | N/A |   |
| Jules L. Fisher    |       | 0                                                        |       | 0 | % | N/A |   | N/A |   |

 

Thefollowing table sets forth information concerning the options exercised by eachNamed Executive Officer during the fiscal year ended April 30, 2004.  It also sets forth information concerningunexercised options held by such persons as of April 30, 2004.  No stock appreciation rights were exercisedby such persons during the last fiscal year or were outstanding at the end ofthat year.

 

AGGREGATEDOPTION EXERCISES IN LAST FISCAL YEARAND FISCAL YEAR END OPTION VALUES

 
| **Name**                                                                      | ** ** | **Shares  Acquired  on Exercise**                                       | ** ** | **Value  Realized  ($)** |       | ** **        | ** ** | ** ** |   |
|-------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|--------------------------|------------|-------------------|------------|------------|--------|
| **Number  of Securities  Underlying Unexercised Options  at Fiscal Year End** | ** ** | **Value  of Unexercised In the  Money Options at Fiscal Year  End (1)** |
| **Exercisable**                                                               | ** ** | **Unexercisable**                                                       | ** ** | **Exercisable**          | ** ** | **Unexercisable** |
| ** **                                                                    | ** ** | ** **                                                              | ** ** | ** **               |       |              |       |       |   |   |   |   |   |
| Lawrence  L. Horsch                                                           | ** ** | 0                                                                       |       | N/A                      |       | 86,977            |       | 66,666     |   | $ | 35,577 |   | $ | 53,333 |   |
| Blair P. Mowery                                                               |       | 0                                                                       |       | N/A                      |       | 300,000           |       | 0          |   | 0 |   | N/A |   |
| Allan R. Seck                                                                 |       | 0                                                                       |       | N/A                      |       | 80,000            |       | 20,000     |   | 0 |   | 0 |   |
| Jules L. Fisher                                                               |       | 0                                                                       |       | N/A                      |       | 19,000            |       | 57,000     |   | 0 |   | 0 |   |
|                                                                               |            |                                                                         |            |                          |            |                   |            |            |        |  |  |  |  |  |  |

 

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(1)                                  Representsthe fair market value of one publicly traded unit at April 30, 2004 minus theper share exercise price of the option to purchase shares of common stock.

 

Employment Agreements

 

Under aletter agreement effective April 16, 2004, Blair P. Mowery resigned from hisposition as our President and Chief Executive Officer and became President ofour Heart Valve Division.  This agreementprovided that Mr. Mowery’s employment would continue on an at-will basis, thathis salary would remain at $165,000 per year, and that Mr. Mowery would remainon the Board of Directors until a new Chief Executive Officer is hired, afterwhich Mr. Mowery would resign as a member of the Board.  The agreement provided that if Mr. Moweryremained in the position of President of the Heart Valve Division until the newChief Executive Officer is hired and thereafter decided to leave the company,he would receive one year’s severance, including regular pay and fringebenefits.  The agreement further providedthat in the event the company should sell its Heart Valve Division after thearrival of a new Chief Executive Officer, Mr. Mowery would be paid a bonus tobe determined by the compensation committee.

 

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In July2004, Mr. Mowery resigned from his position as President of our Heart ValveDivision.  He also resigned from ourboard of directors.  Pursuant to theterms of his severance agreement, Mr. Mowery will be paid one year’s severance,including regular pay and fringe benefits. He has also agreed to certain non-compete terms.  In addition, we have agreed to issue afive-year option to Mr. Mowery for the purchase of 25,000 shares of our commonstock at an exercise price of $1.50 per share.

 

In May1999, we entered into a letter agreement with Allan R. Seck.  Under this agreement, Mr. Seck wasemployed to serve as our Vice President - Sales and Marketing at a salary of$132,000 per year plus a bonus of one percent of sales over $3,500,000 peryear.  We retained the right to terminateMr. Seck’s employment at will. However, upon a change in control of our company, we agreed to pay himan amount equal to two years’ salary and accelerate the vesting of Mr. Seck’sunvested stock options to be immediately exercisable.  In consideration of Mr. Seck’s entry intothis agreement, we granted him a stock options to purchase 100,000 shares ofour common stock at a price of $2.50 per share. Such options vest over four years and expire on July 26, 2005.  In March 2001, Mr. Seck became Senior VicePresident, Sales and Marketing.  In August2001, we amended our agreement with Mr. Seck to provide that the bonus based onannual sales would be payable only through fiscal year 2002.  In consideration of Mr. Seck’s entry intothis amendment, we agreed to increase his salary by an amount not to exceed 15percent and develop a new executive and sales incentive plan in which he wouldbe eligible to participate.  In June2004, Mr. Seck became Vice President, Business Development.

 

In July2004, Mr. Seck resigned from his position as Vice President, BusinessDevelopment.  Pursuant to the terms ofhis severance agreement, Mr. Seck will be paid 10 weeks’ severance, includingregular pay and fringe benefits.  He hasalso agreed to certain non-compete terms.

 

We havealso entered into various agreements with Lawrence L. Horsch, our Acting ChiefExecutive Officer and Chairman of the Board. For more information about these agreements, please review “CertainRelationships and Related Transactions.”

 

**Director Compensation**

 

Ourdirectors are reimbursed for certain reasonable expenses incurred in attendingboard meetings.  Directors who are alsoemployees receive no remuneration for services as members of the board or anyboard committee.  Through the end ofcalendar year 2003, under our 1993 director stock option plan, directors whoare not employed by us were entitled to receive automatic annual stock optiongrants for the purchase of 7,000 shares.

 

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

 

Thefollowing table sets forth certain information known to us regarding beneficialownership of our common stock as of July 23, 2004, by:  (a) each person who is known to us to ownbeneficially more than five percent of our common stock, (b) each director, (c)each Named Executive Officer (as defined herein), and (d) all executiveofficers and directors as a group.  Thepercentage of beneficial ownership is based on 10,730,833 shares outstanding asof July 23, 2004.  As indicated in thefootnotes, shares issuable pursuant to warrants and options are deemedoutstanding for computing the percentage of the person holding such warrants oroptions but are not deemed outstanding for computing the percentage of anyother person.  Unless otherwise noted,each person identified below has sole voting and investment power with respectto such shares.  Except as otherwisenoted below, we know of no agreements among our shareholders which relate tovoting or investment power with respect to our common stock.  Unless otherwise indicated, the address foreach listed shareholder is c/o MedicalCV, Inc., 9725 South Robert Trail, InverGrove Heights, Minnesota 55077. 

 
| **Name and Address of Beneficial Owner (1)**                             | ** ** | **Number  of  Shares  Beneficially  Owned (1)** | ** ** | **Percent  Beneficially  Owned (1)** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------|------------|
| Paul K. Miller                                                           |       | 3,320,251                                       | (2)        | 26.7                                 | %          |
| Perkins Capital  Management, Inc.                                        |       | 1,660,000                                       | (3)        | 14.6                                 | %          |
| 730 East Lake Street                                                     |       |                                            |       |                                 |       |
| Wayzata, MN 55391                                                        |       |                                            |       |                                 |       |
| Peter L. Hauser                                                          |       | 1,005,557                                       | (4)        | 8.6                                  | %          |
| 16913  Kings Court                                                       |       |                                            |       |                                 |       |
| Lakeville,  Minnesota 55044                                              |       |                                            |       |                                 |       |
| Adel A.  Mikhail, Ph.D.                                                  |       | 760,552                                         | (5)        | 6.9                                  | %          |
| Graphite Enterprise Trust  PLC                                           |       | 630,000                                         | (6)        | 5.9                                  | %          |
| 4th Floor,  Berkeley Square House                                        |       |                                            |       |                                 |       |
| Berkeley Square, London  W1X 5PA                                         |       |                                            |       |                                 |       |
| United Kingdom                                                           |       |                                            |       |                                 |       |
| Blair P. Mowery (7)                                                      |       | 315,000                                         | (8)        | 2.9                                  | %          |
| Lawrence L. Horsch                                                       |       | 232,690                                         | (9)        | 2.2                                  | %          |
| Salvador Mercé Cervelló                                        |       | 133,000                                         | (10)       | 1.2                                  | %          |
| Allan R. Seck (11)                                                       |       | 110,000                                         | (12)       | 1.0                                  | %          |
| Susan L. Critzer                                                         |       | 14,000                                          | (13)       | *                                    |       |
| David B. Kaysen                                                          |       | 14,000                                          | (13)       | *                                    |       |
| Jules L. Fisher (14)                                                     |       | 0                                               | (13)       | —                               |       |
| All  current directors and executive officers as a group (eight persons) |       | 4,524,493                                       | (15)       | 35.0                                 | %          |

 

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*                      Less thanone percent.

 

(1)               Beneficialownership is determined in accordance with the rules of the Securities andExchange Commission and includes voting or investment power with respect tosecurities.  Securities “beneficiallyowned” by a person may include securities owned by or for, among others, thespouse, children, or certain other relatives of such person as well as othersecurities as to which the person has or shares voting or investment power orhas the option or right to acquire within 60 days of July 23, 2004.

(2)               Represents(a) 1,367,580 shares, (b) 120,000 shares owned by Gracon Contracting Co., anentity over which Mr. Miller exercises control, (c) 35,000 shares purchasablepursuant to the exercise of options, (d) 100,000 shares purchasable pursuant tothe exercise of warrants, (e) 1,488,671 shares purchasable pursuant to theexercise of warrants held by PKM Properties, LLC, an entity over which Mr.Miller exercises control, (f)

 

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4,500units owned by Mr. Miller’s spouse, and (g) 100,000 units.  Each such unit consists of one share ofcommon stock and one Class A Warrant to purchase one share of common stock.

(3)               Includes615,000 shares purchasable pursuant to the exercise of warrants.

(4)               Represents(a) 53,000 shares, (b) 37,500 units purchasable upon the exercise of warrants,(c) 516,357 shares purchasable upon the exercise of warrants, and (d) 180,600units held by Mr. Hauser’s IRA.  Eachunit consists of one share of common stock and one Class A Warrant to purchaseone share of common stock.

(5)               Represents499,552 shares held by Adel A. Mikhail and Narguis Mikhail, Dr. Mikhail’sspouse, as joint tenants, 240,000 shares purchasable pursuant to the exerciseof warrants and 21,000 shares purchasable pursuant to the exercise of options.

(6)               Includes126,000 shares held by Graphite Enterprise Trust Limited Partnership, an entityover which Foreign & Colonial Enterprise Trust PLC exercises control.

(7)               Mr.Mowery resigned as President, Heart Valve Division in July 2004.

(8)               Includes300,000 shares purchasable pursuant to the exercise of options.

(9)               Represents(a) 115,714 shares, (b) 30,000 shares purchasable pursuant to the exercise ofwarrants, and (c) 86,976 shares, purchasable pursuant to the exercise ofoptions.

(10)         Includes28,000 shares purchasable pursuant to the exercise of options.  Mr. Mercé Cervelló is the Managing andGeneral Director of Mercé v. Electromedicina, S.L.

(11)         Mr. Seckresigned as Vice President, Business Development in July 2004.

(12)         Includes100,000 shares purchasable pursuant to the exercise of options.

(13)         Representsshares purchasable pursuant to the exercise of options.

(14)         Mr. Fisherresigned as our Chief Financial Officer in February 2004.

(15)         Includes198,976 shares purchasable pursuant to the exercise of options and 1,988,171shares purchasable pursuant to the exercise of warrants.

 

Certainshares, options, and warrants beneficially owned by our officers, directors,former directors, significant shareholders, and employees are subject to anescrow agreement with the Commissioner of Commerce for the State ofMinnesota.  The depositors, who placed anaggregate of 1,664,845 shares into escrow, entered into this escrow agreementas a condition of the registration of the units sold in our initial publicoffering.  The term of escrow runsthrough November 20, 2004.

 

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Equity Compensation 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**     |       | 1,151,727                                                                                                 |       | $                                                                                        | 2.81       |                                                                                                                                                         | 664,941    | (1) |
| **Equity compensation plans not approved by  security holders** |       | 3,151,315                                                                                                 | (2)        | $                                                                                        | 1.78       |                                                                                                                                                         | 0          |   |
| **Total**                                                       |       | 4,303,042                                                                                                 |       | $                                                                                        | 2.05       |                                                                                                                                                         | 664,941    |   |

 

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(1)                                  Represents2,500 shares remaining available for future issuance under our 1997 StockOption Plan and 662,441 shares remaining available for future issuance underour 2001 Equity Incentive Plan.

(2)                                  Represents(a) 350,000 shares of common stock underlying a five-year warrant exercisableat $0.596 per share issued to Paul K. Miller in connection with a line ofcredit with PKM Properties, which warrant expires January 17, 2008, (b) 350,000shares of common stock underlying a five-year warrant exercisable at $0.6275per share issued to Paul K. Miller in connection with a sale-leasebacktransaction entered into on April 4, 2003, which warrants expire on April 4,2008, (c) 100,000 shares of common stock underlying a seven-year warrant exercisableat $2.95 per share issued to Segmed Inc. in connection with a purchase oftechnology, which warrants expire on August 7, 2009, (d) 240,000 shares ofcommon stock underlying a five-year warrant exercisable at $2.125 per shareissued to Adel A. Mikhail, Ph.D., a director and our former chief executiveofficer, on February 2, 2001, pursuant to a severance and consulting agreementdated November 1, 2000, (e) an aggregate of 100,000 shares of common stockunderlying warrants exercisable at $2.00 per share issued to Paul K. Miller, adirector, on November 22, 1999 and December 6, 2000, in connection with Mr.Miller’s guarantee of a bank loan, both of which warrants expire on November19, 2004, (f) 150,000 units underlying a warrant exercisable at $6.75 per unitissued to Equity Securities Investments, Inc. on November 20, 2001, inconnection with its services as underwriter of our initial public offering, (g)380,357 shares of common stock underlying a ten-year warrant exercisable at$0.70 per share issued to Peter L. Hauser in connection with a July 2003financing with Mr. Hauser, (h) 380,357 shares of common stock underlying aten-year warrant exercisable at $0.70 per share issued to PKM in connectionwith a July 2003 financing with PKM, (i) 25,000 shares of common stockunderlying a seven-year warrant exercisable at $1.46 issued to LightWaveAblation Systems, Inc. in connection with a purchase of technology, whichwarrant expires on August 27, 2010, (j) 77,381 shares of common stockexercisable at $1.68 underlying a ten-year warrant issued to PKM in connectionwith an amendment to our financing with PKM, which warrant expires on November13, 2013, (k) 90,909 shares of common stock exercisable at $1.43 underlying aten-year warrant issued to Draft Co. in consideration of a loan agreement withDraft Co., which warrant expires on November 24, 2013, (l) 330,933 shares ofcommon stock exercisable at $2.00 underlying a ten-year warrant issued to PKMin connection with an extension of the maturity date of the JanuaryDiscretionary Credit Agreement, which warrant expires on February 3,

 

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2014, (m) 136,000 shares ofcommon stock exercisable at $2.00 underlying a ten-year warrant issued to PeterL. Hauser in connection with the extension of the maturity date of the $1.0million financing provided by Mr. Hauser, which warrant expires February 3,2014, (n) 95,189 units underlying a five-year warrant exercisable at $1.8375per unit issued to our finder in connection with its services in our 2004private placement, each unit consisting of one share of common stock and awarrant to purchase a share of our common stock at $1.8375 per share, and (o)100,000 shares of common stock underlying a stock option exercisable at $0.70per share granted to Lawrence L. Horsch in August 2003.

 

**ITEM 12****                             ****CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

*Agreements with Lawrence L. Horsch*

 

In February 2003, we enteredinto an advisory agreement with Lawrence L. Horsch, who became one of our directorsand Chairman of the Board in August 2003 and our Acting Chief Executive Officerin April 2004.  Pursuant to thisagreement, Mr. Horsch agreed to provide 10 hours of advisory services permonth, for a retainer of $750 per month. As additional consideration, we issued a five-year option to Mr. Horschfor the purchase of 18,000 shares of common stock exercisable at $0.51 pershare.  Such option vested to the extentof 1,500 shares per month during the term of the advisory agreement.  Mr. Horsch began providing advisory servicesto us under this agreement on February 18, 2003.  Following his appointment as Chairman of theBoard, we agreed with Mr. Horsch to terminate the advisory agreement.  At the termination of the advisory agreement,Mr. Horsch had been paid $4,500 in advisory fees and the option granted to Mr.Horsch had vested to the extent of 9,000 shares.

 

Effective August 19, 2003,upon the termination of the advisory agreement, we entered into a letteragreement with Mr. Horsch to address our relationship with him as Chairman ofthe Board.  Pursuant to this agreement,Mr. Horsch agreed to provide 32 hours of service per month as Chairman of theBoard, for a retainer of $60,000 per year. Pursuant to the agreement, Mr. Horsch agreed to purchase 85,714 sharesof common stock from our company at a price of $0.70 per share.  As additional consideration, we issued aten-year option to Mr. Horsch for the purchase of 100,000 shares of commonstock exercisable at $0.70 per share. Such option vests in full upon the fourth anniversary of the date ofgrant. ** **Thisvesting may be accelerated to the extent of one-third of the shares purchasableunder the option upon the occurrence of each of three performancemeasures:  the completion of certainadditional debt or equity financing, certain advances in product developmentand achievement of certain stock performance. The agreement provides for a term of 12 months; however, it may beterminated if our board of directors determines to remove Mr. Horsch asChairman of the Board.

 

OnApril 16, 2004, we entered into an arrangement with Mr. Horsch to compensatehim for the extra hours he has worked and will be working beyond the 32 hoursper month agreed upon in the August 19, 2003 letter agreement.   Pursuant to this arrangement, Mr. Horschwill be granted ten-year options to purchase shares of common stock exercisableat $1.67 per share.  The number of sharesof common stock purchasable pursuant to the options will be the value of thehours (at $156.25 per hour) divided by .30 with the result divided by theexercise price.  As of April 30, 2004, nooptions had been issued to Mr. Horsch under this arrangement.

 

*Separation Agreement with Adel A. Mikhail, Ph.D.*

 

In November 2000, we enteredinto a separation agreement and release with Adel A. Mikhail, Ph.D.  Dr. Mikhail was our founder and served as ourPresident and Chief Executive Officer from March 1992 until June 2001, at whichtime he retired.  Among other things, theseparation agreement provided that following the termination of his employmentas President and Chief Executive Officer, we would retain Dr. Mikhail as anindependent consultant for a period of two years to provide advice andtechnical expertise with respect to our operations.  Dr. Mikhail agreed to provide up to 40 hoursof consulting services per month, for a retainer of $6,000 per month.  We agreed to pay Dr. Mikhail at the rate of$125 per hour, up to a maximum of $1,000 per day, for services rendered beyond40 hours per month.  Dr. Mikhail beganproviding consulting services to us under this agreement in June 2001.  During our fiscal year ended April 30, 2003,we paid Dr. Mikhail $74,385 in consulting fees.

 

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In June 2003, upon theexpiration of the consulting arrangement set forth in the separation agreement,we entered into a technical assistance agreement with Dr. Mikhail.  Pursuant to this agreement, Dr. Mikhailagreed to continue performing consulting services as an independent contractorin exchange for the same compensation set forth in the separationagreement.  During our fiscal year endedApril 30, 2004, we paid Dr. Mikhail $ 72,000 in technical assistance fees.

 

*Arrangements and Transactions with Paul K. Miller and PKMProperties, LLC*

 

*JanuaryDiscretionary Credit Agreement*.  In January 2003, we requiredfunding to meet critical working capital shortages.  To address these needs we established adiscretionary line of credit with PKM, pursuant to which we borrowed anaggregate of $943,666.  The line ofcredit initially had a maturity date of April 17, 2003.  On April 15, 2003, the maturity date wasextended to September 17, 2003.  The lineof credit requires the payment of interest at the higher of 7 percent or 1percent above a bank reference rate (7 percent was the rate in effect as ofApril 30, 2003).  In October 2003, theCompany amended the discretionary line of credit with PKM established inJanuary 2003 to extend the maturity date and increase the interest rate to 10percent.  The line of credit containsvarious representations and loan covenants as are customary in banking andfinance transactions.  In connection withthe January Discretionary Credit Agreement, PKM was issued a second mortgage onour real estate and a security interest in all of our remaining assets,including inventory, equipment, accounts and contract rights, instruments,deposits and intangibles, including patents and trademarks.  As additional consideration, we also issuedto PKM a warrant with a five-year term to purchase 350,000 shares of our commonstock at an exercise price of $0.596 per share. In February 2004, the maturity date of this loan was extended to June30, 2005.  As of May 31, 2004, PKM hadadvanced $943,333 under the January Discretionary Credit Agreement.

 

*FinancingTransaction*.  On April 4, 2003, we sold our real estate,including real property and office-warehouse-manufacturing facility, togetherwith certain personal property related thereto, to PKM.  The purchase price for the property was $3.84million, paid with (1) $1.0 million in cash (subject to certain reductions,prorations and credits), (2) PKM’s assumption of a mortgage note against theproperty in the amount of $2.5 million in favor of Associated Bank Minnesota,dated November 23, 1999, and (iii) PKM’s assumption of our promissory note withDakota Electric Association and land special assessments payable to DakotaCounty aggregating $336,105.  Asadditional consideration, we issued to PKM a five-year warrant for the purchaseof 350,000 shares of our common stock at an exercise price of $0.625 per share.

 

Concurrent with the sale ofthe property, we entered into a ten-year lease for the property with a base annualrent of $360,000 for the first and second year; $370,800 per year for thethird, fourth and fifth year, and $389,340 for the remaining years of the leasesubject to an increase for additional interest payable by PKM on its long-termpermanent financing of the property, which may increase base monthly rents byup to one-twelfth of the additional annual interest payable by PKM.  Assuming we are not in default under theterms of the lease, we have two options to extend the lease for five-yearperiods upon expiration of the initial ten-year term at a market rate.  We also pay under the lease operating costsand real estate taxes.  Under certainconditions, we also have an option to purchase the building at the end of theinitial ten-year term at the fair value at that time.  The purpose of the transaction was to retireour bank debt and provide us with additional required working capital.

 

*DiscretionaryCredit Agreement*.  In July 2003, we entered into an additionaldiscretionary credit agreement with PKM, pursuant to which PKM agreed to lendto us up to an additional $935,000.  Werequired additional funding to meet ongoing working capital needs, including tomeet obligations to PKM under the above-described January Discretionary CreditAgreement and facilities lease.  Theinterest rate is 10 percent per year. The line of credit contains various representations and loan covenantsas are customary in banking and finance transactions and is secured by asecurity interest in substantially all of our remaining property, includinginventory, equipment, accounts and contract rights, instruments, deposits andintangibles, including patents and trademarks.

 

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As additional consideration,we agreed to issue PKM ten-year warrants for the purchase of up to 380,357shares of our common stock at an exercise price of $0.70 per share with termsand conditions that include weighted-average anti-dilution rights and providecertain rights to PKM to require registration of the common stock underlyingthe warrants under federal and state securities laws.  We also agreed to modify certain terms of thewarrants issued to PKM in connection with the January Discretionary CreditAgreement to conform to the terms of the warrants issued as part of this bridgedebt financing.  We also agreed to payPKM a placement fee of 6.5 percent of the amount borrowed under the CreditAgreement.  In addition, we paid counselfor PKM approximately $56,000 to cover fees and expenses incurred on behalf of PKMin connection with the Credit Agreement. The Credit Agreement is a discretionary credit facility.  PKM may, in its sole discretion, decide notto make any additional loans under the May Credit Agreement, and is notcontractually obligated to do so.  InNovember 2003, the Company amended the $1.0 million term debt with PKMinitiated on July 3, 2003, to provide for an additional $500,000 of borrowingunder the same terms as the July 8, 2003 financing.  The Company issued, as additionalconsideration, ten-year warrants to purchase up to 77,381 shares of commonstock at an exercise price of $1.68 per share with terms and conditions thatinclude weighted-average anti-dilution rights. In February 2004, the maturity date of this loan was extended to June30, 2005.  In conjunction with theextension, the Company issued a warrant with a ten year term to purchase up to330,933 shares of the Company's common stock at an exercise price of $2.00 pershare.

 

*April2004 Short-Term Loan. *In April 2004, we issued a short-termpromissory note to PKM in the principal amount of $150,000.  The note required the payment of interest ata rate of 10 percent per year.  We repaidsuch note in full during April 2004.

 

*Transaction with Peter L. Hauser*

 

In July 2003, we entered intoa loan agreement and borrowed $1.0 million from Peter L. Hauser, an existingshareholder, pursuant to a subordinated note with an interest rate of 10percent per year.  Pursuant to anintercreditor agreement with PKM, the loan is secured by substantially all ofour assets.  We issued to Mr. Hauserten-year warrants for the purchase of 380,357 shares of our common stock onterms comparable to the warrants issued to PKM in connection with theDiscretionary Credit Agreement. Following this transaction, Mr. Hauser became the beneficial owner ofover 10 percent of our securities.  InFebruary 2004, the maturity date of this loan was extended to June 30,2005.  In connection with the extension,the Company issued a warrant with a ten-year term to purchase up to 136,000shares of the Company’s common stock at an exercise price of $2.00 per share.

 

*Loan from Allan R. Seck*

 

In December 2002, wereceived a $60,000 unsecured advance from Allan R. Seck, our Senior VicePresident — Sales and Marketing, to fund working capital requirements.  This note required us to pay interest at therate of six percent per year.  This loanwas repaid in full in early April 2003.

 

*Related**Party**Distributor*

 

We sell heart valves througha distribution network of approximately 37 exclusive distributors,including Mercé v. Electromedicina, S.L. The Managing and General Director of Mercé v. Electromedicina, SalvadorMercé Cervelló, is one of our board members. During the fiscal years ended April 30, 2004 and 2003, such distributormade net purchases of product from our company equal to approximately 29.4percent and 29.6 percent of our net sales, respectively.  Our accounts receivable with this distributoraccounted for approximately 35.7 and 37.9 percent of our accounts receivable atApril 30, 2004 and 2003, respectively. Obligations to us from our distributors are unsecured.  Distributors could fail to pay receivables orcease distributing our products at any time, thereby materially and adverselyaffecting our business, financial condition, operating results and cashflows.  We anticipate that we willcontinue to do business with Mercé v. Electromedicina in future periods.

 

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*General*

 

The transactions set forthherein were approved by a majority of our independent, disinterested directorswho had access, at our expense, to our legal counsel or independent legalcounsel.  We believe that all suchtransactions were made on terms no less favorable to us than we could haveobtained from unaffiliated third parties. In the future, all material affiliated transactions will be approved bya majority of our independent, disinterested directors who will have access, atour expense, to our legal counsel or independent legal counsel and will be on termsno less favorable to us than we could obtain from unaffiliated third parties.

 
| **ITEM 13** |   | **EXHIBITS, LIST AND REPORTS ON FORM 8-K**                                                                                                                                                                                                                                                                                                           |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| (a)         |   | Exhibits                                                                                                                                                                                                                                                                                                                                             |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
|        |   | See  “Index to Exhibits.”                                                                                                                                                                                                                                                                                                                  |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| (b)         |   | Reports  on Form 8-K                                                                                                                                                                                                                                                                                                                                 |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
|        |   | On March 23, 2004, we filed a Current Report on Form 8-K relating (1)  to our filing of a 510(k) application with the U.S. Food and Drug  Administration for the Atrilaze TM Soft Tissue Ablation System and (2) our  release of material non-public information relating to our results of  operations for a completed quarterly fiscal period. |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| **ITEM 14** |   | **PRINCIPAL ACCOUNTANT  FEES AND SERVICES**                                                                                                                                                                                                                                                                                                          |

 

**Audit andNon-Audit Fees**

 

The following table presentsfees for audit and other services provided by PricewaterhouseCoopers LLP forthe years ended April 30, 2004 and 2003.

 
| ** **             | ** ** | **Year Ended**     | ** ** |
|------------------------|------------|--------------------|------------|
| ** **             | ** ** | **April 30, 2004** | ** ** | **April 30, 2003** | ** ** |
|                   |       |               |       |   |   |
| Audit fees (1)         |       | $                  | 109,980    |   | $ | 74,738 |   |
| Audit-related fees (2) |       | 12,078             |       | 900 |   |
| Tax fees (3)           |       | —             |       | — |   |
| All other fees         |       | —             |       | — |   |
| Total Fees             |       | $                  | 122,058    |   | $ | 75,638 |   |

 

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(1) Audit fees consist offees for services provided in connection with the audit of our financialstatements and reviews of our quarterly financial statements.

 

(2) Audit-related feesconsist of assurance and related services that include, but are not limited to,internal control reviews, attest services not required by statute or regulationand consultation concerning financial accounting and reporting standards.

 

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(3) PricewaterhouseCoopersLLP provided us no tax compliance, tax advice, or tax planning services.

 

Pre-Approval Policies and Procedures

 

 

Allservices provided by our independent auditors, PricewaterhouseCoopers LLP, aresubject to pre-approval by our Audit Committee. The Audit Committee hasauthorized each of its members to approve services by ourindependent auditors in the event there is aneed for such approval prior to the next full Audit Committee meeting.  Any interim approval given by an AuditCommittee member must be reported to the Audit Committee no later than its nextscheduled meeting. Before granting any approval, the Audit Committee (or acommittee member if applicable) gives due consideration to whether approval ofthe proposed service will have a detrimental impact on ourauditor's independence. The AuditCommittee pre-approved all services provided by PricewaterhouseCoopers LLP infiscal 2004.

 

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**SIGNATURES**

 

Inaccordance with Section 13 or 15(d) of the Exchange Act, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized, in the City of Inver Grove Heights, State ofMinnesota, on July 29, 2004.

 
|   | MedicalCV,  Inc. |
|--------|------------------|
|   |             |   |
|   | By               | /s/  Lawrence L. Horsch |
|   |             | Lawrence  L. Horsch |
|   |             | Chairman  of the Board and Acting Chief  Executive Officer  (Principal Executive Officer) |

 

**POWER OF ATTORNEY**

 

KNOW ALL BY THESE PRESENT, thateach person whose signature appears below constitutes and appoints Lawrence L.Horsch and John H. Jungbauer as his or her true and lawful attorney-in-fact andagent, with full powers of substitution and resubstitution, for him or her andin his or her name, place and stead, in any and all capacities, to sign any orall amendments to this report, and to file the same, with all exhibits thereto,and other documents in connection therewith, with the SEC, granting unto saidattorney-in-fact and agent, full power and authority to do and perform each andevery act and thing requisite or necessary to be done in and about thepremises, as fully to all intents and purposes as he or she might or could doin person, hereby ratifying and confirming all that said attorney-in-fact andagent, or her substitute or substitutes, may lawfully do or cause to be done byvirtue 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/ Lawrence L. Horsch |       |                                                   |       |          |
| Lawrence L. Horsch     |       | Chairman of the Board and Acting                       |       | July 29, 2004 |
|                   |       | Chief Executive Officer (Principal  Executive Officer) |       |          |
|                   |       |                                                   |       |          |
| /s/ John H. Jungbauer  |       |                                                   |       |          |
| John H. Jungbauer      |       | Chief Financial Officer (Principal                     |       | July 29, 2004 |
|                   |       | Accounting Officer and Principal  Financial Officer)   |       |          |
|                   |       |                                                   |       |          |
| /s/ Susan L. Critzer   |       |                                                   |       |          |
| Susan L. Critzer       |       | Director                                               |       | July 29, 2004 |
|                   |       |                                                   |       |          |
| /s/ David B. Kaysen    |       |                                                   |       |          |
| David B. Kaysen        |       | Director                                               |       | July 29, 2004 |

 

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| /s/ Salvador Mercé Cervellό |   |     |   |          |
|---------------------------------------|--------|----------|--------|---------------|
| Salvador Mercé Cervellό     |   | Director |   | July 29, 2004 |
|                                  |   |     |   |          |
| /s/ Adel A. Mikhail, Ph.D.            |   |     |   |          |
| Adel A. Mikhail, Ph.D.                |   | Director |   | July 29, 2004 |
|                                  |   |     |   |          |
| /s/ Paul K. Miller                    |   |     |   |          |
| Paul K. Miller                        |   | Director |   | July 29, 2004 |

 

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**INDEX TO 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                |       | 1992  Stock Option Plan (incorporated by reference to our Registration Statement on  Form SB-2, filed on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.2                |       | 1993  Director Stock Option Plan (incorporated by reference to our Registration  Statement on Form SB-2, filed on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.3                |       | 1997  Stock Option Plan (incorporated by reference to our Registration Statement on  Form SB-2, filed on August 31, 2001 (File No. 333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.4                |       | 2001  Equity Incentive Plan (incorporated by reference to our Registration  Statement on Form SB-2, filed on August 31, 2001 (File No.  333-68884)).                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.5                |       | Warrant  Agreement by and between the Registrant and 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)).                                                                                                                                                                                                                                                                                                                                                                      |
| 10.6                |       | 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)).                                                                                                                                                                                                                                                                                                                                                                      |
| 10.7                |       | 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)).                                                                                                                                                                                                                                                                                                                                                                       |
| 10.8                |       | 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)). |
| 10.9                |       | 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)).                                                                                                                                                                                                                                                                                                                                                         |
| 10.10               |       | 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))                                                                                                                                                                                                                                                                                                      |
| 10.11               |       | 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)).                                                                                                                                                                                                                                                                                                                                            |
| 10.12               |       | 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)).                                                                                                                                                                                                                                                                                                                                                                     |

 

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| 10.13 |   | 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)).                                                                    |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14 |   | 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)).                                   |
| 10.15 |   | 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)). |
| 10.16 |   | 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)).                                                        |
| 10.17 |   | 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)).                                                                                               |
| 10.18 |   | $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)).                                                                  |
| 10.19 |   | 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)).                 |
| 10.20 |   | 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)).                                               |
| 10.21 |   | 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)).                                                   |
| 10.22 |   | 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)).                                                                       |
| 10.23 |   | 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)).                                                                   |
| 10.24 |   | 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)).                                                                                    |
| 10.25 |   | Warrant  Agreement to purchase 320,178 shares of common stock issued by the Registrant  to PKM Properties, LLC, dated July 1, 2003 (incorporated by reference to our  Current Report on Form 8-K, filed July 14, 2003 (File No. 000-33295)).                                                   |
| 10.26 |   | Warrant  Agreement to purchase 60,179 shares of common stock issued by MedicalCV, Inc.  to PKM Properties, LLC, dated August 20, 2003 (incorporated by reference to  our Quarterly Report on Form 10-QSB filed on December 15, 2003 (File No.  000-33295)).                                    |
| 10.27 |   | Warrant  Agreement to purchase 77,381 shares of common stock issued by the Registrant  to PKM Properties, LLC, dated November 13, 2003 (incorporated by reference to  our Quarterly Report on Form 10-QSB filed on March 22, 2004 (File No.  000-33295)).                                      |
| 10.28 |   | Warrant  Agreement to purchase 136,000 shares of common stock issued by the Registrant  to Peter L. Hauser, dated February 3, 2004.                                                                                                                                                            |
| 10.29 |   | Warrant  Agreement to purchase 330,933 shares of common stock issued by the Registrant  to PKM Properties, LLC, dated February 3, 2004.                                                                                                                                                        |
| 10.30 |   | Letter  Agreement between the Registrant and Lawrence L. Horsch, dated effective  August 19, 2003.                                                                                                                                                                                             |

 

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| 10.31 |   | Non-Qualified  Stock Option Agreement issued issued by the Registrant to Lawrence L. Horsch  in the amount of 100,000 shares, dated August 19, 2003.                                                                              |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.32 |   | Purchase  Agreement between the Registrant and PKM Properties, LLC, dated April 4,  2003.                                                                                                                                         |
| 10.33 |   | Building  Lease Agreement between the Registrant and PKM Properties, LLC, dated April  4, 2003.                                                                                                                                   |
| 10.34 |   | Technology  Purchase Agreement between the Registrant and LightWave Ablation Systems,  Inc., Gregory Brucker and Robert Svenson M.D., dated August 27, 2003.                                                                      |
| 10.35 |   | Warrant  Agreement to purchase 25,000 shares of common stock issued by the Registrant  to LightWave Ablation Systems, Inc., dated August 27, 2003.                                                                                |
| 10.36 |   | Technology  Assignment Agreement between the Registrant, LightWave Ablation Systems,  Inc., Robert H. Svenson, M.D. and Gregory Brucker, dated August 27, 2003.                                                                   |
| 10.37 |   | Proprietary  Information and Inventions Agreement between the Registrant, Robert H.  Sevenson, M.D. and Gregory Brucker, dated August 10, 2003.                                                                                   |
| 10.38 |   | Technical  Assistance Agreement between the Registrant and Robert H. Svenson, M.D.,  dated August 7, 2003.                                                                                                                        |
| 10.39 |   | Technical  Assistance Agreement between the Registrant and Gregory Brucker, dated August  7, 2003.                                                                                                                                |
| 10.40 |   | Technical  Assistance Agreement between the Registrant and Adel Mikhail, Ph.D., dated  June 14, 2003.                                                                                                                             |
| 10.41 |   | Assignment  Agreement between the Registrant, Segmed, Inc. and William F. Northrup III,  M.D., dated August 7, 2002                                                                                                               |
| 10.42 |   | Technical  Assistance Agreement between the Registrant and William F. Northrup III, M.D.  dated August 7, 2002.                                                                                                                   |
| 10.43 |   | Warrant  Agreement to purchase up to 100,000 shares of common stock issued by the  Registrant to Segmed, Inc., dated August 7, 2002.                                                                                              |
| 10.44 |   | First  Amended and Restated Subordination and Intercreditor Agreement by and between  Peter L. Hauser, PKM Properties, LLC and Draft Co., accepted and acknowledged  by the Registrant dated November 24, 2003.                   |
| 10.45 |   | Amendment  No. 1 to First Amended and Restated Subordination and Intercreditor Agreement  by and between Peter L. Hauser, PKM Properties, LLC and Draft Co., accepted  and acknowledged by the Registrant dated January 29, 2004. |
| 23    |   | Consent  of Independent Auditors.                                                                                                                                                                                                 |
| 24    |   | Power  of Attorney (included on signature page).                                                                                                                                                                                  |
| 31.1  |   | Acting  Chief Executive Officer Certification pursuant to Rule 13a-14, as adopted  pursuant to the Sarbanes-Oxley Act of 2002.                                                                                                    |
| 31.2  |   | Chief  Financial Officer Certification pursuant to Rule 13a-14, as adopted pursuant  to the Sarbanes-Oxley Act of 2002.                                                                                                           |
| 32.1  |   | Acting  Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to the Sarbanes-Oxley Act of 2002.                                                                                         |
| 32.2  |   | Chief  Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to the Sarbanes-Oxley Act of 2002.                                                                                                |

 

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